UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

þANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year endedFiscal Year Ended December 31, 20042006
OR
o
oTRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___ to

___

Commission File Number 1-5823

CNA FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
   
Delaware
(State or other jurisdiction of
incorporation or organization)
 36-6169860
(I.R.S. Employer
Identification No.)
   
CNA Center333 S. Wabash
Chicago, Illinois

(Address of principal executive offices)
 6068560604
(Zip Code)

(312) 822-5000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
   
Title of each class Name of each exchange on
which registered
Title of each class which registered


Common Stock
with a par value
of $2.50 per share
 New York Stock Exchange
Chicago Stock Exchange
Pacific ExchangeNYSE Arca

Securities registered pursuant to Section 12(g) of the Act: None
None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yesþ Noo
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Act. Yeso Noþ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yesüþ No...

Noo

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S–KS-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10–K10-K or any amendment to this Form 10–K. [10-K.üo ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Act. (check one):
Large Accelerated Filerþ Accelerated Filero Non-Accelerated Filero
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yesüo No...

Noþ

As of February 21, 2005, 255,953,95816, 2007, 271,406,984 shares of common stock were outstanding. The aggregate market value of the common stock of CNA Financial Corporation held by non–affiliatesnon-affiliates of the registrant as of June 30, 20042006 was approximately $545$738 million based on the closing price of $24.59$32.96 per share of the common stock on the New York Stock Exchange on June 30, 2004.

2006.

DOCUMENTS INCORPORATED
BY REFERENCE:

Portions of the CNA Financial Corporation Proxy Statement prepared for the 20052007 annual meeting of shareholders, pursuant to Regulation 14A, are incorporated by reference into Part III of this Report.



 


         
Item   Page
Number
   Number
PART I
 1.    3 
 2.    11 
 3.    11 
 4.    11 
PART II
 5.    12 
 6.    14 
 7.    15 
 7A.    88 
 8.    94 
 9.    175 
 9A.    175 
 9B.    175 
PART III
 10.    176 
 11.    176 
 12.    177 
 13.    177 
 14.    177 
PART IV
 15.    178 
 By-Laws
 Employment Agreement with Michael Fusco
 Supplemental Executive Savings and Capital Accumulation Plan
 First Amendment to Supplemental Executive Savings and Capital Accumulation Plan
 Second Amendment to Supplemental Executive Savings and Capital Plan
 Board of Directors Term Sheet
 Primary Subsidiaries of CNAF
 Independent Auditors' Consent
 302 Certification
 302 Certification
 906 Certification
 906 Certification
       
Item   Page
Number   Number
     PART I
1.   3 
       
1A.   8 
       
1B.   15 
       
2.   15 
       
3.   15 
       
4.   15 
       
     PART II
5.   16 
       
6.   17 
       
7.   18 
       
7A.   60 
       
8.   65 
       
9.   139 
       
9A.   139 
       
9B.   139 
       
     PART III
10.   140 
       
11.   141 
       
12.   141 
       
13.   141 
       
14.   141 
       
     PART IV
15.   142 
 Certificate of Amendment of Certificate of Incorporation
 Amendment to Employment Agreement
 Significant Subsidiaries
 Consent of Independent Registered Public Accounting Firm
 Certification
 Certification
 Certification
 Certification

 


PART I

ITEM 1. BUSINESS

CNA Financial Corporation (CNAF) was incorporated in 1967 and is an insurance holding company. Collectively, CNAF and its subsidiaries are referred to as CNA or the Company. CNA’sReferences to “CNA,” “the Company,” “we,” “our,” “us” or like terms refer to the business of CNA and its subsidiaries. Our property and casualty insurance operations are conducted by Continental Casualty Company (CCC), incorporated in 1897, and its affiliates, and The Continental Insurance Company (CIC), organized in 1853, and its affiliates. CIC became an affiliatea subsidiary of the Companyours in 1995 as a result of the acquisition of The Continental Corporation (Continental). Life and group insurance operations, which were either sold or are being managed as a run-off operation, are conducted within CCC and Continental Assurance Company (CAC). Loews Corporation (Loews) owned approximately 91%89% of theour outstanding common stock and 100% of the Series H preferred stock of CNAF as of December 31, 2004.

CNA serves2006.

We serve a wide variety of customers, including small, medium and large businesses; associations; professionals;businesses, associations, professionals, and groups and individuals with a broad range of insurance and risk management products and services.

Insurance

Our insurance products primarily include property and casualty coverages. CNAOur services include risk management, information services, warranty and claims administration. CNAOur products and services are marketed through independent agents, brokers, managing general agents and direct sales.

During 2003, CNA completed a strategic review of its operations and decided to concentrate its efforts on the

Our core business, property and casualty business. As a result of this review, the following actions in relation to CNA’s insurance operations, were taken:

On April 30, 2004, CNA sold its individual life insurance business. The business sold included term, universal and permanent life insurance policies and individual annuity products. CNA’s individual long term care and structured settlement businesses were excluded from the sale. Consideration from the sale was approximately $700 million. CNA recorded a realized investment loss of $389 million after-tax ($622 million pretax) in 2004.

On December 31, 2003, CNA sold the majority of its group benefits business. The business sold included group life and accident, short and long term disability and certain other products. CNA’s group long term care and specialty medical businesses were excluded from the sale. Consideration from the sale was approximately $530 million, resulting in an after-tax realized investment loss on the sale of $122 million ($163 million pretax), including an after-tax realized investment gain of $8 million ($13 million pretax) recorded in the second quarter of 2004.

CNA is continuing to service its existing group and individual long term care commitments and is managing these businesses as a run-off operation.

During 2003, the Company sold the renewal rights for most of the treaty business of CNA Re and withdrew from the assumed reinsurance business. CNA is managing the run-off of its retained liabilities.

On August 1, 2004, CNA sold the retirement plan trust and recordkeeping business portfolio of CNA Trust to Union Bank of California. Consideration from the sale was approximately $12 million, resulting in an after-tax realized investment gain on the sale of $5 million ($9 million pretax). On November 19, 2004, the charter of CNA Trust was sold to Nevada Security Bank for a nominal fee and CNA Trust is no longer a subsidiary of CNA.

As a result of the strategic review described above, in 2004 CNA changed how it manages its core operations and makes business decisions. Accordingly, the Company revised its reportable business segment structure to reflect these changes. CNA’s core operations, property and casualty operations, are now reported in two business segments: Standard Lines and Specialty Lines. CNA’sOur non-core operations are managed in two segments: Life and Group Non-Core and Corporate and Other Non-Core. Prior period segment disclosures have been conformed to the current year presentation.

3


Standard Lines includes standard property and casualty coverages, excess and surplus lines, and insurance and risk management products. CNA Global (formerly included in Specialty Lines), which consists of marine and global standard lines, is included in Standard Lines.

Specialty Lines includes professional financial and specialty property and casualty products and services.

Life and Group Non-Core includes the results of the life and group lines of business which have been sold or placed in run-off. This segment also includes Life Operations and Group Operations (formerly separate reportable segments) and certain run-off life and group operations formerly included in the Corporate and Other segment.

Corporate and Other Non-Core includes the results of several property and casualty and other lines placed in run-off, including CNA Re (formerly a stand alone property and casualty segment), and CNA Guaranty and Credit (formerly included in Specialty Lines). This segment also includes results related to the centralized adjusting and settlement of asbestos and environmental pollution and mass tort (APMT) claims, participation in voluntary insurance pools and other non-insurance operations.

In 2004, CNA conducted its operations through four operating segments: Standard Lines, Specialty Lines, Life and Group Non-Core and Corporate and Other Non-Core. These segments are managed separately because of differences in their product lines and markets. Discussions of each segment including the products offered, the customers served, the distribution channels used and competition are set forth in the MD&AManagement’s Discussion and Analysis (MD&A) included under Item 7 and in Note N of the Consolidated Financial Statements included under Item 8.

Competition

The property and casualty insurance industry is highly competitive both as to rate and service. CNA’sOur consolidated property and casualty subsidiaries compete not only with other stock insurance companies, but also with mutual insurance companies, reinsurance companies and other entities for both producers and customers. CNAWe must continuously allocate resources to refine and improve itsour insurance products and services.

Rates among insurers vary according to the types of insurers and methods of operation. CNA competesWe compete for business not only on the basis of rate, but also on the basis of availability of coverage desired by customers, ratings and quality of service, including claim adjustment services.

There are approximately 2,400 individual companies that sell property and casualty insurance in the United States. CNA’sOur consolidated property and casualty subsidiaries ranked as the fourteenth13th largest property and casualty insurance organization and we are the seventh largest commercial insurance writer in the United States based upon 20032005 statutory net written premiums.

Regulation

The insurance industry is subject to comprehensive and detailed regulation and supervision throughout the United States. Each state has established supervisory agencies with broad administrative powers relative to licensing insurers and agents, approving policy forms, establishing reserve requirements, fixing minimum interest rates for accumulation of surrender values and maximum interest rates of policy loans, prescribing the form and content of statutory financial reports and regulating solvency and the type and amount of investments permitted. Such regulatory powers also extend to premium rate regulations, which require that rates not be excessive, inadequate or unfairly discriminatory. In addition to regulation of dividends by insurance subsidiaries, intercompany transfers of assets may be subject to prior notice or approval by the state insurance regulators, depending on the size of such transfers and payments in relation to the financial position of the insurance affiliates making the transfer or payment.

Insurers are also required by the states to provide coverage to insureds who would not otherwise be considered eligible by the insurers. Each state dictates the types of insurance and the level of coverage that must be provided to such involuntary risks. CNA’sOur share of these involuntary risks is mandatory and generally a function of itsour respective share of the voluntary market by line of insurance in each state.

43


Insurance

Further, insurance companies are subject to state guaranty fund and other insurance-related assessments. Guaranty fund and other insurance-related assessments are levied by the state departments of insurance to cover claims of insolvent insurers.

Reform of the U.S. tort liability system is another issue facing the insurance industry. Over the last decade, many states have passed some type of reform. In 2004,recent years, for example, significant state general tort reforms have been enacted in Georgia, Ohio, Mississippi and South Carolina. Specific state legislation addressing state asbestos reform has been passed in Ohio, Georgia, Florida and Texas. A few more states will be considering such legislation in the coming year. Although these states’ legislatures have begun to address their litigious environments, some reforms are being challenged in the courts and it will take some time before they are finalized. Even though there has been some tort reform measures were enacted in Ohio and Mississippi. Nevertheless, a number of state courts have recently modified or overturned such reforms. Additionally,success, new causes of action and theories of damages continue to be proposed in state court actions or by legislatures. ContinuedAs a result of this unpredictability in the law, means that insurance underwriting and rating is expected to continue to be difficult in commercial lines, professional liability and some specialty coverages.

Although the Federal Governmentfederal government and its regulatory agencies do not directly regulate the business of insurance, federal legislative and regulatory initiatives can impact the insurance industry in a variety of ways. These initiatives and legislation include tort reform proposals; class action reform proposals; proposals to establish a privately financed trust to process asbestos bodily injury claims; proposals to overhaul the Superfund hazardous waste removal and liability statutesaddressing natural catastrophe exposures; terrorism risk mechanisms; and various tax proposals affecting insurance companies. In 1999, Congress passed the Financial Services Modernization or “Gramm-Leach-Bliley” Act (GLB Act), which repealed portions of the Glass-Steagall Act and enabled closer relationships between banks and insurers. Although “functional regulation” was preserved by the GLB Act for state oversight of insurance, additional financial services modernization legislation could include provisions for an alternate federal system of regulation for insurance companies.

On February 18, 2005, President Bush signed into law the Class Action Fairness Act of 2005, which, with limited exceptions, confers federal jurisdiction over any class action filed after its enactment involving a putative class of 100 or more members if all aggregated claims exceed $5 million and at least one claimant has diverse residence, for jurisdictional purposes, from at least one defendant. Federal jurisdiction under the Act may be mandatory, discretionary or disallowed depending on the composition and citizenship of the class members and certain defendants. The Act also applies to some individual personal injury lawsuits in which the claims of 100 or more plaintiffs against the same company have been joined for trial. Certain types of class actions are exempt from the jurisdictional provisions of the Act, including those against government defendants, those that involve only a claim regarding a company’s internal affairs and certain types of securities litigation. Closer scrutiny is required of class actions in which the benefit reaching the class consists of a coupon or voucher, especially where attorneys’ fees by class counsel have been requested as part of such a settlement, and a duty on defendants to notify federal and state officials of every class action settlement is imposed.

CNAF’s

In addition, our domestic insurance subsidiaries are subject to risk-based capital requirements. Risk-based capital is a method developed by the National Association of Insurance Commissioners (NAIC) to determine the minimum amount of statutory capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The formula for determining the amount of risk-based capital requirements specifies various factors, weighted based on the perceived degree of risk, which are applied to certain financial balances and financial activity. The adequacy of a company’s actual capital is evaluated by a comparison to the risk-based capital requirements,results, as determined by the formula. Companies below minimum risk-based capital requirements are classified within certain levels, each of which determines arequires specified level of regulatory attention applicable to a company.corrective action. As of December 31, 20042006 and 2003,2005, all of CNAF’sour domestic insurance subsidiaries exceeded the minimum risk-based capital requirements.

Subsidiaries with insurance operations outside the United States are also subject to regulation in the countries in which they operate. CNA hasWe have operations in the United Kingdom, Canada and other countries.

Terrorism Insurance

Information related to terrorism insurance is set forth in the MD&A included under Item 7.

5


Reinsurance

Information on CNA’s reinsurance activities is set forth in the MD&A included under Item 7 and in Note H of the Consolidated Financial Statements included under Item 8.

Employee Relations

As of December 31, 2004, CNA2006, we had approximately 10,6009,800 employees and hashave experienced satisfactory labor relations. CNA hasWe have never had work stoppages due to labor disputes.

CNA has

We have comprehensive benefit plans for substantially all of itsour employees, including retirement plans, savings plans, disability programs, group life programs and group healthcare programs. See Note J of the Consolidated Financial Statements included under Item 8 for further discussion of CNA’sour benefit plans.

64


Supplementary Insurance Data

The following table sets forth supplementary insurance data:

Supplementary Insurance Data
                        
Years ended December 31 2004 2003 2002      
(In millions, except ratio information) 
 
 
 2006 2005 2004
Trade Ratios – GAAP basis (a) 
Trade Ratios — GAAP basis (a) 
Loss and loss adjustment expense ratio  74.6%  112.0%  79.8%  75.7%  89.4%  74.6%
Expense ratio 31.5 37.3 28.9  30.0 31.2 31.5 
Dividend ratio 0.2 1.4 0.9  0.3 0.3 0.2 
 
 
 
 
 
 
        
 
Combined ratio  106.3%  150.7%  109.6%  106.0%  120.9%  106.3%
 
 
 
 
 
 
        
Trade Ratios – Statutory basis (a) 
 
Trade Ratios — Statutory basis (preliminary) (a) 
Loss and loss adjustment expense ratio  78.1%  118.1%  79.2%  78.7%  92.2%  78.1%
Expense ratio 27.2 34.6 30.1  30.2 30.0 27.2 
Dividend ratio 0.6 1.2 1.0  0.2 0.5 0.6 
 
 
 
 
 
 
        
Combined Ratio  105.9%  153.9%  110.3%
 
 
 
 
 
 
  
Individual Life and Group Life Insurance Inforce (d) 
Combined ratio  109.1%  122.7%  105.9%
       
 
Individual Life and Group Life Insurance Inforce 
Individual life $11,566 $330,805 $345,272  $9,866 $10,711 $11,566 
Group life 45,079 58,163 92,479  5,787 9,838 45,079 
 
 
 
 
 
 
        
 
Total $56,645 $388,968 $437,751  $15,653 $20,549 $56,645 
 
 
 
 
 
 
        
Other Data – Statutory basis (b) 
 
Other Data — Statutory basis (preliminary) (b) 
Property and casualty companies’ capital and surplus (c) $6,998 $6,170 $6,836  $8,137 $6,940 $6,998 
Life and group company(ies)’ capital and surplus 1,178 707 1,645 
Life company’s capital and surplus 687 627 1,177 
Property and casualty companies’ written premiums to surplus ratio 1.0 1.1 1.3  0.9 1.0 1.0 
Life companies’ capital and surplus-percent to total liabilities  56.0%  13.0%  21.0%
Life company’s capital and surplus-percent to total liabilities  38.9%  33.1%  56.0%
Participating policyholders-percent of gross life insurance inforce  1.4%  0.5%  0.4%  4.4%  3.5%  1.4%

(a) Trade ratios reflect the results of CNA’sour property and casualty insurance subsidiaries. Trade 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 and the expenses incurred related to uncollectible reinsurance receivables to net earned premiums. The primary difference in this ratio between accounting principles generally accepted in the United States of America (GAAP) and statutory accounting practices (SAP) is related to the treatment of active life reserves (ALR) related to long term care insurance products written in property and casualty insurance subsidiaries. For GAAP, ALR is classified as claim and claim adjustment expense reserves whereas for SAP, ALR is classified as unearned premium reserves. The expense ratio, using amounts determined in accordance with GAAP, is the percentage of underwriting and acquisition expenses (including the amortization of deferred acquisition expenses) to net earned premiums. The expense ratio, using amounts determined in accordance with SAP, is the percentage of acquisition and underwriting expenses (with no deferral of acquisition expenses) to net written premiums. The dividend ratio, using amounts determined in accordance with GAAP, is the ratio of dividends incurred to net earned premiums. The dividend ratio, using amounts determined in accordance with SAP, is the ratio of dividends paid to net earned premiums. The combined ratio is the sum of the loss and loss adjustment expense, expense and dividend ratios.

(b) Other data is determined in accordance with SAP. Life and group statutory capital and surplus as a percent of total liabilities is determined after excluding separate account liabilities and reclassifying the statutorily required Asset Valuation Reserve to surplus.

(c) Surplus includes the property and casualty companies’ equity ownership of the life and group company(ies)’company’s capital and surplus.

(d)  The decline in gross inforce is attributable to the sales of the group benefits and the individual life businesses. See Note H of the Consolidated Financial Statements included under Item 8 for additional inforce information.

75


The following table displays the distribution of gross written premiums for CNA’sour operations by geographic concentration.

Gross Written Premiums
                        
 Percent of Total
 Percent of Total
Years ended December 31 2004 2003 2002 2006 2005 2004
 
 
 
California  9.3%  8.5%  7.7%  9.6%  9.0%  9.3%
Florida 7.9 7.1 7.1 
New York 7.9 7.3 7.2  7.3 7.9 7.9 
Florida 7.1 7.6 6.7 
Texas 5.4 5.7 6.2  5.9 5.7 5.4 
New Jersey 5.3 4.5 4.6  4.4 3.8 5.3 
Illinois 5.1 9.3 9.1  4.1 4.2 5.1 
Pennsylvania 4.7 4.2 4.5  3.4 4.2 4.7 
United Kingdom 3.2 2.8 2.3 
Missouri 3.0 2.8 1.4 
Massachusetts 3.2 3.1 2.8  2.4 3.3 3.2 
All other states, countries or political subdivisions (a) 52.0 49.8 51.2  48.8 49.2 48.3 
 
 
 
 
 
 
        
 
Total  100.0%  100.0%  100.0%  100.0%  100.0%  100.0%
 
 
 
 
 
 
        

(a) No other individual state, country or political subdivision accounts for more than 3.0% of gross written premiums.

Approximately 5.0%7.1%, 3.2%6.1% and 3.5%5.0% of CNA’sour gross written premiums were derived from outside of the United States for the years ended December 31, 2004, 20032006, 2005 and 2002. Gross written premiums from the United Kingdom were approximately 2.3%, 1.8%, and 1.7% of CNA’s premiums for the years ended December 31, 2004, 2003 and 2002.2004. Premiums from any individual foreign country excluding the United Kingdom were not significant.

Property and Casualty Claim and Claim Adjustment Expenses

The following loss reserve development table illustrates the change over time of reserves established for property and casualty claim and claim adjustment expenses at the end of the preceding ten calendar years for CNA’sour property and casualty insurance operations. The table excludes theour life subsidiaries,subsidiary(ies), and as such, the carried reserves will not agree to the Consolidated Financial Statements included under Item 8. The first section shows the reserves as originally reported at the end of the stated year. The second section, reading down, shows the cumulative amounts paid as of the end of successive years with respect to the originally reported reserve liability. The third section, reading down, shows re-estimates of the originally recorded reserves as of the end of each successive year, which is the result of the Company’sour property and casualty insurance subsidiaries’ expanded awareness of additional facts and circumstances that pertain to the unsettled claims. The last section compares the latest re-estimated reserves to the reserves originally established, and indicates whether the original reserves were adequate or inadequate to cover the estimated costs of unsettled claims.

The loss reserve development table for property and casualty companies is cumulative and, therefore, ending balances should not be added since the amount at the end of each calendar year includes activity for both the current and prior years. Additionally, the development amounts in the table below are the amounts prior to consideration of any related reinsurance bad debt allowance impacts.

86


Schedule of Loss Reserve Development
                                                                   
Calendar Year Ended 1994 (a) 1995 (b) 1996 1997 1998 1999 (c) 2000 2001 (d) 2002 (e) 2003 2004                       
(In millions) 
 
 
 
 
 
 
 
 
 
 
 1996 1997 1998 1999 (a) 2000 2001 (b) 2002 (c) 2003 2004 2005 2006 
Originally reported gross reserves for unpaid claim and claim adjustment expenses $21,639 $31,044 $29,357 $28,533 $28,317 $26,631 $26,408 $29,551 $25,648 $31,282 $31,201  $29,559 $28,731 $28,506 $26,850 $26,510 $29,649 $25,719 $31,284 $31,204 $30,694 $29,459 
Originally reported ceded recoverable 2,705 6,089 5,660 5,326 5,424 6,273 7,568 11,798 10,583 13,997 13,788  5,385 5,056 5,182 6,091 7,333 11,703 10,490 13,847 13,682 10,438 8,078 
                       
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
Originally reported net reserves for unpaid claim and claim adjustment expenses $18,934 $24,955 $23,697 $23,207 $22,893 $20,358 $18,840 $17,753 $15,065 $17,285 $17,413  $24,174 $23,675 $23,324 $20,759 $19,177 $17,946 $15,229 $17,437 $17,522 $20,256 $21,381 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                        
Cumulative net paid as of:  
One year later $3,656 $6,510 $5,851 $5,954 $7,321 $6,546 $7,686 $5,981 $5,373 $4,341 $  $5,851 $5,954 $7,321 $6,547 $7,686 $5,981 $5,373 $4,382 $2,651 $3,442 $ 
Two years later 7,087 10,485 9,796 11,394 12,241 11,935 11,988 10,355 8,727    9,796 11,394 12,241 11,937 11,992 10,355 8,768 6,104 4,963   
Three years later 9,195 13,363 13,602 14,423 16,020 15,247 15,291 12,912     13,602 14,423 16,020 15,256 15,291 12,954 9,747 7,780    
Four years later 10,624 16,271 15,793 17,042 18,271 18,136 17,292      15,793 17,042 18,271 18,151 17,333 13,244 10,870     
Five years later 12,577 17,947 17,736 18,568 20,779 19,586       17,736 18,568 20,779 19,686 17,775 13,922      
Six years later 13,472 19,465 18,878 20,723 21,928        18,878 20,723 21,970 20,206 18,970       
Seven years later 14,394 20,410 20,828 21,608         20,828 21,649 22,564 21,231        
Eight years later 15,024 22,237 21,567          21,609 22,077 23,453         
Nine years later 15,602 22,883           21,986 22,800          
Ten years later 16,158            22,642           
 
Net reserves re-estimated as of:  
End of initial year $18,934 $24,955 $23,697 $23,207 $22,893 $20,358 $18,840 $17,753 $15,065 $17,285 $17,413  $24,174 $23,675 $23,324 $20,759 $19,177 $17,946 $15,229 $17,437 $17,522 $20,256 $21,381 
One year later 18,922 24,864 23,441 23,470 23,920 20,785 21,306 17,805 17,496 17,520   23,970 23,904 24,306 21,163 21,502 17,980 17,650 17,671 18,513 20,588  
Two years later 18,500 24,294 23,102 23,717 23,774 22,903 21,377 20,368 18,095    23,610 24,106 24,134 23,217 21,555 20,533 18,248 19,120 19,044   
Three years later 18,088 23,814 23,270 23,414 25,724 22,780 23,890 20,945     23,735 23,776 26,038 23,081 24,058 21,109 19,814 19,760    
Four years later 17,354 24,092 22,977 24,751 25,407 25,293 24,420      23,417 25,067 25,711 25,590 24,587 22,547 20,384     
Five years later 17,506 23,854 24,105 24,330 27,456 25,703       24,499 24,636 27,754 26,000 25,594 22,983      
Six years later 17,248 24,883 23,736 26,037 27,782        24,120 26,338 28,078 26,625 26,023       
Seven years later 17,751 24,631 25,250 26,239         25,629 26,537 28,437 27,009        
Eight years later 17,650 26,023 25,437          25,813 26,770 28,705         
Nine years later 18,193 26,169           26,072 26,997          
Ten years later 18,230            26,305           
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                        
Total net (deficiency) redundancy $704 $(1,214) $(1,740) $(3,032) $(4,889) $(5,345) $(5,580) $(3,192) $(3,030) $(235) $  $(2,131) $(3,322) $(5,381) $(6,250) $(6,846) $(5,037) $(5,155) $(2,323) $(1,522) $(332) $ 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                        
 
Reconciliation to gross re-estimated reserves:  
Net reserves re-estimated $18,230 $26,169 $25,437 $26,239 $27,782 $25,703 $24,420 $20,945 $18,095 $17,520 $  $26,305 $26,997 $28,705 $27,009 $26,023 $22,983 $20,384 $19,760 $19,044 $20,588 $ 
Re-estimated ceded recoverable 2,992 8,479 7,650 7,052 7,475 9,745 10,734 16,526 15,850 14,410   7,619 6,953 7,469 9,810 10,541 15,939 15,298 13,722 12,624 10,094  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                        
Total gross re-estimated reserves $21,222 $34,648 $33,087 $33,291 $35,257 $35,448 $35,154 $37,471 $33,945 $31,930 $  $33,924 $33,950 $36,174 $36,819 $36,564 $38,922 $35,682 $33,482 $31,668 $30,682 $ 
                       
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
Net (deficiency) redundancy related to:  
Asbestos claims $(2,126) $(2,354) $(2,456) $(2,354) $(2,111) $(1,534) $(1,469) $(697) $(696) $(54) $  $(2,461) $(2,361) $(2,120) $(1,544) $(1,479) $(707) $(707) $(65) $(11) $ $ 
Environmental and mass tort claims  (727)  (770)  (715)  (739)  (520)  (620)  (610)  (148)  (151)  (1)    (807)  (834)  (618)  (722)  (716)  (256)  (263)  (117)  (116)  (63)  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                        
Total asbestos, environmental and mass tort  (2,853)  (3,124)  (3,171)  (3,093)  (2,631)  (2,154)  (2,079)  (845)  (847)  (55)    (3,268)  (3,195)  (2,738)  (2,266)  (2,195)  (963)  (970)  (182)  (127)  (63)  
Other claims 3,557 1,910 1,431 61  (2,258)  (3,191)  (3,501)  (2,347)  (2,183)  (180)   1,137  (127)  (2,643)  (3,984)  (4,651)  (4,074)  (4,185)  (2,141)  (1,395)  (269)  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                        
Total net (deficiency) redundancy $704 $(1,214) $(1,740) $(3,032) $(4,889) $(5,345) $(5,580) $(3,192) $(3,030) $(235) $  $(2,131) $(3,322) $(5,381) $(6,250) $(6,846) $(5,037) $(5,155) $(2,323) $(1,522) $(332) $ 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                        

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(a)  Reflects reserves of CNA’s property and casualty insurance subsidiaries, excluding reserves for CIC and its insurance affiliates, which were acquired on May 10, 1995 (the Acquisition Date). Accordingly, the reserve development (net reserves recorded at the end of the year, as initially estimated, less net reserves re-estimated as of subsequent years) does not include CIC.

(b)  (a)Includes CIC gross reserves of $9,713 million and net reserves of $6,063 million acquired on the Acquisition Date and subsequent development thereon.

(c) Ceded recoverable includes reserves transferred under retroactive reinsurance agreements of $784 million as of December 31, 1999.

(d)
(b) Effective January 1, 2001, CNAwe established a new life insurance company, CNA Group Life Assurance Company (CNAGLA). Further, on January 1, 2001 approximately $1,055 million of reserves were transferred from CCC to CNAGLA.

(e)
(c) Effective October 31, 2002, CNAwe sold CNA Reinsurance Company Limited (CNA Re U.K.). As a result of the sale, net reserves were reduced by approximately $1,316 million. See Note P of the Consolidated Financial Statements included under Item 8 for further discussion of the sale.

Additional information as to CNA’sregarding our property and casualty claim and claim adjustment expense reserves and reserve development is set forth in the MD&A included under Item 7 and in Notes A and F of the Consolidated Financial Statements included under Item 8.

Investments

Information on the Company’sour investments is set forth in the MD&A included under Item 7 and in Notes A, B, C and D of the Consolidated Financial Statements included under Item 8.

Available Information

CNA files

We file annual, quarterly and current reports, proxy statements and other documents with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934 (Exchange Act). The public may read and copy any materials that CNA fileswe file with the SEC at the SEC’s Public Reference Room at 450 Fifth100 F Street, NW,NE, Washington, DCD.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers, including CNA, that file electronically with the SEC. The public can obtain any documents that CNA fileswe file with the SEC at http://www.sec.gov.

CNA

We also makesmake available free of charge on or through itsour internet website (http://www.cna.com) CNA’sour Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after CNAwe electronically filesfile such material with, or furnishesfurnish it to, the SEC. Copies of these reports may also be obtained, free of charge, upon written request to: CNA Financial Corporation, CNA Center, 43 South,333 S. Wabash Avenue, Chicago, IL 60685,60604, Attn. Jonathan D. Kantor, Executive Vice President, General Counsel and Secretary.
ITEM 1A. RISK FACTORS
Our business faces many risks. We have described below some of the more significant risks which we face. There may be additional risks that we do not yet know of or that we do not currently perceive to be significant that may also impact our business. Each of the risks and uncertainties described below could lead to events or circumstances that have a material adverse effect on our business, results of operations, financial condition or equity. You should carefully consider and evaluate all of the information included in this Report and any subsequent reports we may file with the Securities and Exchange Commission or make available to the public before investing in any securities we issue.
If we determine that loss reserves are insufficient to cover our estimated ultimate unpaid liability for claims, we may need to increase our loss reserves.
We maintain loss reserves to cover our estimated ultimate unpaid liability for claims and claim adjustment expenses for reported and unreported claims and for future policy benefits. Reserves represent our best estimate at a given point in time. Insurance reserves are not an exact calculation of liability but instead are complex estimates derived by us, generally utilizing a variety of reserve estimation techniques from numerous assumptions and expectations about future events, many of which are highly uncertain, such as estimates of claims severity, frequency of claims, mortality, morbidity, expected interest rates, inflation, claims handling, case reserving policies and procedures, underwriting and pricing policies, changes in the legal and regulatory environment and the lag time between the occurrence of an insured event and the time of its ultimate settlement. Many of these uncertainties are not precisely quantifiable and require significant judgment on our part. As trends in underlying claims develop, particularly in so-called “long tail” or long duration coverages, we are sometimes required to add to our reserves. This is called unfavorable development and results in a charge to our earnings in the amount of the added reserves, recorded in the

8


period the change in estimate is made. These charges can be substantial and can have a material adverse effect on our results of operations and equity. Additional information on our reserves is included in Management’s Discussion and Analysis (MD&A) under Item 7 and Note F to the Consolidated Financial Statements included under Item 8.
We are subject to the uncertain effects of emerging or potential claims and coverages issues that arise as industry practices and legal, judicial, social and other environmental conditions change. These issues have had, and may continue to have, a negative effect on our business by either extending coverage beyond the original underwriting intent or by increasing the number or size of claims, resulting in further increases in our reserves which can have a material adverse effect on our results of operations and equity. The effects of these and other unforeseen emerging claim and coverage issues are extremely hard to predict. Examples of emerging or potential claims and coverage issues include:
increases in the number and size of claims relating to injuries from medical products;
the effects of accounting and financial reporting scandals and other major corporate governance failures, which have resulted in an increase in the number and size of claims, including director and officer and errors and omissions insurance claims;
class action litigation relating to claims handling and other practices;
construction defect claims, including claims for a broad range of additional insured endorsements on policies;
clergy abuse claims, including passage of legislation to reopen or extend various statutes of limitations; and
mass tort claims, including bodily injury claims related to silica, welding rods, benzene, lead and various other chemical exposure claims.
In light of the many uncertainties associated with establishing the estimates and making the assumptions necessary to establish reserve levels, we review and change our reserve estimates in a regular and ongoing process as experience develops and further claims are reported and settled. In addition, we periodically undergo state regulatory financial examinations, including review and analysis of our reserves. If estimated reserves are insufficient for any reason, the required increase in reserves would be recorded as a charge against our earnings for the period in which reserves are determined to be insufficient. These charges can be substantial and can materially adversely affect our results of operations and equity.
Loss reserves for asbestos, environmental pollution and mass torts are especially difficult to estimate and may result in more frequent and larger additions to these reserves.
Our experience has been that establishing reserves for casualty coverages relating to asbestos, environmental pollution and mass tort (which we refer to as APMT) claim and claim adjustment expenses is subject to uncertainties that are greater than those presented by other claims. Estimating the ultimate cost of both reported and unreported asbestos, environmental pollution and mass tort claims is subject to a higher degree of variability due to a number of additional factors including, among others, the following:
coverage issues including whether certain costs are covered under the policies and whether policy limits apply;
inconsistent court decisions and developing legal theories;
increasingly aggressive tactics of plaintiffs’ lawyers;
the risks and lack of predictability inherent in major litigation;
changes in the volume of asbestos, environmental pollution and mass tort claims which cannot now be anticipated;
continued increases in mass tort claims relating to silica and silica-containing products;
the impact of the exhaustion of primary limits and the resulting increase in claims on any umbrella or excess policies we have issued;
the number and outcome of direct actions against us;

9


our ability to recover reinsurance for these claims; and
changes in the legal and legislative environment in which we operate.
As a result of this higher degree of variability, we have necessarily supplemented traditional actuarial methods and techniques with additional estimating techniques and methodologies, many of which involve significant judgment on our part. Consequently, we may periodically need to record changes in our claim and claim adjustment expense reserves in the future in these areas in amounts that may be material. Additional information on APMT is included in MD&A under Item 7 and Note F to the Consolidated Financial Statements included under Item 8.
Environmental pollution claims.The estimation of reserves for environmental pollution claims is complicated by the assertion by many policyholders of claims for defense costs and indemnification. We and others in the insurance industry are disputing coverage for many such claims. Key coverage issues in these claims include the following:
whether cleanup costs are considered damages under the policies (and accordingly whether we would be liable for these costs);
the trigger of coverage and the allocation of liability among triggered policies;
the applicability of pollution exclusions and owned property exclusions;
the potential for joint and several liability; and
the definition of an occurrence.
To date, courts have been inconsistent in their rulings on these issues, thus adding to the uncertainty of the outcome of many of these claims.
Further, the scope of federal and state statutes and regulations determining liability and insurance coverage for environmental pollution liabilities have been the subject of extensive litigation. In many cases, courts have expanded the scope of coverage and liability for cleanup costs beyond the original intent of our insurance policies. Additionally, the standards for cleanup in environmental pollution matters are unclear, the number of sites potentially subject to cleanup under applicable laws is unknown, and the impact of various proposals to reform existing statutes and regulations is difficult to predict.
Asbestos claims.The estimation of reserves for asbestos claims is particularly difficult for many of the same reasons discussed above for environmental pollution claims, as well as the following:
inconsistency of court decisions and jury attitudes, as well as future court decisions;
specific policy provisions;
allocation of liability among insurers and insureds;
missing policies and proof of coverage;
the proliferation of bankruptcy proceedings and attendant uncertainties;
novel theories asserted by policyholders and their legal counsel;
the targeting of a broader range of businesses and entities as defendants;
uncertainties in predicting the number of future claims and which other insureds may be targeted in the future;
volatility in claim numbers and settlement demands;
increases in the number of non-impaired claimants and the extent to which they can be precluded from making claims;
the efforts by insureds to obtain coverage that is not subject to aggregate limits;
the long latency period between asbestos exposure and disease manifestation, as well as the resulting potential for involvement of multiple policy periods for individual claims;
medical inflation trends;

10


the mix of asbestos-related diseases presented; and
the ability to recover reinsurance.
In addition, a number of our insureds have asserted that their claims for insurance are not subject to aggregate limits on coverage. If these insureds are successful in this regard, our potential liability for their claims would be unlimited. Some of these insureds contend that their asbestos claims fall within the so-called “non-products” liability coverage within their policies, rather than the products liability coverage, and that this “non-products” liability coverage is not subject to any aggregate limit. It is difficult to predict the extent to which these claims will succeed and, as a result, the ultimate size of these claims.
Catastrophe losses are unpredictable.
Catastrophe losses are an inevitable part of our business. Various events can cause catastrophe losses, including hurricanes, windstorms, earthquakes, hail, explosions, severe winter weather, and fires, and their frequency and severity are inherently unpredictable. In addition, longer-term natural catastrophe trends may be changing and new types of catastrophe losses may be developing due to climate change, a phenomenon that has been associated with extreme weather events linked to rising temperatures, and includes effects on global weather patterns, greenhouse gases, sea, land and air temperatures, sea levels, rain, and snow. For example, in 2005, we experienced substantial losses from Hurricanes Katrina, Rita and Wilma and in 2004, we experienced substantial losses from Hurricanes Charley, Frances, Ivan and Jeanne. The extent of our losses from catastrophes is a function of both the total amount of our insured exposures in the affected areas and the severity of the events themselves. In addition, as in the case of catastrophe losses generally, it can take a long time for the ultimate cost to us to be finally determined. As our claim experience develops on a particular catastrophe, we may be required to adjust our reserves, or take additional unfavorable development, to reflect our revised estimates of the total cost of claims. We believe we could incur significant catastrophe losses in the future. Additional information on catastrophe losses is included in the MD&A under Item 7 and Note F to the Consolidated Financial Statements included under Item 8.
Our key assumptions used to determine reserves and deferred acquisition costs for our long term care product offerings could vary significantly.
Our reserves and deferred acquisition costs for our long term care product offerings are based on certain key assumptions including morbidity, which is the frequency and severity of illness, sickness and diseases contracted, policy persistency, which is the percentage of policies remaining in force, interest rates and/or future health care cost trends. If actual experience differs from these assumptions, the deferred acquisition costs may not be fully recovered and the reserves may not be adequate, requiring us to add to reserves, or take unfavorable development. Therefore, our financial results could be adversely impacted.
We continue to face exposure to losses arising from terrorist acts, despite the passage of the Terrorism Risk Insurance Extension Act of 2005.
We may bear substantial losses from future acts of terrorism. The Terrorism Risk Insurance Extension Act of 2005 (TRIEA) extended, until December 31, 2007, the program established by the Terrorism Risk Insurance Act of 2002. Under this program, insurers are required to offer terrorism insurance and the federal government will share the risk of loss by commercial property and casualty insurers arising from future terrorist attacks. TRIEA does not provide complete protection for future losses derived from acts of terrorism. Additional information on TRIEA is included in the MD&A under Item 7.
High levels of retained overhead expenses associated with business lines in run-off negatively impact our operating results.
During the past few years, we ceased offering certain insurance products relating principally to our life, group and reinsurance segments. Many of these business lines were sold, others have been placed in run-off and, as a result, revenue will progressively decrease. Our results of operations have been materially, adversely affected by the high levels of retained overhead expenses associated with these run-off operations, and will continue to be so affected if we are not successful in eliminating or reducing these costs.
Our premium writings and profitability are affected by the availability and cost of reinsurance.
We purchase reinsurance to help manage our exposure to risk. Under our reinsurance arrangements, another insurer assumes a specified portion of our claim and claim adjustment expenses in exchange for a specified portion of policy premiums. Market conditions determine the availability and cost of the reinsurance protection we purchase,

11


which affects the level of our business and profitability, as well as the level and types of risk we retain. If we are unable to obtain sufficient reinsurance at a cost we deem acceptable, we may be unwilling to bear the increased risk and would reduce the level of our underwriting commitments. Additional information on Reinsurance is included in the MD&A under Item 7 and Note H to the Consolidated Financial Statements included under Item 8.
We may not be able to collect amounts owed to us by reinsurers.
We have significant amounts recoverable from reinsurers which are reported as receivables in our balance sheets and are estimated in a manner consistent with claim and claim adjustment expense reserves or future policy benefits reserves. The ceding of insurance does not, however, discharge our primary liability for claims. As a result, we are subject to credit risk relating to our ability to recover amounts due from reinsurers. Certain of our reinsurance carriers have experienced deteriorating financial conditions or have been downgraded by rating agencies. In addition, reinsurers could dispute amounts which we believe are due to us. If we are not able to collect the amounts due to us from reinsurers, our claims expenses will be higher which could materially adversely affect our results of operations or equity. Additional information on reinsurance is included in the MD&A under Item 7 and Note H to the Consolidated Financial Statements included under Item 8.
Rating agencies may downgrade their ratings of us and thereby adversely affect our ability to write insurance at competitive rates or at all.
Ratings are an increasingly important factor in establishing the competitive position of insurance companies. Our insurance company subsidiaries, as well as our public debt, are rated by four major rating agencies, namely, A.M. Best Company, Inc., Standard & Poor’s Rating Services, Moody’s Investors Service, Inc. and Fitch, Inc. Ratings reflect the rating agency’s opinions of an insurance company’s financial strength, capital adequacy, operating performance, strategic position and ability to meet its obligations to policyholders and debtholders. Agency ratings are not a recommendation to buy, sell or hold any security, and may be revised or withdrawn at any time by the issuing organization. Each agency’s rating should be evaluated independently of any other agency’s rating.
Due to the intense competitive environment in which we operate, the uncertainty in determining reserves and the potential for us to take material unfavorable development in the future, and possible changes in the methodology or criteria applied by the rating agencies, the rating agencies may take action to lower our ratings in the future. If our property and casualty insurance financial strength ratings are downgraded below current levels, our business and results of operations could be materially adversely affected. The severity of the impact on our business is dependent on the level of downgrade and, for certain products, which rating agency takes the rating action. Among the adverse effects in the event of such downgrades would be the inability to obtain a material volume of business from certain major insurance brokers, the inability to sell a material volume of our insurance products to certain markets, and the required collateralization of certain future payment obligations or reserves.
In addition, we believe that a lowering of the debt ratings of Loews Corporation by certain of the rating agencies could result in an adverse impact on our ratings, independent of any change in our circumstances. We have entered into several settlement agreements and assumed reinsurance contracts that require collateralization of future payment obligations and assumed reserves if our ratings or other specific criteria fall below certain thresholds. The ratings triggers are generally more than one level below our current ratings. Additional information on our ratings is included in the MD&A under Item 7.
We are subject to extensive federal, state and local governmental regulations that restrict our ability to do business and generate revenues.
The insurance industry is subject to comprehensive and detailed regulation and supervision throughout the United States. Most insurance regulations are designed to protect the interests of our policyholders rather than our investors. Each state in which we do business has established supervisory agencies that regulate the manner in which we do business. Their regulations relate to, among other things, the following:
standards of solvency including risk-based capital measurements;
restrictions on the nature, quality and concentration of investments;
restrictions on our ability to withdraw from unprofitable lines of insurance;
the required use of certain methods of accounting and reporting;

12


the establishment of reserves for unearned premiums, losses and other purposes;
potential assessments for funds necessary to settle covered claims against impaired, insolvent or failed insurance companies;
licensing of insurers and agents;
approval of policy forms; and
limitations on the ability of our insurance subsidiaries to pay dividends to us.
Regulatory powers also extend to premium rate regulations which require that rates not be excessive, inadequate or unfairly discriminatory. The states in which we do business also require us to provide coverage to persons whom we would not otherwise consider eligible. Each state dictates the types of insurance and the level of coverage that must be provided to such involuntary risks. Our share of these involuntary risks is mandatory and generally a function of our respective share of the voluntary market by line of insurance in each state.
We are subject to capital adequacy requirements and, if we do not meet these requirements, regulatory agencies may restrict or prohibit us from operating our business.
Insurance companies such as us are subject to risk-based capital standards set by state regulators to help identify companies that merit further regulatory attention. These standards apply specified risk factors to various asset, premium and reserve components of our statutory capital and surplus reported in our statutory basis of accounting financial statements. Current rules require companies to maintain statutory capital and surplus at a specified minimum level determined using the risk-based capital formula. If we do not meet these minimum requirements, state regulators may restrict or prohibit us from operating our business. If we are required to record a charge against earnings in connection with a change in estimates or circumstances, we may violate these minimum capital adequacy requirements unless we are able to raise sufficient additional capital. Examples of events leading us to record a charge against earnings include impairment of our investments or unexpectedly poor claims experience.
Our insurance subsidiaries, upon whom we depend for dividends in order to fund our working capital needs, are limited by state regulators in their ability to pay dividends.
We are a holding company and are dependent upon dividends, loans and other sources of cash from our subsidiaries in order to meet our obligations. Dividend payments, however, must be approved by the subsidiaries’ domiciliary state departments of insurance and are generally limited to amounts determined by formula which varies by state. The formula for the majority of the states is the greater of 10% of the prior year statutory surplus or the prior year statutory net income, less the aggregate of all dividends paid during the twelve months prior to the date of payment. Some states, however, have an additional stipulation that dividends cannot exceed the prior year’s earned surplus. If we are restricted, by regulatory rule or otherwise, from paying or receiving inter-company dividends, we may not be able to fund our working capital needs and debt service requirements from available cash. As a result, we would need to look to other sources of capital which may be more expensive or may not be available at all.
We are responding to subpoenas, interrogatories and inquiries relating to insurance brokers and agents, contingent commissions and bidding practices, and certain finite-risk insurance products.
Along with other companies in the industry, we have received subpoenas, interrogatories and inquiries from: (i) California, Connecticut, Delaware, Florida, Hawaii, Illinois, Michigan, Minnesota, New Jersey, New York, North Carolina, Ohio, Pennsylvania, South Carolina, West Virginia and the Canadian Council of Insurance Regulators concerning investigations into practices including contingent compensation arrangements, fictitious quotes, and tying arrangements; (ii) the Securities and Exchange Commission (SEC), the New York State Attorney General, the United States Attorney for the Southern District of New York, the Connecticut Attorney General, the Connecticut Department of Insurance, the Delaware Department of Insurance, the Georgia Office of Insurance and Safety Fire Commissioner and the California Department of Insurance concerning reinsurance products and finite insurance products purchased and sold by us; (iii) the Massachusetts Attorney General and the Connecticut Attorney General concerning investigations into anti-competitive practices; and (iv) the New York State Attorney General concerning declinations of attorney malpractice insurance. We continue to respond to these subpoenas, interrogatories and inquiries to the extent they are still open.
Subsequent to receipt of the SEC subpoena, we produced documents and provided additional information at the SEC’s request. In addition, the SEC and representatives of the United States Attorney’s Office for the Southern District of New York conducted interviews with several of our current and former executives relating to the

13


restatement of our financial results for 2004, including our relationship with and accounting for transactions with an affiliate that were the basis for the restatement. The SEC also requested information relating to our restatement in 2006 of prior period results. It is possible that our analyses of, or accounting treatment for, finite reinsurance contracts or discontinued operations could be questioned or disputed by regulatory authorities. As a result, further restatements of our financial results are possible.
In prior years, we restated our financial results and identified material weaknesses in our internal control over financial reporting.
In May of 2005 we restated our financial results for prior years to correct our accounting for several reinsurance contracts, primarily with a former affiliate, and to correct our equity accounting for that affiliate. In February of 2006 we restated our financial results for prior years to correct the accounting for discontinued operations acquired in our merger with The Continental Corporation in 1995. Additionally, in March of 2006, we restated our financial results for prior years to correct classification errors within our Consolidated Statements of Cash Flows.
As a result of the foregoing restatements, we identified material weaknesses in our internal control over financial reporting as of December 31, 2004 and 2005, respectively. We also determined that our internal control over financial reporting as of such dates was not effective. Our system of internal control over financial reporting is a process designed to provide reasonable assurance to our management, Audit Committee and Board of Directors regarding the reliability of our financial reporting and the preparation and fair presentation of our published financial statements. Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, and the implementing rules of the Securities and Exchange Commission, the periodic reports we file with the SEC include information on our system of disclosure controls and procedures, as well as our overall internal control over financial reporting.
While we have remediated the referenced material weaknesses, if we fail to maintain effective internal control over financial reporting, we could be scrutinized by regulators in a manner that extends beyond the SEC’s requests for information relating to the restatements (as further described in the prior risk factor). We could also be scrutinized by securities analysts and investors. As a result of this scrutiny, we could suffer a loss of public confidence in our financial reporting capabilities and thereby face adverse effects on our business and the market price of our securities.
Our investment portfolio, which is a key component of our overall profitability, may suffer reduced returns or losses, especially with respect to our equity in various limited partnership net assets which are often subject to greater leverage and volatility.
Investment returns are an important part of our overall profitability. General economic conditions, stock market conditions, fluctuations in interest rates, and many other factors beyond our control can adversely affect the returns and the overall value of our equity investments and our ability to control the timing of the realization of investment income. In addition, any defaults in the payments due to us for our investments, especially with respect to liquid corporate and municipal bonds, could reduce our investment income and realized investment gains or could cause us to incur investment losses. Further, we invest a portion of our assets in equity investments, primarily through limited partnerships, which are subject to greater volatility than our fixed income investments. In some cases, these limited partnerships use leverage and are thereby subject to even greater volatility. Although limited partnership investments generally provide higher expected return, they present greater risk and are more illiquid than our fixed income investments. As a result of these factors, we may not realize an adequate return on our investments, may incur losses on sales of our investments and may be required to write down the value of our investments.
We may be adversely affected by the cyclical nature of the property and casualty business.
The property and casualty market is cyclical and has experienced periods characterized by relatively high levels of price competition, less restrictive underwriting standards and relatively low premium rates, followed by periods of relatively lower levels of competition, more selective underwriting standards and relatively high premium rates.
We face intense competition in our industry.
All aspects of the insurance industry are highly competitive and we must continuously allocate resources to refine and improve our insurance products and services. Insurers compete on the basis of factors including products, price, services, ratings and financial strength. We may lose business to competitors offering competitive insurance products at lower prices. We compete with a large number of stock and mutual insurance companies and other entities for both distributors and customers. In addition, the Graham-Leach-Bliley Act of 1999 has encouraged

14


growth in the number, size and financial strength of our potential competitors by removing barriers that previously prohibited holding companies from simultaneously owning commercial banks, insurers and securities firms.
We may suffer losses from non-routine litigation and arbitration matters which may exceed the reserves we have established.
We face substantial risks of litigation and arbitration beyond ordinary course claims and APMT matters, which may contain assertions in excess of amounts covered by reserves that we have established. These matters may be difficult to assess or quantify and may seek recovery of very large or indeterminate amounts that include punitive or treble damages. Accordingly, unfavorable results in these proceedings could have a material adverse impact on our results of operations.
Additional information on litigation is included in the MD&A under Item 7 and Note G to the Consolidated Financial Statements included under Item 8.
We are dependent on a small number of key executives and other key personnel to operate our business successfully.
Our success substantially depends upon our ability to attract and retain high quality key executives and other employees. We believe there are only a limited number of available qualified executives in the business lines in which we compete. We rely substantially upon the services of our executive officers to implement our business strategy. The loss of the services of any members of our management team or the inability to attract and retain other talented personnel could impede the implementation of our business strategies. We do not maintain key man life insurance policies with respect to any of our employees.

ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES

CNA Center,

The 333 S. Wabash Avenue building, located in Chicago, Illinois and owned by CAC,Continental Assurance Company (CAC), a wholly ownedwholly-owned subsidiary of CCC, serves as theour home office for CNAF and its subsidiaries. CNAF’soffice. Our subsidiaries own or lease office space in various cities throughout the United States and in other countries. The following table sets forth certain information with respect to theour principal office buildings owned or leased by CNAF’s subsidiaries:locations:
     
  Amount (Square
Feet) of Building  
  Owned and Occupied or Leased  
Location or Leased and Occupied by CNA Principal Usage
Location
Occupied by CNA
Principal Usage
CNA Center, 333 S. Wabash Avenue, Chicago, Illinois 897,490(a)904,990 Principal executive offices of CNAF
401 Penn Street, Reading, Pennsylvania171,406Property and casualty insurance offices
2405 Lucien Way, Maitland, Florida 128,267(b)147,815 Property and casualty insurance offices
40 Wall Street, New York, New York 126,147(b)110,131 Property and casualty insurance offices
3500 Lacey Road, Downers Grove, Illinois675 Placentia Avenue, Brea, California 117,749(b)78,655 Property and casualty insurance offices
600 N. Pearl Street, Dallas, Texas 95,828(b)75,544 Property and casualty insurance offices
675 Placentia Avenue, Brea, California88,031(b)Property and casualty insurance offices
1111 E. Broad Street, Columbus, Ohio83,702(a)Property and casualty insurance offices
401 Penn Street, Reading, Pennsylvania71,178(a) Property and casualty insurance offices
1100 Cornwall Road, Monmouth Junction,
New Jersey
 46,515(b)74,067 Property and casualty insurance offices
100 CNA Drive, Nashville, Tennessee3175 Satellite Boulevard, Duluth, Georgia 19,981(b)48,696 LifeProperty and casualty insurance offices
405 Howard Street, San Francisco, California47,195Property and casualty insurance offices
4150 N. Drinkwater Boulevard, Scottsdale, Arizona37,799Property and casualty insurance offices

(a)  Represents property owned by CNAF or its subsidiaries.
(b)  Represents property leased by CNAF or its subsidiaries.

We lease our office space described above except for the Chicago, Illinois building and the Reading, Pennsylvania building, which are owned. We consider that our properties are generally in good condition, are well maintained and are suitable and adequate to carry on our business.

ITEM 3. LEGAL PROCEEDINGS

Information on CNA’sour legal proceedings is set forth in NoteNotes F and G of the Consolidated Financial Statements included under Item 8.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

None.

1115


PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

CNAF’s

Our common stock is listed on the New York Stock Exchange, the Chicago Stock Exchange, and the Pacific Exchange,NYSE Arca and is traded on the Philadelphia Stock Exchange, under the symbol CNA.

As of February 21, 2005, CNAF16, 2006, we had 255,953,958271,406,984 shares of common stock outstanding. Approximately 91%89% of CNAF’sour outstanding common stock is owned by Loews. CNAFWe had 2,2542,094 stockholders of record as of February 21, 200516, 2006 according to the records maintained by the Company’sour transfer agent.

During 2003 CNAF sold $750 million of its participating convertible preferred stock, Series I Issue, to Loews. The preferred stock converted into 32,327,015 shares of CNAF common stock on April 20, 2004. The number of shares was determined utilizing a conversion price per share of common stock that was based on average market prices of CNAF common stock from November 17, 2003 through November 21, 2003. The terms of the Series I Issue were approved by a special committee of independent members of CNAF’s Board of Directors. Following conversion, Loews owned approximately 91% of CNAF’s outstanding common stock of approximately 256.0 million shares. The proceeds from the Series I Issue were applied by CNAF to increase the statutory surplus of CNAF’s principal insurance subsidiary, CCC. The issuance of the Series I Issue was exempt from registration under Section 4(2) of the Securities Act of 1933.

During 2002, CNAF sold $750 million of a then new issue of preferred stock, designated Series H Cumulative Preferred Issue (Series H Issue), to Loews. The terms of the Series H Issue were approved by a special committee of independent members of CNAF’s Board of Directors. The proceeds from the Series H Issue were applied by CNAF to increase the statutory surplus of CNAF’s principal insurance subsidiary, CCC.

The Series H 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 rating levels of the financial strength rating of CCC from its rating at the time of issuance by any of A.M. Best Company, Standard & Poor’s or Moody’s Investor Services or (ii) one year following an increase by one intermediate rating 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 Series H Issue unless and until one of the two triggering events described above has occurred. Beginning with the quarter following an increase of one intermediate rating level in CCC’s financial strength rating, however, current (but not accrued cumulative) quarterly dividends can be paid. As of February 21, 2005, there has not been any change to CCC’s financial strength rating from its rating at the time of issuance. As of December 31, 2004, the Company has $127 million of undeclared (and therefore unrecorded) accumulated dividends.

The Series H 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 Series H Issue have been paid. CNAF may not issue any equity securities ranking senior to or on par with the Series H Issue without the consent of a majority of its stockholders. The Series H 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 issuance of the Series H Issue was exempt from registration under Section 4(2) of the Securities Act of 1933.

12


The table below shows the high and low closing sales prices for CNAF’sour common stock based on the New York Stock Exchange Composite Transactions.

Common Stock Information
                                
 2004
 2003
 2006 2005
 High
 Low
 High
 Low
 High Low High Low
Quarter:  
Fourth $27.06 $22.17 $24.50 $18.57  $40.32 $36.19 $34.91 $28.52 
Third 29.54 23.98 25.65 20.87  36.04 33.05 30.46 28.40 
Second 30.49 26.32 26.50 22.26  33.20 30.90 28.90 26.21 
First 28.65 24.52 27.35 21.21  33.60 29.88 29.79 25.84 

No dividends have been paid on CNAF’sour common stock in 20042006 or 2003. CNAF’s2005. Our ability to pay dividends is influenced, in part,limited by regulatory dividend restrictions of itson our principal operating insurance subsidiaries as described insubsidiaries.
The following graph compares the MD&A included under Item 7 and in Note L to the Consolidated Financial Statements included under Item 8.

Additional information on CNAF’stotal return of our common stock, repurchases is includedthe Standard & Poor’s 500 Composite Stock Index (“S&P 500”) and the Standard & Poor’s 500 Property & Casualty Insurance Index for the five years ended December 31, 2006. The graph assumes that the value of the investment in Note L to the Consolidated Financial Statements included under Item 8.

our common stock and for each index was $100 on December 31, 2001 and that dividends were reinvested.
Stock Price Performance Graph
                         
Company Index 2001 2002 2003 2004 2005 2006
CNA Financial Corp.  100   87.76   82.62   91.70   112.20   138.22 
S&P 500 Index  100   77.90   100.25   111.15   116.61   135.03 
S&P Property & Casualty Insurance  100   88.98   112.48   124.20   142.97   161.38 

1316


ITEM 6. SELECTED FINANCIAL DATA

The following table presents selected financial data.

The table should be read in conjunction with Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8. Financial Statements and Supplementary Data of this Form 10-K.

Selected Financial Data
                                        
As of and for the Years Ended December 31 2004 2003 2002 2001 2000
As of and for the Years Ended           
December 31           
(In millions, except per share data and ratios) 
 
 
 
 
 2006 2005 2004 2003 2002 
Results of Operations:
  
Revenues $9,930 $11,716 $12,286 $13,089 $15,408  $10,376 $9,862 $9,924 $11,715 $12,293 
 
 
 
 
 
 
 
 
 
 
            
Income (loss) from continuing operations $441 $(1,433) $247 $(1,592) $1,177  $1,137 $243 $446 $(1,419) $263 
Income (loss) from discontinued operations, net of tax    (35) 11 5   (29) 21  (21) 2  (43)
Cumulative effects of changes in accounting principles, net of tax    (57)  (61)        (57)
 
 
 
 
 
 
 
 
 
 
            
Net income (loss)
 $441 $(1,433) $155 $(1,642) $1,182  $1,108 $264 $425 $(1,417) $163 
 
 
 
 
 
 
 
 
 
 
            
Earnings (loss) per Share:
 
 
Basic Earnings (Loss) per Share:
 
Income (loss) from continuing operations $1.47 $(6.58) $1.10 $(8.20) $6.40  $4.17 $0.68 $1.49 $(6.52) $1.18 
Income (loss) from discontinued operations, net of tax    (0.16) 0.06 0.03 
Cumulative effects of changes in accounting principles, net of tax    (0.26)  (0.32)  
Income (loss) from discontinued operations  (0.11) 0.08  (0.09) 0.01  (0.20)
Cumulative effects of changes in accounting principles      (0.26)
 
 
 
 
 
 
 
 
 
 
            
Earnings (loss) per share available to common stockholders
 $1.47 $(6.58) $0.68 $(8.46) $6.43 
 
Basic earnings (loss) per share available to common stockholders
 $4.06 $0.76 $1.40 $(6.51) $0.72 
           
 
Diluted Earnings (Loss) per Share:
 
Income (loss) from continuing operations $4.16 $0.68 $1.49 $(6.52) $1.18 
Income (loss) from discontinued operations  (0.11) 0.08  (0.09) 0.01  (0.20)
Cumulative effects of changes in accounting principles      (0.26)
           
 
Diluted earnings (loss) per share available to common stockholders
 $4.05 $0.76 $1.40 $(6.51) $0.72 
           
 
 
 
 
 
 
 
 
 
 
  
Financial Condition:
  
Total investments $39,231 $38,100 $35,293 $35,826 $36,059  $44,096 $39,695 $39,231 $38,100 $35,293 
Total assets 62,500 68,612 61,731 65,723 62,785  60,283 59,016 62,496 68,296 61,426 
Insurance reserves 43,650 45,492 40,179 43,623 39,054  41,080 42,436 43,653 45,494 40,250 
Long and short term debt 2,257 1,904 2,292 2,567 2,729  2,156 1,690 2,257 1,904 2,292 
Stockholders’ equity 9,207 8,952 9,401 8,122 9,400  9,768 8,950 8,974 8,735 9,139 
 
Book value per share $32.55 $31.80 $38.68 $36.33 $51.29  $36.03 $31.26 $31.63 $30.95 $37.51 
Statutory Surplus:
 
 
Statutory Surplus (preliminary):
 
Property and casualty companies (a) $6,998 $6,170 $6,836 $6,241 $8,373  $8,137 $6,940 $6,998 $6,170 $6,836 
Life and group insurance company(ies) 1,178 707 1,645 1,752 1,274  687 627 1,177 707 1,645 

(a) Surplus includes the property and casualty companies’ equity ownership of the life and group company(ies)’ capital and surplus.

1417


ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

The following discussion highlights significant factors impacting the consolidated operations and financial condition of CNA Financial Corporation (CNAF) and its subsidiaries (collectively CNA or the Company). Based on 2003 statutory net written premiums, CNA is the fourteenth largest property and casualty company.

Loews Corporation (Loews) owned approximately 91% of the outstanding common stock and 100% of the preferred stock of CNAF as of December 31, 2004.

The following discussion should be read in conjunction with Item 1A. Risk Factors, Item 6. Selected Financial Data and Item 8. Financial Statements and Supplementary Data.

Data of this Form 10-K.

Index to this MD&A
Management’s discussion and analysis of financial condition and results of operations is comprised of the following sections:
   
  Page No.
Consolidated Operations 16
Net Prior Year Development18
Strategic Review2019
Critical Accounting Estimates 2422
Reserves Estimates and Uncertainties 2623
Reinsurance 29
Terrorism Insurance 3330
Restructuring 3330
Segment Results 3530
Standard Lines 3530
Specialty Lines 4333
Life and Group Non-Core 4736
Corporate and Other Non-Core 4937
Asbestos and Environmental Pollution and Mass Tort (APMT) Reserves 5239
Investments 6545
Net Investment Income 6545
Net Realized Investment Gains (Losses) 6646
Valuation and Impairment of Investments 6949
Liquidity and Capital Resources 7653
Cash Flows 76
Debt78
Related Parties7953
Commitments, Contingencies, and Guarantees 53
81Off-Balance Sheet Arrangements 54
Regulatory Matters 82
Ratings8354
Dividends from Subsidiaries 8455
Loews 55
85Ratings 55
Accounting Pronouncements 8556
Forward-Looking Statements 8657

1518


CONSOLIDATED OPERATIONS

Results of Operations

The following table includes the consolidated results of our operations. For more detailed components of CNA’sour business operations and the net operating income financial measure, see the segment discussions within this MD&A.

             
Years ended December 31         
(In millions, except per share data) 2006  2005  2004 
Revenues
            
Net earned premiums $7,603  $7,569  $8,209 
Net investment income  2,412   1,892   1,680 
Other revenues  275   411   283 
          
             
Total operating revenues  10,290   9,872   10,172 
          
             
Claims, Benefits and Expenses
            
Net incurred claims and benefits  6,025   6,975   6,434 
Policyholders’ dividends  22   24   11 
Amortization of deferred acquisition costs  1,534   1,543   1,680 
Other insurance related expenses  757   829   972 
Restructuring and other related charges  (13)     (3)
Other expenses  401   329   326 
          
             
Total claims, benefits and expenses  8,726   9,700   9,420 
          
             
Operating income from continuing operations before income tax and minority interest  1,564   172   752 
Income tax (expense) benefit on operating income  (450)  105   (126)
Minority interest  (44)  (24)  (27)
          
             
Net operating income from continuing operations  1,070   253   599 
             
Realized investment gains (losses), net of participating policyholders’ and minority interests  86   (10)  (248)
Income tax (expense) benefit on realized investment gains (losses)  (19)     95 
          
             
Income from continuing operations  1,137   243   446 
             
Income (loss) from discontinued operations, net of income tax (expense) benefit of $7, $(2) and $(1)  (29)  21   (21)
          
             
Net income
 $1,108  $264  $425 
          
             
Basic Earnings per Share
            
             
Income from continuing operations $4.17  $0.68  $1.49 
Income (loss) from discontinued operations  (0.11)  0.08   (0.09)
          
             
Basic earnings per share available to common stockholders $4.06  $0.76  $1.40 
          
             
Diluted Earnings per Share
            
             
Income from continuing operations $4.16  $0.68  $1.49 
Income (loss) from discontinued operations  (0.11)  0.08   (0.09)
          
             
Diluted earnings per share available to common stockholders $4.05  $0.76  $1.40 
          
             
Weighted Average Outstanding Common Stock and Common Stock Equivalents
            
             
Basic  262.1   256.0   256.0 
          
Diluted  262.3   256.0   256.0 
          

Consolidated Operations

             
Years ended December 31 2004 2003 2002
(In millions, except per share data) 
 
 
Revenues
            
Net earned premiums $8,209  $9,214  $10,213 
Net investment income  1,674   1,647   1,730 
Realized investment gains (losses), net of participating policyholders’ and minority interests  (248)  460   (252)
Other revenues  295   395   595 
   
 
   
 
   
 
 
Total revenues  9,930   11,716   12,286 
   
 
   
 
   
 
 
Claims, benefits and expenses
            
Insurance claims and policyholders’ benefits  6,446   10,287   8,420 
Amortization of deferred acquisition costs  1,680   1,965   1,791 
Other operating expenses  1,183   1,686   1,621 
Restructuring and other related charges        (37)
Interest  124   130   150 
   
 
   
 
   
 
 
Total claims, benefits and expenses  9,433   14,068   11,945 
   
 
   
 
   
 
 
Income (loss) from continuing operations before income tax and minority interest  497   (2,352)  341 
Income tax (expense) benefit  (29)  913   (68)
Minority interest  (27)  6   (26)
   
 
   
 
   
 
 
Income (loss) from continuing operations  441   (1,433)  247 
Loss from discontinued operations, net of tax of $9        (35)
   
 
   
 
   
 
 
Income (loss) before cumulative effects of changes in accounting principle  441   (1,433)  212 
Cumulative effect of change in accounting principles, net of tax of $7        (57)
   
 
   
 
   
 
 
Net income (loss)
 $441  $(1,433) $155 
   
 
   
 
   
 
 
Basic and diluted earnings (loss) per share:
            
Income (loss) from continuing operations $1.47  $(6.58) $1.10 
Income (loss) from discontinued operations, net of tax        (0.16)
   
 
   
 
   
 
 
Income (loss) before cumulative effect of change in accounting principles  1.47   (6.58)  0.94 
Cumulative effect of change in accounting principle, net of tax        (0.26)
   
 
   
 
   
 
 
Basic and diluted earnings (loss) per share available to common stockholders
 $1.47  $(6.58) $0.68 
   
 
   
 
   
 
 
Weighted average outstanding common stock and common stock equivalents
  256.0   227.0   223.6 
   
 
   
 
   
 
 

2004 Compared with 2003

Net results increased $1,874 million in 2004 as compared with 2003. This improvement in net results was due principally to decreased net unfavorable prior year development of $1,838 million after-tax ($2,827 million pretax), $356 million after-tax ($547 million pretax) decrease in the bad debt provisions for insurance and reinsurance receivables, $66 million after-tax ($101 million pretax) decrease in interest expenses related to additional cessions to corporate aggregate reinsurance treaties and $59 million after-tax ($90 million pretax) decrease in certain insurance related assessments. These favorable impacts to net income in 2004 were partially offset by increased catastrophe losses and decreased net realized investment results. The impact of catastrophes was $196 million after-tax ($301

1619


2006 Compared with 2005
Net income increased $844 million pretax) and $93 million after-tax ($143 million pretax) in 2004 and 2003.2006 as compared with 2005. This increase was primarily due to increased net operating income and net realized investment results. These favorable impacts were partially offset by unfavorable results from discontinued operations. See the Investments section of this MD&A for further discussion of net investment income and net realized investment results.
Net operating income from continuing operations increased $817 million in 2006 as compared with 2005. Favorably impacting net operating income was increased net investment income and significantly decreased unfavorable net prior year development as discussed below. The 2005 results included a $334 million after-tax impact of catastrophes resulting from Hurricanes Katrina, Wilma, Rita, Dennis and Ophelia, net of anticipated reinsurance recoveries. Additionally, the 2005 results included a $115 million benefit related to a federal income tax settlement and release of federal income tax reserves.
Unfavorable net prior year development of $185 million was recorded in 2006, including $251 million of unfavorable claim and allocated claim adjustment expense reserve development and $66 million of favorable premium development. Unfavorable net prior year development of $807 million, including $945 million of unfavorable claim and allocated claim adjustment expense reserve development and $138 million of favorable premium development, was recorded in 2005. Further information on Net Prior Year Development for 2006 and 2005 is included in Note F of the Consolidated Financial Statements included under Item 8.
During 2006 and 2005, we commuted several significant reinsurance contracts that resulted in unfavorable development of $110 million and $433 million, which is included in the development above, and which were partially offset by the release of previously established allowance for uncollectible reinsurance. These commutations resulted in an unfavorable impact of $31 million after-tax and $259 million after-tax in 2006 and 2005. These contracts contained interest crediting provisions and maintenance charges. Interest charges associated with the reinsurance contracts commuted were $9 million after-tax and $55 million after-tax in 2006 and 2005. The 2005 amount includes the interest charges associated with the contract commuted in 2006. There will be no further interest crediting charges or other charges related to these commuted contracts in future periods.
Net earned premiums increased $34 million in 2006 as compared with 2005, including an $80 million increase related to the Specialty Lines segment and a $3 million increase related to the Standard Lines segment. Net earned premiums for the Life and Group Non-Core segment decreased $63 million. See the Segment Results section of this MD&A for further discussion.
Loss from discontinued operations was $29 million for the year ended December 31, 2006. Results in 2006 reflect a $29 million impairment loss on the anticipated sale of a portion of the run-off business. Further information on this impairment loss is included in Note Q of the Consolidated Financial Statements included under Item 8. Also, the 2006 results were impacted by an increase in unallocated loss adjustment expense reserves and bad debt provision for reinsurance receivables. These items were partially offset by the release of tax reserves and net investment income.
2005 Compared with 2004
Net income decreased $161 million in 2005 as compared with 2004, due to decreased net operating income partially offset by improved net investment results. See the Investments section of this MD&A for further discussion of net investment results.
Net operating income from continuing operations decreased $346 million in 2005 as compared with 2004. This decrease in net operating income was primarily driven by increased unfavorable net prior year development of $437 million after-tax which includes the impact of significant commutations in 2005 and 2004, decreased earned premiums, and increased catastrophe impacts of $178in 2005. Partially offsetting these impacts were increased net investment income, a $115 million after-tax ($273benefit related to a federal income tax settlement and release of federal income tax reserves, and lower insurance acquisition and operating expenses.
Unfavorable net prior year development of $807 million pretax)was recorded in 2005, including $945 million of unfavorable claim and allocated claim adjustment expense reserve development and $138 million of favorable premium development. Unfavorable net prior year development of $134 million, including $250 million of unfavorable claim and allocated claim adjustment expense reserve development and $116 million of favorable premium development, was recorded in 2004. Further information on Net Prior Year Development for 2005 and 2004 is included in Note F of the Consolidated Financial Statements included under Item 8.

20


During 2005 and 2004, we commuted several significant reinsurance contracts that resulted in unfavorable development of $433 million and $76 million, which is included in the development above, and which was partially offset by the release of previously established allowance for uncollectible reinsurance. These commutations resulted in an unfavorable impact of $259 million after-tax and favorable impact of $18 million after-tax in 2005 and 2004. These contracts contained interest crediting provisions and maintenance charges. Interest charges associated with the reinsurance contracts commuted were $47 million after-tax and $86 million after-tax in 2005 and 2004. There will be no further interest crediting charges or other charges related to these commuted contracts in future periods.
Unfavorable net prior year development was also recorded related to our assumed reinsurance operations which are in run-off, workers’ compensation and excess workers’ compensation lines, primarily in accident years 2003 and prior, the architects and engineers book of business, pollution exposures and large directors and officers (D&O) claims.
The impact of catastrophes was $334 million after-tax and $196 million after-tax in 2005 and 2004. This increase was primarily due to 2005 catastrophe impacts resulting from Hurricanes Katrina, Wilma, Rita, Dennis and Ophelia and 2004 catastrophe impacts primarily resulting from Hurricanes Charley, Frances, Ivan and Jeanne. These impacts are net of anticipated reinsurance recoveries, and include the effect of reinstatement premiums and estimated insurance assessments.

Unfavorable net prior year development of $125 million, including $241 million of unfavorable claim and claim adjustment expense reserve development and $116 million of favorable premium development, was recorded in 2004. Unfavorable net prior year development of $2,952 million, including $2,409 million of unfavorable claim and claim adjustment expense reserve development and $543 million of unfavorable premium development, was recorded in 2003.

Net realized investment results, decreased $438after-tax, improved $143 million after-tax in 20042005 as compared with 2003. This decrease2004. Net results in investment results was primarily due to the2004 included a loss on the sale of the individual life insurance business of $389 million after-tax, ($622 million pretax) and losses on derivatives of $55 million after-tax ($84 million pretax). These decreases werewhich was partly offset by athe 2004 gain of $105 million after-tax ($162 million pretax) gain on the dispositionsale of the Company’s equity holdings ofour investment in Canary Wharf Group PLC (Canary Wharf), a London-based real estate company, and a reduction in impairment losses for other-than-temporary declines in market values for fixed maturity and equity securities. Impairment losses of $60 million after-tax ($93 million pretax) were recorded in 2004 across various sectors, including an after-tax impairment loss of $36 million ($56 million pretax) related to loans made under a credit facility to a national contractor, while in 2003 impairment losses of $209 million after-tax ($321 million pretax) were recorded across various sectors including the airline, healthcare and energy industries.

company.

Net earned premiums decreased $1,005$640 million in 20042005 as compared with 2003. The decrease in net2004. Net earned premiums was due primarily to reduced premiums from the individual life and group benefits businesses, as well as CNA Re, as a result of the decisions made in 2003 to focus on the core property and casualty business. Partially offsetting these unfavorable impacts was a $357operations decreased by $309 million, decreaseas discussed in premiums ceded to corporate aggregate and other reinsurance treaties in 2004 as compared to 2003. The 2003 cessions were principally due to the unfavorable net prior year development recorded in 2003.

2003 Compared with 2002

Net results decreased $1,588 million in 2003 as compared with 2002. The decline in net results was due primarily to increased unfavorable net prior year development of $1,837 million after-tax ($2,826 million pretax), a $55 million after-tax ($84 million pretax) increase in catastrophe losses, a $65 million after-tax ($100 million pretax) increase in unallocated loss adjustment expense (ULAE) reserves and a $27 million after-tax ($42 million pretax) increase in dividend development. In addition, net results in 2003 included a $396 million after-tax ($610 million pretax) increasemore detail in the bad debt provision for insurance and reinsurance receivables, a $69 million after-tax ($104 million pretax) increase in insurance related assessments and increased interest expense of $90 million after-tax ($137 million pretax) related to additional cessions to the corporate aggregate and other reinsurance treaties. These items were partially offset by a $434 million after-tax ($712 million pretax) increase in net realized investment results and increased limited partnership income of $165 million after-tax ($254 million pretax). Net income in 2002 also included a $35 million after-tax ($44 million pretax) loss from discontinued operations and a $57 million after-tax ($64 million pretax) charge for the cumulative effect of a change in accounting principle.

Unfavorable net prior year development of $2,952 million, including $2,409 million of unfavorable claim and claim adjustment expense reserve development and $543 million of unfavorable premium development, was recorded in 2003. Unfavorable net prior year development of $126 million, including $35 million of unfavorable claim and claim adjustment expense reserve development and $91 million of unfavorable premium development, was recorded in 2002.

Net realized investment results increased $434 million after-tax in 2003 as compared with 2002. This change was due primarily to $209 million after-tax ($321 million pretax) of impairment losses for other-than-temporary declines in market values for fixed maturity and equity securities recorded in 2003 as compared to $578 million after-tax ($890 million pretax) recorded in 2002. Also contributing to this increase were improved realized results related to fixed maturity and derivative securities in 2003. These increases were partially offset by the $130 million after-tax ($176 million pretax) recorded loss on the salesegment discussions below. The remainder of the Group Benefits business. See the Investments section of this MD&A for further details.

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The loss from discontinued operations of $35 million after-tax in 2002 related to the results of CNA Vida, CNA’s Chilean-based life insurer, which was sold during 2002.

The cumulative effect of a change in accounting principle in 2002 related to the adoption of Statement of Financial Accounting Standards No. 142,Goodwill and Other Intangible Assets (SFAS 142). During 2002, the Company completed its initial goodwill impairment testing and recorded a $57 million after-tax ($64 million pretax) impairment charge. The impairment charge consisted of a $43 million after-tax ($43 million pretax) charge in Standard Lines, a $5 million after-tax ($8 million pretax) charge in Specialty Lines, an $8 million after-tax ($12 million pretax) charge in Life and Group Non-Core, and a $1 million after-tax ($1 million pretax) charge in Corporate and Other Non-Core.

Net earned premiums decreased $999 million in 2003 as compared with the same period in 2002. The decrease in net earned premiums was primarily due primarily to the July 1, 2002 transfer of the National Postal Mail Handlers Union group benefits plan (the Mail Handlers Plan) to First Health Corporation. Net earned premiums for the Mail Handlers Plan were $1,151 million in 2002. Net earned premium was also impacted by increased ceded premiums to corporate aggregate and other reinsurance treaties resulting from unfavorable net prior year development recorded in 2003. Partially offsetting these adverse premium items were rate increases, increased retention and new business, primarily in Standard Lines and Specialty Lines.

Net Prior Year Development

The results of operations for the years ended December 31, 2004, 2003 and 2002 were impacted by net prior year development recorded for the property and casualty and the Corporate and Other Non-Core segments. Changes in estimates of claim and allocated claim adjustment expense reserves and premium accruals for prior accident years are defined as net prior year development within this MD&A. These changes can be favorable or unfavorable. The development discussed below is the amount prior to consideration of any related reinsurance allowance impacts.

The following tables summarize pretax net prior year development by segment for the property and casualty segments and the Corporate and Other Non-Core segment for the years ended December 31, 2004, 2003 and 2002.

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The following table summarizes the pretax 2004 net prior year development by segment.

2004 Net Prior Year Development

                 
          Corporate  
  Standard Specialty and Other  
  Lines Lines Non-Core Total
(In millions) 
 
 
 
Pretax unfavorable net prior year claim and allocated claim adjustment expense development excluding the impact of corporate aggregate reinsurance treaties:                
Property and casualty, excluding APMT $105  $75  $23  $203 
APMT        55   55 
   
 
   
 
   
 
   
 
 
Total  105   75   78   258 
Ceded losses related to corporate aggregate reinsurance treaties  8   (17)  9    
   
 
   
 
   
 
   
 
 
Pretax unfavorable net prior year development before impact of premium development  113   58   87   258 
   
 
   
 
   
 
   
 
 
Unfavorable (favorable) premium development, excluding impact of corporate aggregate reinsurance treaties  (96)  (33)  12   (117)
Ceded premiums related to corporate aggregate reinsurance treaties  (1)  5   (3)  1 
   
 
   
 
   
 
   
 
 
Pretax unfavorable (favorable) premium development  (97)  (28)  9   (116)
   
 
   
 
   
 
   
 
 
Total 2004 unfavorable net prior year development (pretax)
 $16  $30  $96  $142 
   
 
   
 
   
 
   
 
 
Total 2004 unfavorable net prior year development (after-tax)
 $10  $20  $62  $92 
   
 
   
 
   
 
   
 
 

The following table summarizes the pretax 2003 net prior year development by segment.

2003 Net Prior Year Development

                 
          Corporate  
  Standard Specialty and Other  
  Lines Lines Non-Core Total
(In millions) 
 
 
 
Pretax unfavorable net prior year claim and allocated claim adjustment expense development excluding the impact of corporate aggregate reinsurance treaties:                
Property and casualty, excluding APMT $1,424  $313  $355  $2,092 
APMT        795   795 
   
 
   
 
   
 
   
 
 
Total  1,424   313   1,150   2,887 
Ceded losses related to corporate aggregate reinsurance treaties  (485)  (56)  (102)  (643)
   
 
   
 
   
 
   
 
 
Pretax unfavorable net prior year development before impact of premium development  939   257   1,048   2,244 
   
 
   
 
   
 
   
 
 
Unfavorable (favorable) premium development, excluding impact of corporate aggregate reinsurance treaties  211   6   (32)  185 
Ceded premiums related to corporate aggregate reinsurance treaties  269   31   58   358 
   
 
   
 
   
 
   
 
 
Pretax unfavorable premium development  480   37   26   543 
   
 
   
 
   
 
   
 
 
Total 2003 unfavorable net prior year development (pretax)
 $1,419  $294  $1,074  $2,787 
   
 
   
 
   
 
   
 
 
Total 2003 unfavorable net prior year development (after-tax)
 $922  $191  $698  $1,811 
   
 
   
 
   
 
   
 
 

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The following table summarizes the pretax 2002 net prior year development by segment.

2002 Net Prior Year Development

                 
          Corporate  
  Standard Specialty and Other  
  Lines Lines Non-Core Total
(In millions) 
 
 
 
Pretax unfavorable (favorable) net prior year claim and allocated claim adjustment expense development excluding the impact of corporate aggregate reinsurance treaties:                
Property and casualty, excluding APMT $(191) $55  $248  $112 
APMT            
   
 
   
 
   
 
   
 
 
Total  (191)  55   248   112 
Ceded losses related to corporate aggregate reinsurance treaties  (14)  (41)  (93)  (148)
   
 
   
 
   
 
   
 
 
Pretax unfavorable (favorable) net prior year development before impact of premium development  (205)  14   155   (36)
   
 
   
 
   
 
   
 
 
Unfavorable (favorable) premium development, excluding impact of corporate aggregate reinsurance treaties  76   17   (103)  (10)
Ceded premiums related to corporate aggregate reinsurance treaties  10   29   62   101 
   
 
   
 
   
 
   
 
 
Pretax unfavorable (favorable) premium development  86   46   (41)  91 
   
 
   
 
   
 
   
 
 
Total 2002 unfavorable (favorable) net prior year development (pretax)
 $(119) $60  $114  $55 
   
 
   
 
   
 
   
 
 
Total 2002 unfavorable (favorable) net prior year development (after-tax)
 $(77) $39  $74  $36 
   
 
   
 
   
 
   
 
 

Strategic Review

During 2003, CNA completed a strategic review of its operations and decided to concentrate efforts on its property and casualty business. As a result of this review and several significant charges in 2003, a capital plan was developed to replenish statutory capital of the property and casualty subsidiaries. A summary of the capital plan, related actions and other significant business decisions is discussed below:

Sale of Individual Life Business –On April 30, 2004, CNA sold its individual life insurance business. The business sold included term, universal and permanent life insurance policies and individual annuity products. CNA’s individual long term care and structured settlement businesses were excluded from the sale. Consideration from the sale was approximately $700 million. CNA recorded a realized investment loss of $389 million after-tax ($622 million pretax) in 2004. See Note P to the Consolidated Financial Statements in Item 8 for further information.

Sale of Group Benefits Business –On December 31, 2003, CNA sold the majority of its group benefits business. The business sold included group life and accident, short and long term disability and certain other products. CNA’s group long term care and specialty medical businesses were excluded from the sale. Consideration from the sale was approximately $530 million, resulting in realized investment loss on the sale of $122 after-tax ($163 million pretax), including an after-tax realized investment gain of $8 million ($13 million pretax) recorded in the second quarter of 2004. See Note P to the Consolidated Financial Statements included under Item 8 for further information.

Exit from Reinsurance Business –During 2003, the Company sold the renewal rights for most of the treaty business of CNA Re and withdrew from the assumed reinsurance business. CNA is managing the run-off of its retained liabilities.

Expense Initiatives –During 2003, the Company undertook an expense initiative, of which the primary components were a reduction of the workforce by approximately five percent, lower commissions and other acquisition costs, principally related to workers compensation, and reduced spending in other areas. The Company achieved the

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targeted workforce reduction in 2003. Actions related to reducing commissions and other acquisition expenses began in 2003 and were completed in 2004.

During 2004, the Company undertook additional expense initiatives that produced expense savings of approximately $100 million. The primary components of the expense initiatives were a reduction in certain business expenses through more stringent expense policies and guidelines, reduced facilities cost through consolidation of locations and, to a lesser extent, workforce reductions. The Company is currently formulating plans to reach its goal of an additional $100 million of expense reductions in 2005.

Capital Plan –In November of 2003, the Company established a capital plan to replenish statutory capital impacted by the strategic review and charges for prior year development and related matters. Under the capital plan, in November of 2003, CNAF sold to Loews $750 million of a new series of convertible preferred stock which converted into 32,327,015 shares of CNAF common stock on April 20, 2004, and received commitments from Loews for additional capital support of up to $650 million through the purchase of surplus notes of Continental Casualty Company (CCC), CNA’s principal insurance subsidiary, in the event certain additions to CCC’s statutory capital were not achieved through asset sales. As a result of this commitment, Loews purchased $300 million principal amount of surplus notes in February of 2004 in relation to CNA’s sale of the individual life business and $46 million principal amount of surplus notes in February ofon April 30, 2004, in relation to the sale of the group benefits business. The $300 million surplus note was repaid in June of 2004, and the $46 million surplus note was repaid in December of 2004, thereby fulfilling all of the commitments under the capital plan.

Revised Business Segment Reporting –As a result of the strategic review and other actions described above, in 2004 CNA changed how it manages its core operations and makes business decisions. Accordingly, the Company revised its reportable business segment structure to reflect these changes. CNA’s core operations, property and casualty operations, are now reported in two business segments: Standard Lines and Specialty Lines. CNA’s non-core operations are managed in two segments: Life and Group Non-Core and Corporate and Other Non-Core. Prior period segment disclosures have been conformed to the current year presentation.

Standard Lines includes standard property and casualty coverages, excess and surplus lines and insurance and risk management products. CNA Global (formerly included in Specialty Lines), which consists of marine and global standard lines, is also included in Standard Lines.

Specialty Lines includes professional financial and specialty property and casualty products and services.

Life and Group Non-Core includes the results of Life Operations and Group Operations (formerly separate reportable segments), which primarily have been sold or placed in run-off, and certain run-off life and group operations formerly included in the Corporate and Other segment.

Corporate and Other Non-Core includes the results of several property and casualty and other lines of business placed in run-off, includingas well as decreased premiums from CNA Re (formerlywhich exited the reinsurance market in 2003.

Income from discontinued operations increased $42 million in 2005 as compared to 2004, primarily due to a stand alone propertydecrease in unfavorable net prior year development, including the effects of commutations of assumed and casualty segment)ceded reinsurance, increased foreign exchange gains and CNA Guaranty and Credit (formerly included in Specialty Lines). This segment also includesimproved investment results primarily related to the centralized adjusting and settlement of APMT claims, participation in voluntary insurance pools and other non-insurance operations.

realized investment gains.

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Results of Retained and Sold Businesses –Throughout this MD&A, the results of operations include discussion and results for all of CNA’s businesses, including those sold or exited as described above. The following tables provide information about CNA’s historical results of operations for the retained and sold businesses.

Consolidated Net Income (Loss)

                     
          Life and Corporate  
          Group Non- and Other  
  Standard Lines
 Specialty Lines
 Core
 Non-Core (b)
 Total
Year ended December 31, 2004
                    
Net results of businesses retained $360  $378  $13  $117  $868 
Net results of businesses sold (a)        (427)     (427)
   
 
   
 
   
 
   
 
   
 
 
Total consolidated net income (loss) for the year ended December 31, 2004
 $360  $378  $(414) $117  $441 
   
 
   
 
   
 
   
 
   
 
 
Year ended December 31, 2003
                    
Net results of businesses retained $(717) $40  $41  $(761) $(1,397)
Net results of businesses sold (a)        (36)     (36)
   
 
   
 
   
 
   
 
   
 
 
Total consolidated net income (loss) for the year ended December 31, 2003
 $(717) $40  $5  $(761) $(1,433)
   
 
   
 
   
 
   
 
   
 
 
Year ended December 31, 2002
                    
Net results of businesses retained $47  $60  $(42) $  $65 
Net results of businesses sold (a)        90      90 
   
 
   
 
   
 
   
 
   
 
 
Total consolidated net income (loss) for the year ended December 31, 2002
 $47  $60  $48  $  $155 
   
 
   
 
   
 
   
 
   
 
 

(a)Includes the group benefits business sold on December 31, 2003, the individual life business sold on April 30, 2004 and the CNA Trust business sold on August 1, 2004. The gains or losses recognized on these sales are included in these net results.
(b)Includes $52 million, $23 million and $136 million of net income for the years ended December 31, 2004, 2003 and 2002 from CNA Re, which is in run-off.

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Net Earned Premiums

                     
          Life and Corporate  
          Group Non- and Other  
  Standard Lines
 Specialty Lines
 Core
 Non-Core (b)
 Total
Year ended December 31, 2004
                    
Net earned premiums of businesses retained $4,917  $2,277  $806  $94  $8,094 
Net earned premiums of businesses sold (a)        115      115 
   
 
   
 
   
 
   
 
   
 
 
Total net earned premiums for the year ended December 31, 2004
 $4,917  $2,277  $921  $94  $8,209 
   
 
   
 
   
 
   
 
   
 
 
Year ended December 31, 2003
                    
Net earned premiums of businesses retained $4,530  $1,840  $917  $468  $7,755 
Net earned premiums of businesses sold (a)        1,459      1,459 
   
 
   
 
   
 
   
 
   
 
 
Total net earned premiums for the year ended December 31, 2003
 $4,530  $1,840  $2,376  $468  $9,214 
   
 
   
 
   
 
   
 
   
 
 
Year ended December 31, 2002
                    
Net earned premiums of businesses retained $4,678  $1,451  $2,027  $676  $8,832 
Net earned premiums of businesses sold (a)        1,381      1,381 
   
 
   
 
   
 
   
 
   
 
 
Total net earned premiums for the year ended December 31, 2002
 $4,678  $1,451  $3,408  $676  $10,213 
   
 
   
 
   
 
   
 
   
 
 

(a)Includes the group benefits business sold on December 31, 2003 and the individual life business sold on April 30, 2004.
(b)Includes $125 million, $536 million and $642 million of Net Earned Premiums for the years ended December 31, 2004, 2003 and 2002 from CNA Re, which is in run-off.

Reclassification of Change in Allowance for Uncollectible Reinsurance –In 2004, the expenses incurred related to uncollectible reinsurance receivables were reclassified from “Other operating expenses” to “Insurance claims and policyholders’ benefits” on the Consolidated Statements of Operations. Prior period amounts and ratios have been reclassified to conform to the current year presentation. This reclassification had no impact on net income (loss) or the combined ratios in any period; however, this change generally had an unfavorable impact on the loss and loss adjustment expense ratios and a favorable impact on the expense ratios.

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Critical Accounting Estimates

The preparation of the consolidated financial statementsConsolidated Financial Statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires managementus to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statementsConsolidated Financial Statements and the amounts of revenues and expenses reported during the period. Actual results may differ from those estimates.

CNA’s

Our Consolidated Financial Statements and accompanying notes have been prepared in accordance with GAAP applied on a consistent basis. CNAWe continually evaluatesevaluate the accounting policies and estimates used to prepare the Consolidated Financial Statements. In general, management’sour 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 estimates discussed below are considered by managementus to be critical to an understanding of CNA’sour Consolidated Financial Statements as their application places the most significant demands on management’sour judgment. Note A of the Consolidated Financial Statements included under Item 8 should be read in conjunction with this section to assist with obtaining an understanding of the underlying accounting policies related to these estimates. Due to the inherent uncertainties involved with this typethese types of judgment,judgments, actual results could differ significantly from estimates and may have a material adverse impact on the Company’sour results of operations and/or equity.

Insurance Reserves

Insurance reserves are established for both short and long-duration insurance contracts. Short-duration contracts are primarily related to property and casualty insurance policies where the reserving process is based on actuarial estimates of the amount of loss, including amounts for known and unknown claims. Long-duration contracts typically include traditional life insurance and long term care products and are estimated using actuarial estimates about mortality and morbidity, as well as assumptions about expected investment returns. Workers compensation lifetime claim reserves and accident and health claim reserves are calculated using mortality and morbidity assumptions based on Company and industry experience, and are discounted at interest rates that range from 3.5% to 6.5% at December 31, 2004 and 2003. The reserve for unearned premiums on property and casualty and accident and health contracts represents the portion of premiums written related to the unexpired terms of coverage. The inherent risks associated with the reserving process are discussed in the Reserves Estimates and Uncertainties section below.

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 ceding of insurance does not discharge theus of our primary liability ofunder insurance contracts written by us. An exposure exists with respect to property and casualty and life reinsurance ceded to the Company.extent that any reinsurer is unable to meet its obligations or disputes the liabilities assumed under reinsurance agreements. An estimated allowance for doubtful accounts is recorded on the basis of periodic evaluations of balances due from reinsurers, reinsurer solvency, management’sour past experience and current economic conditions.
Reinsurance accounting allows for contractual cash flows to be reflected as premiums and losses, as compared to deposit accounting, which requires cash flows to be reflected as assets and liabilities. To qualify for reinsurance accounting, reinsurance agreements must include risk transfer. Considerable judgment by management may be necessary to determine if risk transfer requirements are met. We believe we have appropriately applied reinsurance accounting principles in our evaluation of risk transfer. However, our evaluation of risk transfer and the resulting accounting could be challenged in connection with regulatory reviews or possible changes in accounting and/or financial reporting rules related to reinsurance, which could materially adversely affect our results of operations and/or equity. Further information on our reinsurance program is providedincluded in the Reinsurance section below.below and Note H of the Consolidated Financial Statements included under Item 8.

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Valuation of Investments and Impairment of Securities

Invested assets are exposed to various risks, such as interest rate, market and credit risks. 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’sour results of operations or equity.

The Company’s

Our investment portfolio is subject to market declines below book value that may be other-than-temporary. The Company hasWe have an impairment committee,Impairment Committee, which reviews the investment portfolio on a quarterly basis, with ongoing analysis as new information becomes available. Any decline that is determined to be other-than-temporary is recorded as an other-than-temporary impairment loss in the results of operations in the period in which the determination occurred.

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The Company continues to monitor potential changes in authoritative guidance related to recognizing other-than-temporary impairments. Any such changes may cause the Company to recognize impairment losses in results of operations which would not be recognized under the current guidance, or to recognize such losses in earlier periods, especially those due to increases in interest rates. Such changes could also impact the recognition of investment income on impaired securities. While the impact of changes in authoritative guidance could increase earnings volatility in future periods, because fluctuations in the fair value of securities are already reflected in shareholders’ equity, any changes would not be expected to have a significant impact on equity. Further information on the Company’sour process for evaluating impairments is providedincluded in Note B of the Investments section below.

Consolidated Financial Statements included under Item 8.

Long Term Care Products

The Company’s reserves

Reserves and deferred acquisition costs for itsour long term care product offeringsproducts are based on certain assumptions including morbidity, policy persistency and interest rates. Actual experience may differ from these assumptions. The recoverability of deferred acquisition costs and the adequacy of the reserves are contingent on actual experience related to these key assumptions and other factors including potential future premium increases andsuch as future health care cost trends. The results of operations and/or equity may be materially, adversely affected ifIf actual experience varies significantlydiffers from these assumptions.

assumptions, the deferred acquisition costs may not be fully recovered and the reserves may not be adequate, requiring us to add to reserves, or take unfavorable development. Therefore, our financial results could be adversely impacted.

Pension and Postretirement Benefit Obligations

The Company is required to

We make a significant number of assumptions in order to estimateestimating the liabilities and costs related to itsour pension and postretirement benefit obligations to employees under itsour benefit plans. The assumptions that have the most impact on pensionthese costs are the discount rate, the expected return on plan assets and the rate of compensation increases. These assumptions are evaluated relative to current market factors such as inflation, interest rates and fiscal and monetary policies. Changes in these assumptions can have a material impact on pension obligations and pension expense.
In determining the discount rate assumption, we utilized current market information, including a discounted cash flow analysis of our pension and postretirement obligations and general movements in the current market environment. In particular, the basis for our discount rate selection was fixed income debt securities that receive one of the two highest ratings given by a recognized rating agency. In 2006 and historically, the Moody’s Aa Corporate Bond Index was the benchmark for discount rate selection. The index is used as the basis for the change in discount rate from the last measurement date. Additionally, we have supplemented our discount rate decision with a yield curve analysis. The yield curve was applied to expected future retirement plan payments to adjust the discount rate to reflect the cash flow characteristics of the plans. The yield curve is a hypothetical double A yield curve represented by a series of annualized discount rates reflecting bond issues having a rating of Aa or better by Moody’s Investors Service, Inc. or a rating of AA or better by Standard & Poor’s. Based on all available information, it was determined that 5.750% and 5.625% were the appropriate discount rates as of December 31, 2006 to calculate our accrued pension and postretirement liabilities, respectively. Accordingly, the 5.750% and 5.625% rates will also be used to determine our 2007 pension and postretirement expense. At December 31, 2005, the discount rates used to calculate our accrued pension and postretirement liabilities were 5.625% and 5.500% respectively.
Further information on the Company’sour pension and postretirement benefit obligations is included in Note J of the Consolidated Financial Statements included under Item 8.

Legal Proceedings

The Company is

We are involved in various legal proceedings that have arisen during the ordinary course of business. The Company evaluatesWe evaluate the facts and circumstances of each situation, and when the Company determineswe determine it is necessary, a liability is estimated and recorded. Further information on the Company’sour legal proceedings and related contingent liabilities is provided in NoteNotes F and G of the Consolidated Financial Statements included under Item 8.

Loans to National Contractor

CNA Surety has provided significant surety bond protection for a large national contractor that undertakes projects for the construction of government and private facilities, a substantial portion of which have been reinsured by CCC. In order to help this contractor meet its liquidity needs and complete projects which had been bonded by CNA Surety, commencing in 2003 CNAF has provided loans to the contractor through a credit facility. In December of 2004, the credit facility was amended to increase the maximum available loans to $106 million from $86 million. The amendment also provides that CNAF may in its sole discretion further increase the amounts available for loans under the credit facility, up to an aggregate maximum of $126 million. As of December 31, 2004 and 2003, there were $99 million and $80 million of total debt outstanding under the credit facility. Additional loans in January and February of 2005 brought the total debt outstanding under the credit facility, less accrued interest, to $104 million as of February 24, 2005. Loews, through a participation agreement with CNAF, provided funds for and owned a participation of $29 million and $25 million of the loans outstanding as of December 31, 2004 and 2003, and has agreed to participation of one-third of any additional loans which may be made above the original $86 million credit facility limit up to the $126 million maximum available line.

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In connection with the amendment to increase the maximum available line under the credit facility in December of 2004, the term of the loan under the credit facility was extended to mature in March of 2009 and the interest rate was reduced prospectively from 6% over prime rate to 5% per annum, effective as of December 27, 2004, with an additional 3% interest accrual when borrowings under the facility are at or below the original $86 million limit. Loans under the credit facility are secured by a pledge of substantially all of the assets of the contractor and certain of its affiliates. In connection with the credit facility, CNAF has also guaranteed or provided collateral for letters of credit which are charged against the maximum available line and, if drawn upon, would be treated as loans under the credit facility. As of December 31, 2004 and 2003, these guarantees and collateral obligations aggregated $13 million and $7 million.

As of December 31, 2004, the aggregate amount of outstanding principal and accrued interest under the credit facility was $70 million, net of participation by Loews in the amount of $29 million.

The contractor implemented a restructuring plan intended to reduce costs and improve cash flow, and appointed a chief restructuring officer to manage execution of the plan. In the course of addressing various expense, operational and strategic issues, however, the contractor has decided to substantially reduce the scope of its original business and to concentrate on those segments determined to be potentially profitable. As a consequence, operating cash flow, and in turn the capacity to service debt, has been reduced below previous levels. Restructuring plans have also been extended to accommodate these circumstances. In light of these developments, CNA has taken an impairment charge of $56 million pretax ($36 million after-tax) for the fourth quarter of 2004, net of the participation by Loews, with respect to amounts loaned under the facility. Any draws under the credit facility beyond $106 million or further changes in the national contractor’s business plan or projections may necessitate further impairment charges. Indemnification and subrogation rights, including rights to contract proceeds on construction projects in the event of default, exist that reduce CNA Surety’s and ultimately the Company’s exposure to loss. While CNAF believes that the contractor’s restructuring efforts may be successful and provide sufficient cash flow for its operations, the contractor’s failure to achieve its restructuring plan or perform its contractual obligations under the credit facility or under the Company’s surety bonds could have a material adverse effect on the Company’s results of operations and/or equity. If such failures occur, the Company estimates the surety loss, net of indemnification and subrogation recoveries, but before the effects of minority interest, to be approximately $200 million pretax. In addition, such failures could cause the remaining unimpaired amount due under the credit facility to be uncollectible.

Further information on the Company’s exposure to this national contractor and this credit agreement are provided in Note S of the Consolidated Financial Statements included under Item 8 and the Liquidity and Capital Resources section below.

Reserves - - Estimates and Uncertainties

The Company maintains

We maintain reserves to cover itsour estimated ultimate unpaid liability for claim and claim adjustment expenses, including the estimated cost of the claims adjudication process, for claims that have been reported but not yet settled (case

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(case reserves) and claims that have been incurred but not reported (IBNR). Claim and claim adjustment expense reserves are reflected as liabilities and are included on the Consolidated Balance Sheets under the heading “Insurance Reserves.” Adjustments to prior year reserve estimates, if necessary, are reflected in the results of operations in the period that the need for such adjustments is determined. The carried case and IBNR reserves are provided in the Segment Results section of this MD&A and in Note F of the Consolidated Financial Statements included under Item 8.

The level of reserves maintained by the Companywe maintain represents management’sour best estimate, as of a particular point in time, of what the ultimate settlement and administration of claims will cost based on itsour assessment of facts and circumstances known at that time. Reserves are not an exact calculation of liability but instead are complex estimates that are derived by the Company,we derive, generally utilizing a variety of actuarial reserve estimation techniques, from numerous assumptions and expectations about future events, both internal and external, many of which are highly uncertain.

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Among the many uncertain future events about which the Company makes assumptions and estimates, many of which have become increasingly unpredictable, are claims severity, frequency of claims, mortality, morbidity, expected interest rates, inflation, claims handling and case reserving policies and procedures, underwriting and pricing policies, changes in the legal and regulatory environment and the lag time between the occurrence of an insured event and the time it is ultimately settled, referred to in the insurance industry as the “tail.” These factors must be individually considered in relation to the Company’s evaluation of each type of business. Many of these uncertainties are not precisely quantifiable, particularly on a prospective basis, and require significant management judgment.

Given the factors described above, it is not possible to quantify precisely the ultimate exposure represented by claims and related litigation. As a result, the Company regularly reviews the adequacy of its reserves and reassesses its reserve estimates as historical loss experience develops, additional claims are reported and settled and additional information becomes available in subsequent periods.

In addition, the Company is subject to the uncertain effects of emerging or potential claims and coverage issues that arise as industry practices and legal, judicial, social and other environmental conditions change. These issues have had, and may continue to have, a negative effect on the Company’s business by either extending coverage beyond the original underwriting intent or by increasing the number or size of claims. Recent examples of emerging or potential claims and coverage issues include:

•  increases in the number and size of water damage claims, including those related to expenses for testing and remediation of mold conditions;
•  increases in the number and size of claims relating to injuries from medical products, and exposure to lead;
•  the effects of accounting and financial reporting scandals and other major corporate governance failures, which have resulted in an increase in the number and size of claims, including director and officer and errors and omissions insurance claims;
•  class action litigation relating to claims handling and other practices;
•  increases in the number of construction defect claims, including claims for a broad range of additional insured endorsements on policies; and
•  increases in the number of claims alleging abuse by members of the clergy.

The impact of these and other unforeseen emerging or potential claims and coverage issues is difficult to predict and could materially adversely affect the adequacy of the Company’s claim and claim adjustment expense reserves and could lead to future reserve additions. See the Segment Results sections of this MD&A for a discussion of changes in reserve estimates and the impact on the Company’s results of operations.

The Company’sOur experience has been that establishing reserves for casualty coverages relating to APMTasbestos, environmental pollution and mass tort (APMT) claim and claim adjustment expenses is subject to uncertainties that are greater than those presented by other claims. Estimating the ultimate cost of both reported and unreported APMT claims is subject to a higher degree of variability due to a number of additional factors, including among others:

 coverage issues, including whether certain costs are covered under the policies and whether policy limits apply;
 inconsistent court decisions and developing legal theories;
 •  increasinglycontinuing aggressive tactics of plaintiffs’ lawyers;
 the risks and lack of predictability inherent in major litigation;

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 changes in the volume of asbestos and environmental pollution and mass tortAPMT claims which cannot now be anticipated;
•  continued increase in mass tort claims relating to silica and silica-containing products;
 the impact of the exhaustion of primary limits and the resulting increase in claims on any umbrella or excess policies the Company haswe have issued;
 the number and outcome of direct actions against the Company;us; and
 •  the Company’sour ability to recover reinsurance for asbestos and environmental pollution and mass tortAPMT claims.

It is also not possible to predict changes in the legal and legislative environment and the impact on the future development of APMT claims. This development will be affected by future court decisions and interpretations, as well as changes in applicable legislation. It is difficult to predict the ultimate outcome of large coverage disputes until settlement negotiations near completion and significant legal questions are resolved or, failing settlement, until the dispute is adjudicated. This is particularly the case with policyholders in bankruptcy where negotiations often involve a large number of claimants and other parties and require court approval to be effective. A further uncertainty exists as to whether a national privately financed trust to replace litigation of asbestos claims with payments to claimants from the trust will be established and approved through federal legislation, and, if established and approved, whether it will contain funding requirements in excess of the Company’sour carried loss reserves.

Due to the factors described above, among others, establishing reserves for APMT claim and claim adjustment expenses is subject to uncertainties that are greater than those presented by other claims.

Traditional actuarial methods and techniques employed to estimate the ultimate cost of claims for more traditional property and casualty exposures are less precise in estimating claim and claim adjustment reserves for APMT, particularly in an environment of emerging or potential claims and coverage issues that arise from industry practices and legal, judicial and social conditions. Therefore, these traditional actuarial methods and techniques are necessarily supplemented with additional estimation techniques and methodologies, many of which involve significant judgments that are required of management. For APMT, we regularly monitor our exposures, including reviews of loss activity, regulatory developments and court rulings. In addition, we perform a comprehensive ground up analysis on our exposures annually. Our actuaries, in conjunction with our specialized claim unit, use various modeling techniques to estimate our overall exposure to known accounts. We use this information and additional modeling techniques to develop loss distributions and claim reporting patterns to determine reserves for accounts that will report APMT exposure in the future. Estimating the average claim size requires analysis of the impact of large losses and claim cost trend based on changes in the cost of repairing or replacing property, changes in the cost of legal fees, judicial decisions, legislative changes, and other factors. Due to the inherent uncertainties in estimating reserves for APMT claim and claim adjustment expenses and the degree of variability due to, among other things, the factors described above, the Companywe may be required to record material changes in itsour claim and claim adjustment expense reserves in the future, should new information become available or other developments emerge.

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See the Asbestos and Environmental Pollution and Mass TortAPMT Reserves section of this MD&A and Note F of the Consolidated Financial Statements included under Item 8 for additional information relating to APMT claims and reserves.
In addition, we are subject to the uncertain effects of emerging or potential claims and coverage issues that arise as industry practices and legal, judicial, social and other environmental conditions change. These issues have had, and may continue to have, a negative effect on our business by either extending coverage beyond the original underwriting intent or by increasing the number or size of claims. Examples of emerging or potential claims and coverage issues include:
increases in the number and size of claims relating to injuries from medical products;
the effects of accounting and financial reporting scandals and other major corporate governance failures, which have resulted in an increase in the number and size of claims, including director and officer and errors and omissions insurance claims;
class action litigation relating to claims handling and other practices;
construction defect claims, including claims for a broad range of additional insured endorsements on policies;
clergy abuse claims, including passage of legislation to reopen or extend various statutes of limitations; and
mass tort claims, including bodily injury claims related to silica, welding rods, benzene, lead and various other chemical exposure claims.
The impact of these and other unforeseen emerging or potential claims and coverage issues is difficult to predict and could materially adversely affect the adequacy of our claim and claim adjustment expense reserves and could lead to future reserve additions. See the Segment Results sections of this MD&A and Note F of the Consolidated Financial Statements included under Item 8 for a discussion of changes in reserve estimates and the impact on our results of operations.
Establishing Reserve Estimates
In developing claim and claim adjustment expense (“loss” or “losses”) reserve estimates, our actuaries perform detailed reserve analyses that are staggered throughout the year. The data is organized at a “product” level. A product can be a line of business covering a subset of insureds such as commercial automobile liability for small and middle market customers, it can encompass several lines of business provided to a specific set of customers such as dentists, or it can be a particular type of claim such as construction defect. Every product is analyzed at least once during the year, and many products are analyzed multiple times. The analyses generally review losses gross of ceded reinsurance and apply the ceded reinsurance terms to the gross estimates to establish estimates net of reinsurance. In addition to the detailed analyses, we review actual loss emergence for all products each quarter.
The detailed analyses use a variety of generally accepted actuarial methods and techniques to produce a number of estimates of ultimate loss. We determine a point estimate of ultimate loss by reviewing the various estimates and assigning weight to each estimate given the characteristics of the product being reviewed. The reserve estimate is the difference between the estimated ultimate loss and the losses paid to date. The difference between the estimated ultimate loss and the case incurred loss (paid loss plus case reserve) is IBNR. IBNR calculated as such includes a provision for development on known cases (supplemental development) as well as a provision for claims that have occurred but have not yet been reported (pure IBNR).
Most of our business can be characterized as long-tail. For long tail business, it will generally be several years between the time the business is written and the time when all claims are settled. Our long-tail exposures include commercial automobile liability, workers’ compensation, general liability, medical malpractice, other professional liability coverages, assumed reinsurance run-off and products liability. Short-tail exposures include property, commercial automobile physical damage, marine and warranty. Each of our property/casualty segments, Standard Lines, Specialty Lines and Corporate and Other Non-Core, contain both long-tail and short-tail exposures.
The methods used to project ultimate loss for both long-tail and short-tail exposures include, but are not limited to, the following:
Paid Development,
Incurred Development,

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Loss Ratio,
Bornhuetter-Ferguson Using Premiums and Paid Loss,
Bornhuetter-Ferguson Using Premiums and Incurred Loss, and
Average Loss.
The Company’spaid development method estimates ultimate losses by reviewing paid loss patterns and applying them to accident years with further expected changes in paid loss. Selection of the paid loss pattern requires analysis of several factors including the impact of inflation on claims costs, the rate at which claims professionals make claim payments and close claims, the impact of judicial decisions, the impact of underwriting changes, the impact of large claim payments and other factors. Claim cost inflation itself requires evaluation of changes in the cost of repairing or replacing property, changes in the cost of medical care, changes in the cost of wage replacement, judicial decisions, legislative changes and other factors. Because this method assumes that losses are paid at a consistent rate, changes in any of these factors can impact the results. Since the method does not rely on case reserves, it is not directly influenced by changes in the adequacy of case reserves.
For many products, paid loss data for recent periods may be too immature or erratic for accurate predictions. This situation often exists for long-tail exposures. In addition, changes in the factors described above may result in inconsistent payment patterns. Finally, estimating the paid loss pattern subsequent to the most mature point available in the data analyzed often involves considerable uncertainty for long-tail products such as workers’ compensation.
The incurred development method is similar to the paid development method, but it uses case incurred losses instead of paid losses. Since the method uses more data (case reserves in addition to paid losses) than the paid development method, the incurred development patterns may be less variable than paid patterns. However, selection of the incurred loss pattern requires analysis of all of the factors above. In addition, the inclusion of case reserves can lead to distortions if changes in case reserving practices have taken place, and the use of case incurred losses may not eliminate the issues associated with estimating the incurred loss pattern subsequent to the most mature point available.
The loss ratio method multiplies premiums by an expected loss ratio to produce ultimate loss estimates for each accident year. This method may be useful if loss development patterns are inconsistent, losses emerge very slowly, or there is relatively little loss history from which to estimate future losses. The selection of the expected loss ratio requires analysis of loss ratios from earlier accident years or pricing studies and analysis of inflationary trends, frequency trends, rate changes, underwriting changes, and other applicable factors.
The Bornhuetter-Ferguson using premiums and paid loss method is a combination of the paid development approach and the loss ratio approach. The method normally determines expected loss ratios similar to the approach used to estimate the expected loss ratio for the loss ratio method and requires analysis of the same factors described above. The method assumes that only future losses will develop at the expected loss ratio level. The percent of paid loss to ultimate loss implied from the paid development method is used to determine what percentage of ultimate loss is yet to be paid. The use of the pattern from the paid development method requires consideration of all factors listed in the description of the paid development method. The estimate of losses yet to be paid is added to current paid losses to estimate the ultimate loss for each year. This method will react very slowly if actual ultimate loss ratios are different from expectations due to changes not accounted for by the expected loss ratio calculation.
The Bornhuetter-Ferguson using premiums and incurred loss method is similar to the Bornhuetter-Ferguson using premiums and paid loss method except that it uses case incurred losses. The use of case incurred losses instead of paid losses can result in development patterns that are less variable than paid patterns. However, the inclusion of case reserves can lead to distortions if changes in case reserving have taken place, and the method requires analysis of all the factors that need to be reviewed for the loss ratio and incurred development methods.
The average loss method multiplies a projected number of ultimate claims by an estimated ultimate average loss for each accident year to produce ultimate loss estimates. Since projections of the ultimate number of claims are often less variable than projections of ultimate loss, this method can provide more reliable results for products where loss development patterns are inconsistent or too variable to be relied on exclusively. In addition, this method can more directly account for changes in coverage that impact the number and size of claims. However, this method can be difficult to apply to situations where very large claims or a substantial number of unusual claims result in volatile average claim sizes. Projecting the ultimate number of claims requires analysis of several factors including the rate

26


at which policyholders report claims to us, the impact of judicial decisions, the impact of underwriting changes and other factors. Estimating the ultimate average loss requires analysis of the impact of large losses and claim cost trend based on changes in the cost of repairing or replacing property, changes in the cost of medical care, changes in the cost of wage replacement, judicial decisions, legislative changes and other factors.
For other more complex products where the above methods may not produce reliable indications, we use additional methods tailored to the characteristics of the specific situation. Such products include construction defect losses and APMT.
For construction defect losses, our actuaries organize losses by report year. Report year groups claims by the year in which they were reported. To estimate losses from claims that have not been reported, various extrapolation techniques are applied to the pattern of claims that have been reported to estimate the number of claims yet to be reported. This process requires analysis of several factors including the rate at which policyholders report claims to us, the impact of judicial decisions, the impact of underwriting changes and other factors. An average claim size is determined from past experience and applied to the number of unreported claims to estimate reserves for these claims.
For many exposures, especially those that can be considered long-tail, a particular accident year may not have a sufficient volume of paid losses to produce a statistically reliable estimate of ultimate losses. In such a case, our actuaries typically assign more weight to the incurred development method than to the paid development method. As claims continue to settle and the volume of paid loss increases, the actuaries may assign additional weight to the paid development method. For most of our products, even the incurred losses for accident years that are early in the claim settlement process will not be of sufficient volume to produce a reliable estimate of ultimate losses. In these cases, we will not assign any weight to the paid and incurred development methods. We will use loss ratio, Bornhuetter-Ferguson and average loss methods. For short-tail exposures, the paid and incurred development methods can often be relied on sooner primarily because our history includes a sufficient number of years to cover the entire period over which paid and incurred losses are expected to change. However, we may also use loss ratio, Bornhuetter-Ferguson and average loss methods for short-tail exposures.
Periodic Reserve Reviews
The reserve analyses performed by our actuaries result in point estimates. Each quarter, the results of the detailed reserve reviews are summarized and discussed with our senior management to determine the best estimate of reserves. This group considers many factors in making this decision. The factors include, but are not limited to, the historical pattern and volatility of the actuarial indications, the sensitivity of the actuarial indications to changes in paid and incurred loss patterns, the consistency of claims handling processes, the consistency of case reserving practices, changes in our pricing and underwriting, and overall pricing and underwriting trends in the insurance market.
Our recorded reserves including APMT reserves, reflect management’sour best estimate as of a particular point in time based upon known facts, current law and management’sour judgment. The reserve analyses performed by the Company’s actuaries result in point estimates. Management uses these point estimates as the primary factor in determining the carried reserve. The carried reserve may differ from the actuarial point estimate as the result of management’sour consideration of the factors noted above including, but not limited to,as well as the potential volatility of the projections associated with the specific product being analyzed and the effects of changes in claims handling, underwriting and other factors impacting claims costs that may not be quantifiable through actuarial analysis. For APMT reserves, the reserve analysis performed by the Company’s actuariesThis process results in both a pointmanagement’s best estimate and a range. Management uses the point estimatewhich is then recorded as the primary factor in determining the carried reserve but also considers the range given the volatility of APMT exposures, as noted above.

For Standard Lines, the December 31, 2004 carried net claim and claim adjustment expense reserve isloss reserve.

Currently, our reserves are slightly higher than the actuarial point estimate. We do not establish a specific provision for uncertainty. For Specialty Lines, the December 31, 2004 carried net claim and claim adjustment expense reserve is also slightly higher than the actuarial point estimate. For both Standard Lines and Specialty Lines, the difference between our reserves and the actuarial point estimate is primarily due to the 2004two most recent complete accident year.years. The claim data from the currentthese accident yearyears is very immature from a claim and claim adjustment expense point of view soimmature. We believe it is prudent to wait until actual experience confirms that the loss ratiosreserves should be adjusted. For Corporate and Other Non-Core, the December 31, 2004 carried net claim and claim adjustment expense reserve is slightly higher than the actuarial point estimate. While the

28


actuarial estimates for APMT exposures reflect current knowledge, management feelswe feel it is prudent, based on the history of developments in this area, to reflect some volatilitymargin in the carried reserve until the ultimate outcome of the issues associated with these exposures is clearer.

The key assumptions fundamental to the reserving process are often different for various products and accident years. Some of these assumptions are explicit assumptions that are required of a particular method, but most of the assumptions are implicit and cannot be precisely quantified. An example of an explicit assumption is the pattern employed in the paid development method. However, the assumed pattern is itself based on several implicit assumptions such as the impact of inflation on medical costs and the rate at which claim professionals close claims.

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As a result, the effect on reserve estimates of a particular change in assumptions usually cannot be specifically quantified, and changes in these assumptions cannot be tracked over time.
Our recorded reserves are management’s best estimate. In order to provide an indication of the variability associated with our net reserves, the following discussion provides a sensitivity analysis that shows the approximate estimated impact of variations in the most significant factor affecting our reserve estimates for particular types of business. These significant factors are the ones that could most likely materially impact the reserves. This discussion covers the major types of business for which we believe a material deviation to our reserves is reasonably possible. There can be no assurance that actual experience will be consistent with the current assumptions or with the variation indicated by the discussion. In addition, there can be no assurance that other factors and assumptions will not have a material impact on our reserves.
Within Standard Lines, the two types of business for which we believe a material deviation to our net reserves is reasonably possible are workers’ compensation and general liability.
For Standard Lines workers’ compensation, since many years will pass from the time the business is written until all claim payments have been made, claim cost inflation on claim payments is the most significant factor affecting workers’ compensation reserve estimates. Workers’ compensation claim cost inflation is driven by the cost of medical care, the cost of wage replacement, expected claimant lifetimes, judicial decisions, legislative changes and other factors. If estimated workers’ compensation claim cost inflation increases by one point for the entire period over which claim payments will be made, we estimate that our net reserves would increase by approximately $500 million. If estimated workers’ compensation claim cost inflation decreases by one point for the entire period over which claim payments will be made, we estimate that our net reserves would decrease by approximately $450 million. Our net reserves for Standard Lines workers’ compensation were approximately $4.4 billion at December 31, 2006.
For Standard Lines general liability, the predominant method used for estimating reserves is the incurred development method. Changes in the cost to repair or replace property, the cost of medical care, the cost of wage replacement, judicial decisions, legislation and other factors all impact the pattern selected in this method. The pattern selected results in the incurred development factor that estimates future changes in case incurred loss. If the estimated incurred development factor for general liability increases by 15%, we estimate that our net reserves would increase by approximately $370 million. If the estimated incurred development factor for general liability decreases by 13%, we estimate that our net reserves would decrease by approximately $320 million. Our net reserves for Standard Lines general liability were approximately $4.0 billion at December 31, 2006.
Within Specialty Lines, we believe a material deviation to our net reserves is reasonably possible for the US Specialty Lines group. This group provides professional liability coverages to various professional firms, including architects, realtors, small and mid-sized accounting firms, law firms and technology firms. US Specialty Lines also provide D&O, employment practices, fiduciary and fidelity coverages. US Specialty Lines also offers insurance products to serve the healthcare delivery system. The most significant factor affecting US Specialty Lines reserve estimates is claim severity. Claim severity for US Specialty Lines is driven by the cost of medical care, the cost of wage replacement, legal fees, judicial decisions, legislation and other factors. Underwriting and claim handling decisions such as the classes of business written and individual claim settlement decisions can also impact claim severity. If the estimated claim severity for US Specialty Lines increases by 7%, we estimate that US Specialty Lines net reserves would increase by approximately $270 million. If the estimated claim severity for US Specialty Lines decreases by 3%, we estimate that US Specialty net reserves would decrease by approximately $110 million. Our net reserves for US Specialty Lines were approximately $3.9 billion at December 31, 2006.
Within Corporate and Other Non-Core, the two types of business for which we believe a material deviation to our net reserves is reasonably possible are CNA Re and APMT.
For CNA Re, the predominant method used for estimating reserves is the incurred development method. Changes in the cost to repair or replace property, the cost of medical care, the cost of wage replacement, the rate at which ceding companies report claims, judicial decisions, legislation and other factors all impact the incurred development pattern for CNA Re. The pattern selected results in the incurred development factor that estimates future changes in case incurred loss. If the estimated incurred development factor for CNA Re increases by 21%, we estimate that our net reserves for CNA Re would increase by approximately $150 million. If the estimated incurred development factor for CNA Re decreases by 21%, we estimate that our net reserves would decrease by approximately $150 million. Our net reserves for CNA Re were approximately $1.2 billion at December 31, 2006.

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For APMT, the most significant factor affecting reserve estimates is overall account size trend. Overall account size trend for APMT reflects the combined impact of economic trends (inflation), changes in the types of defendants involved, the expected mix of asbestos disease types, judicial decisions, legislation and other factors. If the estimated overall account size trend for APMT increases by 4 points, we estimate that our APMT net reserves would increase by approximately $700 million. If the estimated overall account size trend for APMT decreases by 4 points, we estimate that our APMT net reserves would decrease by approximately $400 million. Our net reserves for APMT were approximately $1.9 billion at December 31, 2006.
Given the factors described above, it is not possible to quantify precisely the ultimate exposure represented by claims and related litigation. As a result, we regularly review the adequacy of our reserves and reassess our reserve estimates as historical loss experience develops, additional claims are reported and settled and additional information becomes available in subsequent periods.
In light of the many uncertainties associated with establishing the estimates and making the assumptions necessary to establish reserve levels, the Company reviews itswe review our reserve estimates on a regular basis and makesmake adjustments in the period that the need for such adjustments is determined (see discussion on net prior year development above).determined. These reviews have resulted in the Company identifyingour identification of information and trends that have caused the Companyus to increase itsour reserves in prior periods and could lead to the identification of a need for additional material increases in claim and claim adjustment expense reserves, which could materially adversely affect the Company’sour results of operations, equity, business and insurer financial strength and debt ratings (seeratings. See the Ratings section of this MD&A).

&A for further information regarding our financial strength and debt ratings.

Reinsurance
Due to significant catastrophes during 2005, the cost of our catastrophe reinsurance program has increased. Our catastrophe reinsurance protection cost us premiums of approximately $64 million in 2005, including reinstatement premiums and cost us approximately $79 million in 2006, which did not include any reinstatement premiums. During 2007, our catastrophe reinsurance program will cost us $89 million before the impact of any reinstatement premiums.
The following table presents estimated volatility in carried claim and claim adjustment expense reservesterms of our 2007 catastrophe programs are different than those of our 2006 programs. The Corporate Property Catastrophe treaty provides coverage for the Standard Lines, Specialty Linesaccumulation of losses between $300 million and Corporate$1 billion arising out of a single catastrophe occurrence in the United States, its territories and Other Non-Core segments.possessions, and Canada. Our co-participation is 50% of the first $100 million layer and 10% of the remaining layer. In addition, we previously purchased an aggregate property catastrophe treaty to obtain reinsurance protection against the gross carried loss reserves presented below, Claim and Claim Adjustment Expense Reserves as reflected on the Consolidated Balance Sheet include $3,680 million at December 31, 2004, related to the Life and Group Non-Core segment.

Estimated Volatility in Gross Carried Loss Reserves by Segment

         
  Gross  
  Carried Estimated
  Loss Volatility in
December 31, 2004 Reserves Reserves
(In millions) 
 
Standard Lines $14,302   +/- 7%
Specialty Lines  4,860   +/- 7%
Corporate and Other Non-Core  8,678   +/- 25%

The estimated volatility noted above doesaggregation of losses from multiple catastrophic events. We did not representpurchase an actuarial range around the Company’s gross loss reserves, and it does not represent the range of all possible outcomes. The volatility represents an estimate of the inherent volatility associated with estimating loss reservesaggregate property catastrophe treaty for the specific type of business written by each segment, and along with the associated reserve balances, allows for the quantification of potential earnings impacts in future reporting periods. The primary characteristics influencing the estimated level of volatility are the length of the claim settlement period, the potential for changes in medical and other claim costs, changes in the level of litigation or other dispute resolution processes, changes in the legal environment and the potential for different types of injuries emerging. Ceded reinsurance arrangements may reduce the volatility. Since ceded reinsurance arrangements vary by year, volatility in gross reserves may not result in comparable impacts to net income or shareholders’ equity.

Reinsurance

CNA assumes and cedes reinsurance to other insurers, reinsurers and members of various reinsurance pools and associations. CNA utilizes reinsurance arrangements to limit its maximum loss, provide greater diversification of risk, minimize exposures on larger risks and to exit certain lines of business. The ceding of insurance does not discharge the primary liability of the Company. Therefore, a credit exposure exists with respect to property and casualty and life reinsurance ceded to the extent that any reinsurer is unable to meet the obligations or to the extent that the reinsurer disputes the liabilities assumed under reinsurance agreements.

Property and casualty reinsurance coverages are tailored to the specific risk characteristics of each product line and CNA’s retained amount varies by type of coverage. Treaty reinsurance is purchased to protect specific lines of business such as property, worker’s compensation and professional liability. Corporate catastrophe reinsurance is also purchased for property and worker’s compensation exposure. Most treaty reinsurance is purchased on an excess of loss basis. CNA also utilizes facultative reinsurance in certain lines.

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2007.


The Company’s overall reinsurance program includes certain property and casualty contracts, such as the corporate aggregate reinsurance treaties discussed in more detail later in this section, that are entered into and accounted for on a “funds withheld” basis. Under the funds withheld basis, the Company records the cash remitted to the reinsurer for the reinsurer’s margin, or cost of the reinsurance contract, as ceded premiums. The remainder of the premiums ceded under the reinsurance contract not remitted in cash is recorded as funds withheld liabilities. The Company is required to increase the funds withheld balance at stated interest crediting rates applied to the funds withheld balance or as otherwise specified under the terms of the contract. The funds withheld liability is reduced by any cumulative claim payments made by the Company in excess of the Company’s retention under the reinsurance contract. If the funds withheld liability is exhausted, interest crediting will cease and additional claim payments are recoverable from the reinsurer. The funds withheld liability is recorded in reinsurance balances payable in the Consolidated Balance Sheets.

Interest cost on funds withheld and other deposits is credited during all periods in which a funds withheld liability exists. Pretax interest cost, which is included in net investment income, was $267 million, $344 million and $239 million in 2004, 2003 and 2002. The amount subject to interest crediting rates on such contracts was $2,570 million and $2,789 million at December 31, 2004 and 2003. Certain funds withheld reinsurance contracts, including the corporate aggregate reinsurance treaties, require interest on additional premiums arising from ceded losses as if those premiums were payable at the inception of the contract. Additionally, on the corporate aggregate reinsurance treaties discussed below, if the Company exceeds certain aggregate loss ratio thresholds, the rate at which interest charges are accrued would increase and be retroactively applied to the inception of the contract or to a specified date. Any such retroactive interest is accrued in the period the additional premiums arise or the loss ratio thresholds are met. The amount of retroactive interest, included in the totals above, was $46 million, $147 million and $10 million in 2004, 2003 and 2002.

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.

The following table summarizes the amounts receivable from reinsurers at December 31, 2004 and December 31, 2003.

Components of reinsurance receivables

         
  December 31, 2004 December 31, 2003
(In millions) 
 
Reinsurance receivables related to insurance reserves:        
Ceded claim and claim adjustment expense $13,984  $14,216 
Ceded future policy benefits  1,260   1,218 
Ceded policyholders’ funds  65   7 
Billed reinsurance receivables  685   813 
   
 
   
 
 
Reinsurance receivables
  15,994   16,254 
Allowance for uncollectible reinsurance  (531)  (573)
   
 
   
 
 
Reinsurance receivables, net of allowance for uncollectible reinsurance
 $15,463  $15,681 
   
 
   
 
 

The Company has established an allowance for uncollectible reinsurance receivables. The allowance for uncollectible reinsurance receivables was $531 million and $573 million at December 31, 2004 and December 31, 2003. The net decrease in the allowance was primarily due to a release of a previously established allowance related to The Trenwick Group resulting from the execution of commutation agreements in 2004, partially offset by a net increase in the allowance for other reinsurance receivables. The provision incurred related to uncollectible reinsurance receivables is presented as a component of “Insurance claims and policyholders’ benefits” on the Consolidated Statements of Operations.

Prior to the April of 2004 sale of its individual life and annuity business to Swiss Re Life & Health America Inc. (Swiss Re), CNA had reinsured a portion of this business through coinsurance, yearly renewable term and facultative programs to various reinsurers. As a result of the sale of the individual life and annuity business, 100% of the net reserves were reinsured to Swiss Re. Subject to certain exceptions, Swiss Re assumed the credit risk of

30


the business that was previously reinsured to other carriers. As of December 31, 2004, CNA ceded $1,012 million of future policy benefits to Swiss Re. In connection with the sale of the group benefits business, CNA ceded insurance reserves to Hartford Financial Services, Inc. (Hartford). As of December 31, 2004 and 2003, these ceded reserves were $1,726 million and $1,473 million.

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 $4,561 million and $5,255 million at December 31, 2004 and 2003.

In certain circumstances, including significant deterioration of a reinsurer’s financial strength ratings, the Companywe may engage in commutation discussions with individual reinsurers. The outcome of such discussions may result in a lump sum settlement that is less than the recorded receivable, net of any applicable allowance for doubtful accounts. Losses arising from commutations could have an adverse material impact on the Company’sour results of operations or equity.

operations.

In 2003, the Company commuted all remaining ceded and assumed reinsurance contracts with four Gerling entities. The commutations resulted in a pretax loss of $109 million, which was net of a previously established allowance for doubtful accounts of $47 million. The Company has no further exposure to the Gerling companies that are in run-off.

CNA’s largest recoverables from a single reinsurer at December 31, 2004, including prepaid reinsurance premiums, were approximately $2,236 million from subsidiaries of The Allstate Corporation (Allstate), $2,163 million from subsidiaries of Swiss Reinsurance Group, $1,843 million from subsidiaries of Hannover Reinsurance (Ireland), Ltd., $1,726 million from Hartford Life Group Insurance Company, $944 million from American Reinsurance Company and $603 million from subsidiaries of the Berkshire Hathaway Group.

In 2002, the Company2001, we entered into a one-year corporate aggregate reinsurance treaty covering substantially all of the Company’s property and casualty lines of business (the 2002 Cover). Ceded premium related to the reinsurer’s margin of $10 million was recorded in 2002. No losses were ceded during 2002 under this contract, and the 2002 Cover was commuted as of December 31, 2002.

The Company has an aggregate reinsurance treaty related to the 1999 through 2001 accident years that covers substantially all of the Company’s property and casualty lines of business (the Aggregate Cover). The Aggregate Cover provides for two sections of coverage. These coverages attach at defined loss ratios for each accident year. Coverage under the first section of the Aggregate Cover, which is available for all accident years covered by the treaty, has a $500 million limit per accident year of ceded losses and an aggregate limit of $1 billion of ceded losses for the three accident years. The ceded premiums associated with the first section are a percentage of ceded losses and for each $500 million of limit the ceded premium is $230 million. The second section of the Aggregate Cover, which only relates to accident year 2001, provides additional coverage of up to $510 million of ceded losses for a maximum ceded premium of $310 million. Under the Aggregate Cover, interest charges on the funds withheld liability accrue at 8% per annum. The aggregate loss ratio for the three-year period has exceeded certain thresholds which requires additional premiums to be paid and an increase in the rate at which interest charges are accrued. This rate will increase to 8.25% per annum commencing in 2006. Also, if an additional aggregate loss ratio threshold is exceeded, additional premiums of 10% of amounts in excess of the aggregate loss ratio threshold are to be paid retroactively with interest. Any such premiums would be recorded in the period in which the loss ratio threshold is met.

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 $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.

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The impact of the Aggregate Cover was as follows:

Impact of Aggregate Cover

             
Year ended December 31 2004 2003 2002
(In millions) 
 
 
Ceded earned premium $(1) $(258) $ 
Ceded claim and claim adjustment expenses     500    
Interest charges  (82)  (147)  (51)
   
 
   
 
   
 
 
Pretax (expense) benefit
 $(83) $95  $(51)
   
 
   
 
   
 
 

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 theutilized in 2003. In 2006, we commuted our CCC Cover, interest chargesCover. This commutation had no impact on the funds withheld generally accrueConsolidated Statements of Operations for the year ended December 31, 2006.

Also, in 2006, we commuted several reinsurance treaties, including several finite treaties, with a European reinsurance group. This commutation resulted in a pretax loss, net of allowance for uncollectible reinsurance, of $48 million. We received $35 million of cash in connection with this significant commutation.
As of December 31, 2006 and 2005, there were one and thirteen ceded reinsurance treaties inforce respectively that we consider to be finite reinsurance. In 2003, we discontinued purchases of such contracts. The remaining treaty at 8% per annum. TheDecember 31, 2006 provides reinsurance protection for the 1999 accident year on specified portions of our domestic property and casualty business and is fully utilized. Therefore, we do not expect to cede any additional losses under finite reinsurance contracts in future periods nor incur interest rate increases to 10% per annum if the aggregate loss ratio exceeds certain thresholds. In 2004, the aggregate loss ratio exceeded this threshold which required the interest rate to increase retroactively to the beginningcosts.
Further information on our reinsurance program is included in Note H of the contract, generating retroactive interest charges of $46 million which were recorded in 2004.

Consolidated Financial Statements included under Item 8.

At the Company’s discretion, the contract can be commuted annually on the anniversary date of the contract. The CCC Cover requires mandatory commutation on December 31, 2010, if the agreement has not been commuted on or before such date. Upon mandatory commutation of the CCC Cover, the reinsurer is required to release to the Company the existing balance of the funds withheld account if the unpaid ultimate ceded losses at the time of commutation are less than or equal to the funds withheld account balance. If the unpaid ultimate ceded losses at the time of commutation are greater than the funds withheld account balance, the reinsurer will release the existing balance of the funds withheld account and pay CNA the present value of the projected amount the reinsurer would have had to pay from its own funds absent a commutation. The present value is calculated using 1-year LIBOR as of the date of the commutation.

The impact of the CCC Cover was as follows:

Impact of CCC Cover

             
Year ended December 31 2004 2003 2002
(In millions) 
 
 
Ceded earned premium $  $(100) $(101)
Ceded claim and claim adjustment expenses     143   148 
Interest charges  (91)  (59)  (37)
   
 
   
 
   
 
 
Pretax (expense) benefit
 $(91) $(16) $10 
   
 
   
 
   
 
 

The impact by segment of the Aggregate Cover and the CCC Cover was as follows:

Impact of Aggregate Cover and CCC Cover

             
Year ended December 31 2004 2003 2002
(In millions) 
 
 
Standard Lines $(114) $70  $(53)
Specialty Lines  (1)  9   3 
Corporate and Other Non-Core  (59)     9 
   
 
   
 
   
 
 
Pretax (expense) benefit
 $(174) $79  $(41)
   
 
   
 
   
 
 

3229


Terrorism Insurance

CNA

We and the insurance industry incurred substantial losses related to the 2001 World Trade Center event. For the most part, 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.

The Terrorism Risk Insurance Act of 2002 (the Act)(TRIA) established a program within the Department of the Treasury under which insurers are required to offer terrorism insurance and the federal government will share the risk of loss by commercial property and casualty insurers arising from future terrorist attacks. The Act expiresAlthough TRIA expired on December 31, 2005. Each participating2005, the Terrorism Risk Insurance Extension Act of 2005 (TRIEA) extended this program through December 31, 2007 with changes such as the lines of business covered, the deductible amount that must be paid by the insurance company must pay a deductible, ranging from 7% of direct earned premiums from commercial insurance lines in 2003and the aggregate industry loss prior to 15% in 2005, before federal government assistance becomesbecoming 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 Company is required to participate in the program, but it does not cover life or health insurance products. State law limitations applying to premiums and policies for terrorism coverage are not generally affected under the program. The Act requires insurers to offer terrorism coverage through 2004. On June 18, 2004, the Department of the Treasury announced its decision to extend this offer requirement until December 31, 2005.

While the ActTRIEA provides the property and casualty industry with an increased ability to withstand the effect of a terrorist event through 2005,2007, given the unpredictability of the nature, targets, severity or frequency of potential terrorist events, the Company’sour results of operations or equity could nevertheless be materially adversely impacted by them. The Company isWe are attempting to mitigate this exposure through itsour underwriting practices, as well as policy terms and conditions (where applicable). In addition, under stateUnder the laws the Company isof certain states, we are generally prohibited from excluding terrorism exposure from itsour primary workers compensation. Inworkers’ compensation policies. Further, in those states that mandate property insurance coverage of damage from fire following a loss, the Company is alsowe are prohibited from excluding terrorism exposure under such coverage.

Terrorism-related reinsurance losses are not covered byexposure.

Over the Act. The Company’s assumed reinsurance arrangements either exclude terrorism coverage or significantly limit the level of coverage.

The bills described above would extend the Act for two additionalpast several years, and require that terrorism coverage be made available for all years. Deductibles under the bills would be held at 15% in 2006 and raisedwe have been underwriting our business to 20% in 2007. Notwithstanding these developments, enactment of a law extending the Act is not assured.

If the Act is not extended CNA will, among other steps, seek to exclude risks with perceivedmanage our terrorism exposure to the extentthrough strict underwriting standards, risk avoidance measures and conditional terrorism exclusions where permitted by law. Strict underwriting standards and risk avoidance measures will be taken where exclusions are not permitted. Annual policy renewals with effective dates of January 1, 2005 or later will be underwritten with the assumption that the Act will not be extended and that no Federal backstop forThere is substantial uncertainty as to our ability to effectively contain our terrorism exposure will be available. In July 2004, the National Associationsince, notwithstanding our efforts described above, we continue to issue forms of Insurance Commissioners adoptedcoverage, in particular, workers’ compensation, that are exposed to risk of loss from a Model Bulletin available for use in states that intend to approve terrorism coverage limitations in the event the Act is not reauthorized. Since that time, a number of states have announced that they will approve, on an expedited basis, conditional exclusions which fall within certain limitations. Other states appear unlikely to approve terrorism exclusions. There is no assurance that CNA will be able to eliminate or limit terrorism exposure risks in coverages, or that regulatory authorities will approve policy exclusions for terrorism.

event.

Restructuring

In 2001, the Companywe finalized and approved two separate restructuring plans. The first plan related to the Company’s Information Technology operations. The remaining accrual of $3 million was released during 2004. The seconda plan related to restructuring the property and casualty segments and Life and Group Non-Core segment, discontinuation of the variable life and annuity business and consolidation of real estate locations (the 2001 Plan).

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2001 Plan

The overall goal oflocations. During 2006, we reevaluated the 2001 Plan was to create a simplified and leaner organization for customers and business partners. The major components of the plan included a reduction in the number of strategic business units (SBUs) in the property and casualty operations, changes in the strategic focus of the Life and Group Non-Core segment (formerly Life Operations and Group Operations) and consolidation of real estate locations. The reduction in the number of property and casualty SBUs resulted in consolidation of SBU functions, including underwriting, claims, marketing and finance. The strategic changes in Group Operations included a decision to discontinue the variable life and annuity business.

During 2002, $32 million pretax, or $21 million after-tax, of this accrual was reduced. No restructuring or other related charges or releases related to the 2001 Plan were incurred in 2003 or 2004.

All lease termination costs and impaired asset charges, except lease termination costs incurred by operations in the United Kingdom and software write-offs incurred by Life and Group Non-Core segment, were charged to the Corporate and Other Non-Core segment because office closure and consolidation decisions were not within the control of the other segments affected. Lease termination costs incurred in the United Kingdom related solely to the operations of CNA Re. All other charges were recorded in the segment benefiting from the services or existence of an employee or an asset.

The following tables summarize the 2001 Plan Initial Accrual and the activity in that accrual through December 31, 2004 by type of restructuring cost and by segment.

2001 Plan Initial Accrual

                     
  Employee        
  Termination Lease Impaired    
  and Related Termination Asset Other  
  Benefit Costs Costs Charges Costs Total
(In millions) 
 
 
 
 
2001 Plan Initial Accrual $68  $56  $30  $35  $189 
Costs that did not require cash           (35)  (35)
Payments charged against liability  (2)           (2)
   
 
   
 
   
 
   
 
   
 
 
Accrued costs December 31, 2001  66   56   30      152 
Costs that did not require cash  (1)  (3)  (9)     (13)
Payments charged against liability  (53)  (12)  (4)     (69)
Reduction of accrual  (10)  (7)  (15)     (32)
   
 
   
 
   
 
   
 
   
 
 
Accrued costs December 31, 2002  2   34   2      38 
Costs that did not require cash        (1)     (1)
Payments charged against liability  (2)  (15)        (17)
   
 
   
 
   
 
   
 
   
 
 
Accrued costs December 31, 2003     19   1      20 
Payments charged against liability     (5)        (5)
   
 
   
 
   
 
   
 
   
 
 
Accrued costs December 31, 2004
 $  $14  $1  $  $15 
   
 
   
 
   
 
   
 
   
 
 

34


2001 Plan Initial Accrual

                     
              Corporate  
  Standard Specialty Life and Group and Other  
  Lines Lines Non-Core Non-Core Total
(In millions) 
 
 
 
 
2001 Plan Initial Accrual $42  $4  $54  $89  $189 
Costs that did not require cash        (35)     (35)
Payments charged against liability           (2)  (2)
   
 
   
 
   
 
   
 
   
 
 
Accrued costs December 31, 2001  42   4   19   87   152 
Costs that did not require cash           (13)  (13)
Payments charged against liability  (34)  (1)  (18)  (16)  (69)
Reduction of accrual  (7)  (2)  (1)  (22)  (32)
   
 
   
 
   
 
   
 
   
 
 
Accrued costs December 31, 2002  1   1      36   38 
Costs that did not require cash           (1)  (1)
Payments charged against liability  (1)  (1)     (15)  (17)
   
 
   
 
   
 
   
 
   
 
 
Accrued costs December 31, 2003           20   20 
Payments charged against liability           (5)  (5)
   
 
   
 
   
 
   
 
   
 
 
Accrued costs December 31, 2004
 $  $  $  $15  $15 
   
 
   
 
   
 
   
 
   
 
 

Approximately $3 millionsufficiency of the remaining accrual, for the 2001 Plan, primarilywhich related to lease termination costs, and determined that the liability is expected to be paidno longer required as we have completed our lease obligations. As a result, the excess remaining accrual was released in 2005.

Segment Results

2006, resulting in income of $8 million after-tax for the year ended December 31, 2006.

Further information on the restructuring plan is included in Note O of the Consolidated Financial Statements included under Item 8.
SEGMENT RESULTS
The following is a discussion ofdiscusses the results of continuing operations for the Company’sour operating segments. We utilize the net operating income financial measure to monitor our operations. Net operating income is calculated by excluding from net income the after-tax effects of 1) net realized investment gains or losses, 2) income or loss from discontinued operations and 3) cumulative effects of changes in accounting principles. See further discussion regarding how we manage our business in Note N of the Consolidated Financial Statements included under Item 8. In evaluating the results of the Standard Lines and Specialty Lines, management utilizeswe utilize the combined ratio, the loss ratio, the expense ratio and the dividend ratio. These ratios are calculated using GAAP financial results. The loss ratio is the percentage of net incurred claim and claim adjustment expenses to net earned premiums. The expense ratio is the percentage of insurance underwriting and acquisition expenses, including the amortization of deferred acquisition costs, to net earned premiums. The dividend ratio is the ratio of policyholders’ dividends incurred to net earned premiums. The combined ratio is the sum of the loss, expense and dividend ratios.


STANDARD LINES

Business Overview

Standard Lines works with an independent agency distribution system and network of brokers to market a broad range of property and casualty insurance products and services to small, middle-market and large businesses.businesses

30


domestically and abroad. The Standard Lines operating model focuses on underwriting performance, relationships with selected distribution sources and understanding customer needs.

Standard Lines includes Property, Casualty and CNA Global.

Propertyprovides standard and excess property coverage, as well as marine coverage and boiler and machinery to a wide range of businesses.

Casualtyprovides standard casualty insurance products such as workersworkers’ compensation, general and product liability and commercial auto coverage through traditional products to a wide range of businesses. The majority of Casualty 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, Casualty has the capability to offer specialized, loss-sensitive insurance programs to those customers viewed as higher risk and less predictable in exposure.

35


Excess & Surplus (E&S) is included in Casualty. E&S provides specialized insurance and other financial products for selected commercial risks on both an individual customer and program basis. Customers 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’sProperty and Casualty’s agents and brokers. E&S has specialized underwriting and claim resources in Chicago, Denver and Columbus.

Property and Casualty’s(P&C) field structure consists of 33 branch locations across the country organized into 4 regions. Each branch provides the marketing, underwriting and risk control expertise on the entire portfolio of products. The Centralized Processing Operation 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 claims field structure consists of 26a centralized claim center designed to efficiently handle property damage and medical only claims and 18 claim office locations organized into two zones, East and West.around the country handling the more complex claims. Also, Standard Lines primarily through a wholly owned subsidiary, ClaimsPlus, Inc., a third party administrator, began providingprovides total risk management services relating to claim services, risk control, cost management and information services to the large commercial insurance marketplace, in 2003.

through a wholly-owned subsidiary, ClaimsPlus, Inc., a third party administrator.

CNA Globalconsists of Marinesubsidiaries operating in Europe, Latin America, Canada and Global Standard Lines.

Marine serves domestic and global ocean marine needs, with markets extending across North America, Europe and throughout the world. Marine offers hull, cargo, primary and excess marine liability, marine claims and recovery products and services. Business is sold through national brokers, regional marine specialty brokers and independent agencies.

Global Standard Lines is responsible for coordinating and managing the direct business of CNA’s overseasHawaii. These affiliates offer property and casualty operations. This business identifiesinsurance to small and capitalizesmedium size businesses and capitalize on strategic indigenous opportunities and currently has operations in Hawaii, Europe, Latin America and Canada.

opportunities.

The following table details results of operations for Standard Lines.

Results of Operations
                        
Years ended December 31 2004 2003 2002 2006 2005 2004 
(In millions) 
 
 
 
Net written premiums $4,582 $4,561 $4,755  $4,433 $4,382 $4,582 
Net earned premiums 4,917 4,530 4,678  4,413 4,410 4,917 
Income (loss) before net realized investment gains (losses) 221  (951) 169 
Net realized investment gains (losses) 139 234  (79)
Net investment income 991 767 496 
Net operating income (loss) 617  (41) 220 
Net realized investment gains, after-tax 55 9 139 
Net income (loss) 360  (717) 47  672  (32) 359 
 
Ratios  
Loss and loss adjustment expense  70.7%  98.1%  73.1%  70.1%  87.5%  70.8%
Expense 34.6 42.7 31.5  31.1 32.4 34.6 
Dividend 0.2 2.2 1.6  0.4 0.4 0.2 
 
 
 
 
 
 
        
 
Combined  105.5%  143.0%  106.2%  101.6%  120.3%  105.6%
 
 
 
 
 
 
        

2004

2006 Compared with 2003

Net results increased $1,077 million in 2004 as compared with 2003. This improvement was due primarily to decreased unfavorable net prior year development of $912 million after-tax ($1,403 million pretax), a decrease in the bad debt provision recorded for insurance receivables of $57 million after-tax ($88 million pretax), a decrease in the bad debt provision for reinsurance receivables of $48 million after-tax ($74 million pretax), decreased dividend development of $45 million after-tax ($69 million pretax), a decrease in certain insurance related assessments of $35 million after-tax ($54 million pretax) and increased net investment income of $57 million after-tax ($88 million

36

2005


pretax), primarily due to reduced interest charges of $63 million after-tax ($97 million pretax) related to the corporate aggregate and other reinsurance treaties. These favorable items were partially offset by decreased net realized investment results of $95 million after-tax ($142 million pretax) and increased catastrophe losses in 2004. The impact of catastrophes was $183 million after-tax ($282 million pretax) and $71 million after-tax ($110 million pretax) for 2004 and 2003, as discussed below. These catastrophe impacts are net of anticipated reinsurance recoveries, and include the effect of reinstatement premiums and estimated insurance assessments. See the Investments section of the MD&A for further discussion on net investment income and net realized investment gains.

Net written premiums for Standard Lines increased $21$51 million in 20042006 as compared with 2003.2005. This increase was primarily driven by decreasedfavorable new business, rate and retention in the Property lines of business. Net earned premiums ceded of $270increased $3 million to corporate aggregate and other reinsurance treaties in 20042006 as compared with 2003. The 2003 cessions2005. Net earned premiums were principally dueimpacted by decreased favorable premium development in 2006 as compared to the unfavorable net prior year development recorded in 2003. This favorable impact was partially offset by lower new business2005, as competition increases and carriers protect renewals, as well as intentional underwriting actions in business classified as high hazard. Specifically impacting retention was the impact of intentional underwriting actions, including reductions in certain silica-related risks and workers compensation policies classified as high hazard. The net written premium results are consistent with the Company’s strategy ofdiscussed below. We continue to focus on portfolio optimization. The Company’s priority is a diversified portfolio in profitable classes of business.

31


Standard Lines averaged flat rates for 2006, as compared to average rate increasesdecreases of 4%, 16% and 25%1% for 2004, 2003 and 20022005 for the contracts that renewed during those periods. Retention rates of 70%, 72%81% and 69%77% were achieved for those contracts that were up for renewal. Competitive market pressures are expected to continue to contribute to the moderationrenewal in rate increases as the property and casualty market pricing continues to soften.

each period.

Net earned premiumsresults increased $387$704 million in 20042006 as compared with 2003.2005. This increase was attributable to increases in net operating results and net realized investment gains. See the Investments section of this MD&A for further discussion of net investment income and net realized investment gains.
Net operating results increased $658 million in 2006 as compared with 2005. This increase was primarily driven by decreased ceded premiums of $270 million related to corporate aggregate and other reinsurance treaties.

The combined ratio decreased 37.5 pointssignificantly reduced catastrophe losses in 2004 as compared with 2003. The loss ratio decreased 27.4 points2006, an increase in 2004 as compared with 2003. These improvements were primarily due to decreased net unfavorable prior year development of $1,403 millioninvestment income and a decrease in the bad debt provision recorded forunfavorable net prior year development as discussed below. The 2006 net operating results included catastrophe impacts of $31 million after-tax. The 2005 net operating results included catastrophe impacts of $318 million after-tax related to Hurricanes Katrina, Wilma, Rita, Dennis and Ophelia, net of reinsurance receivables of $74 million. These favorable impacts on the 2004recoveries.

The combined ratio improved 18.7 points in 2006 as compared with 2005. The loss ratio were partially offset by increased catastrophe losses. Catastrophe losses of $260 millionimproved 17.4 points due to decreased unfavorable net prior year development as discussed below and $110 million were recorded in 2004 and 2003. The increased 2004decreased catastrophe losses werein 2006. The 2006 and 2005 loss ratios included 1.3 and 11.1 points related to the impact of catastrophes.
The expense ratio improved 1.3 points in 2006 as compared with 2005. This improvement was primarily due to a $235 million loss resulting from Hurricanes Charley, Frances, Ivan and Jeanne.

decrease in the provision for insurance bad debt. In addition, the 2005 ratio included increased ceded commissions as a result of an unfavorable arbitration ruling related to two reinsurance treaties. Changes in estimates for premium taxes partially offset these favorable impacts.

Unfavorable net prior year development of $16$69 million was recorded in 2006, including $157 million of unfavorable claim and allocated claim adjustment expense reserve development and $88 million of favorable premium development. Unfavorable net prior year development of $452 million, including $559 million of unfavorable claim and allocated claim adjustment expense reserve development and $107 million of favorable premium development, was recorded in 2005. Further information on Standard Lines Net Prior Year Development for 2006 and 2005 is included in Note F of the Consolidated Financial Statements included under Item 8.
During 2006 and 2005, we commuted several significant reinsurance contracts that resulted in unfavorable development of $110 million and $285 million, which is included in the development above, and which was partially offset by the release of previously established allowance for uncollectible reinsurance. These commutations resulted in an unfavorable after-tax impact of $31 million and $173 million in 2006 and 2005. Several of the commuted contracts contained interest crediting provisions. The interest charges associated with the reinsurance contracts commuted were $9 million after-tax and $35 million after-tax in 2006 and 2005. The 2005 amount includes the interest charges associated with the contract commuted in 2006. There will be no further interest crediting charges related to these commuted contracts in future periods.
The following table summarizes the gross and net carried reserves as of December 31, 2006 and 2005 for Standard Lines.
Gross and Net Carried
Claim and Claim Adjustment Expense Reserves
         
December 31 2006  2005 
(In millions)        
Gross Case Reserves $6,746  $7,033 
Gross IBNR Reserves  8,188   8,051 
       
         
Total Gross Carried Claim and Claim Adjustment Expense Reserves
 $14,934  $15,084 
       
Net Case Reserves $5,234  $5,165 
Net IBNR Reserves  6,632   6,081 
       
         
Total Net Carried Claim and Claim Adjustment Expense Reserves
 $11,866  $11,246 
       
2005 Compared with 2004
Net written premiums for Standard Lines decreased $200 million in 2005 as compared with 2004. This decrease was primarily driven by decreased premium writings in our casualty lines of business, increased reinstatement

32


premium in 2005 related to catastrophe losses and decreased rates as discussed further below. Net earned premiums decreased $507 million in 2005 as compared with 2004. This decrease was primarily driven by the decline in premiums written. The lower premium is consistent with our strategy of portfolio optimization. Our priority is a diversified portfolio in profitable classes of business.
Standard Lines averaged rate decreases of 1% for 2005, as compared to average rate increases of 4% for 2004 for the contracts that renewed during those periods. Retention rates of 77% and 70% were achieved for those contracts that were up for renewal in each period.
Net results decreased $391 million in 2005 as compared with 2004. This decrease was attributable to declines in both net operating results and net realized investment results. See the Investments section of this MD&A for further discussion of net investment income and net realized investment results.
Net operating results decreased $261 million in 2005 as compared with 2004. This decrease was due primarily to increased unfavorable net prior year development of $282 million after-tax including $113$185 million after-tax related to significant commutations in 2005, a $135 million after-tax increase in catastrophe losses, the decreased earned premium as discussed above and decreased current accident year results. These unfavorable items were partially offset by a $271 million increase in net investment income and a decrease in the provision for insurance bad debt.
Unfavorable net prior year development of $452 million was recorded in 2005, including $559 million of unfavorable claim and allocated claim adjustment expense reserve development and $107 million of favorable premium development. Unfavorable net prior year development of $18 million, including $115 million of unfavorable claim and allocated claim adjustment expense reserve development and $97 million of favorable premium development. Unfavorable net prior year development of $1,419 million, including $939 million of unfavorable claim and allocated claim adjustment expense reserve development and $480 million of unfavorable premium development, was recorded in 2003.

37


The following table summarizes the gross2004. Further information on Standard Lines Net Prior Year Development for 2005 and net carried reserves as of December 31, 2004 and 2003 for Standard Lines.

Gross and Net Carried
Claim and Claim Adjustment Expense Reserves

         
December 31, 2004 2003
(In millions) 
 
Gross Case Reserves $6,904  $6,416 
Gross IBNR Reserves  7,398   7,866 
   
 
   
 
 
Total Gross Carried Claim and Claim Adjustment Expense Reserves
 $14,302  $14,282 
   
 
   
 
 
Net Case Reserves $4,759  $4,585 
Net IBNR Reserves  4,544   4,382 
   
 
   
 
 
Total Net Carried Claim and Claim Adjustment Expense Reserves
 $9,303  $8,967 
   
 
   
 
 

Approximately $190 million of unfavorable net prior year claim and allocated claim adjustment expense development recorded during 2004 resulted from increased severity trends for workers compensation on large account policies primarilyis included in accident years 2002 and prior. Favorable premium development on retrospectively rated large account policies of $50 million was recorded in relation to this unfavorable net prior year claim and allocated claims adjustment expense development.

Approximately $60 million of unfavorable net prior year claim and allocated claim adjustment expense development was recorded in involuntary pools in which the Company’s participation is mandatory and primarily based on premium writings. Approximately $15 million of this unfavorable net prior year claim and allocated claim adjustment expense development was related to the Company’s shareNote F of the National Workers Compensation Reinsurance Pool (NWCRP). Consolidated Financial Statements included under Item 8.

During 2005 and 2004, the NWCRP reached an agreement with a former pool member to settle their pool liabilities at an amount less than their established share. The result of this settlement will be a higher allocation to the remaining pool members, including the Company. The remainder of this unfavorable net prior year claim and allocated claim adjustment expense development was primarily due to increased severity trends for workers compensation exposures in older years.

Approximately $60 million of unfavorable net prior year claim and allocated claim adjustment expense development resulted from the change in estimates due to increased severity trends for excess and surplus business driven by excess liability, liquor liability and coverages provided to apartment and condominium complexes. Approximately $105 million of favorable net prior year claim and allocated claim adjustment expense development resulted from reserve studies of commercial auto liability policies and the liability portion of package policies. The change was due to improvement in the severity and number of claims for this business. Approximately $85 million of favorable net prior year claim and allocated claim adjustment expense development was due to improvement in the severity and number of claims for property coverages primarily in accident year 2003.

Other favorable net prior year premium development of approximately $50 million resulted primarily from higher audit and endorsement premiums on workers compensation policies.

In addition to the above, during 2004, the Company executed commutation agreements withwe commuted several members of the Trenwick Group. These commutationssignificant reinsurance contracts that resulted in unfavorable claimdevelopment of $285 million and claim adjustment expense reserve$5 million, which is included in the development above, and which was more thanpartially offset by athe release of a previously established allowance for uncollectible reinsurance.

These commutations resulted in an unfavorable impact of $173 million after-tax and favorable impact of $4 million after-tax in 2005 and 2004. These contracts contained interest crediting provisions. The following discussesinterest charges associated with the reinsurance contracts commuted were $42 million and $110 million in 2005 and 2004. There will be no further interest crediting charges related to these commuted contracts in future periods.

The impact of catastrophes was $318 million after-tax and $183 million after-tax for 2005 and 2004, net of anticipated reinsurance recoveries.
The combined ratio increased 14.7 points in 2005 as compared with 2004. The loss ratio increased 16.7 points in 2005 as compared with 2004. These increases were primarily due to increased net prior year development, for Standard Linesincreased catastrophe losses and decreased current accident year results. Catastrophe losses of $470 million and $260 million were recorded in 2003.

Approximately $495 million of unfavorable claim2005 and allocated claim adjustment2004.

The expense reserve development was recorded related to construction defect claimsratio improved 2.2 points in 2003. Based on analyses completed during the third quarter of

38


2003, it became apparent that the assumptions regarding the number of claims, which were used to estimate the expected losses, were no longer appropriate. The analyses indicated that the number of claims reported was higher than expected primarily in states other than California. States where this activity is most evident include Texas, Arizona, Nevada, Washington and Colorado. The number of claims reported in states other than California during the first six months of 2003 was almost 35% higher than the last six months of 2002. The number of claims reported during the last six months of 2002 increased by less than 10% from the first six months of 2002. In California, claims resulting from additional insured endorsements increased throughout 2003. Additional insured endorsements are regularly included on policies provided to subcontractors. The additional insured endorsement names general contractors and developers2005 as additional insureds covered by the policy. Current California case law (Presley Homes, Inc. v. American States Insurance Company, (June 11, 2001) 90 Cal App. 4th 571, 108 Cal. Rptr. 2d 686) specifies that an individual subcontractorcompared with an additional insured obligation has a duty to defend the additional insured in the entire action, subject to contribution or recovery later. In addition, the additional insured is allowed to choose one specific carrier to defend the entire action. These additional insured claims can remain open for a longer period of time than other construction defect claims because the additional insured defense obligation can continue until the entire case is resolved. The adverse reserve development recorded related to construction defect claims was primarily related to accident years 1999 and prior.

Unfavorable net prior year development of approximately $595 million, including $518 million of unfavorable claim and allocated claim adjustment expense reserve development and $77 million of unfavorable premium development, was recorded for large account business including workers compensation coverages in 2003. Many of the policies issued to these large accounts include provisions tailored specifically to the individual accounts. Such provisions effectively result in the insured being responsible for a portion of the loss. An example of such a provision is a deductible arrangement where the insured reimburses the Company for all amounts less than a specified dollar amount. These arrangements often limit the aggregate amount the insured is required to reimburse the Company. Analyses completed during 2003 indicated that the provisions that result in the insured being responsible for a portion of the losses would have less of an impact due to the larger size of claims as well as the increased number of claims. The net prior year development recorded was primarily related to accident years 2000 and prior.

Approximately $98 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development recorded in 2003 resulted from a program covering facilities that provide services to developmentally disabled individuals.2004. This net prior year development was due to an increase in the size of known claims and increases in policyholder defense costs. With regard to average claim size, updated data showed the average claim size increasing at an annual rate of approximately 20%. Prior data had shown average claim size to be level. Similar to the average claim size, updated data showed the average policyholder defense cost increasing at an annual rate of approximately 20%. Prior data had shown average policyholder defense cost to be level. The net prior year development recorded was primarily for accident years 2001 and prior.

Approximately $40 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development recorded in 2003 was for excess workers compensation coverages due to increasing severity. The increase in severity means that a higher percentage of the total loss dollars will be the Company’s responsibility since more claims will exceed the point at which the Company’s coverage begins. The net prior year development recorded was primarily for accident year 2000.

Approximately $73 million of unfavorable development recorded in 2003 was the result of a commutation of all ceded reinsurance treaties with the Gerling Global Group of companies (Gerling), related to accident years 1999 through 2001, including $41 million of unfavorable claim and allocated claim adjustment expense development and $32 million of unfavorable premium development.

Unfavorable net prior year claim and allocated claim adjustment expense reserve development of approximately $40 million recorded in 2003 was related to a program covering tow truck and ambulance operators, primarily impacting the 2001 accident year. The Company had previously expected that loss ratios for this business would be similar to its middle market commercial automobile liability business. During 2002, the Company ceased writing business under this program.

Approximately $25 million of unfavorable net prior year premium development recorded in 2003 was related to a second quarter of 2003 reevaluation of losses ceded to a reinsurance contract covering middle market workers

39


compensation exposures. The reevaluation of losses led to a new estimate of the number and dollar amount of claims that would be ceded under the reinsurance contract. As a result of the reevaluation of losses, the Company recorded approximately $36 million of unfavorable claim and allocated claim adjustment expense reserve development, which was ceded under the contract. The net prior year development was recorded for accident year 2000.

Approximately $11 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development recorded in 2003 was related to directors and officers exposures in Global Lines. The unfavorable net prior year reserve developmentimprovement was primarily due to securities class action cases related to certain known corporate malfeasance cases and investment banking firms. This net prior year development recorded was primarily for accident years 2000 through 2002.

The following premium and claim and allocated claim adjustment expense development was recorded in 2003 as a result of the elimination of deficiencies and redundancies in reserve positions within the segment. Unfavorable net prior year development of approximately $210 million related to small and middle market workers compensation exposures and approximately $110 million related to E&S lines was recorded in 2003. Offsetting these increases was $210 million of favorable net prior year development in the property line of business, including $79 million related to the September 11, 2001 World Trade Center Disaster and related events (WTC event).

Also, offsetting the unfavorable premium and claim and allocated claim adjustment expense 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.

The expense ratio decreased 8.1 points in 2004 as compared with 2003. This decrease in 2004 was primarily due to an increased net earned premium base, an $88 million decrease in the provision for uncollectible insurance receivables, a $54 million decrease in certain insurance related assessments and reduced expenses as a result of expense reduction initiatives as compared with the same period in 2003. Partially offsetting these favorable impacts was $14 million of estimated underwriting assessments related to the 2004 Florida hurricanes.

During 2004, additional bad debt provisions for insurance receivables of $150 million were recorded as compared to $242 million recorded in 2003. The substantial bad debt provisions for insurance receivables in 2004 and 2003 were primarily related to Professional Employer Organization (PEO) accounts. During 2002, Standard Lines ceased writing coverages for PEO businesses, with the last contracts expiring on June 30, 2003. In the third quarter of 2003, the Company performed a review of PEO accounts to estimate ultimate losses and the indicated recoveries under retrospective premium or high-deductible provisions of the insurance contracts. Based on the 2003 analysis of the credit standing of the individual PEO accounts and the amount of collateral held, the Company recorded an increase in the bad debt provision. In the third quarter of 2004, the review of PEO accounts was updated and the population of accounts reviewed was expanded to include Temporary Help accounts as well. Payroll audits performed since the last study identified that the exposure base for many accounts was higher than expected. In addition, recovery estimates were updated based on current credit information on the insured. Based on the updated study, the Company recorded an estimated bad debt provision of $95 million in the third quarter of 2004 for these accounts.

In 2004, the expense ratio was adversely impacted by an additional $55 million bad debt provision for insurance receivables. The primary drivers of the provision were the completion of updated ultimate loss projections on all large account business where the insured is currently in bankruptcy and a comprehensive review of all billed balances that are past due.

The dividend ratio decreased 2.0 points in 2004 as compared with 2003 due to favorable net prior year dividend development of $23 million in 2004, as compared to unfavorable net prior year dividend development of $46 million in 2003, primarily related to workers compensation products. The favorable 2004 dividend development was related to a review that was completed in 2004 which indicated dividends were lower than prior expectations based on decreased usage of dividend programs.

40

debt.


2003 Compared with 2002

Net results decreased $764 million in 2003 as compared with 2002. The decrease in net results was primarily driven by increased unfavorable net prior year development of $999 million after-tax ($1,538 million pretax), an increase in the bad debt provision for insurance and reinsurance receivables of $193 million after-tax ($297 million pretax), an increase in certain insurance-related assessments of $49 million after-tax ($74 million pretax) and decreased net investment income primarily due to increased interest expense of $78 million after-tax ($120 million pretax) related to additional cessions to the corporate aggregate and other reinsurance treaties. Partially offsetting these decreases were increases in net realized investment gains and $94 million after-tax ($145 million pretax) of increased limited partnership income. See the Investments section of this MD&A for further discussion on net investment income and net realized investment gains (losses). Net results for 2002 also included a $43 million after-tax ($43 million pretax) cumulative effect of a change in accounting principle charge related to goodwill impairment.

Net written premiums for Standard Lines decreased $194 million and net earned premiums decreased $148 million in 2003 as compared with 2002. These decreases were due primarily to increased ceded premiums of $259 million, including premiums ceded to corporate aggregate and other reinsurance treaties, primarily as a result of unfavorable net prior year claim and allocated claim adjustment expense reserve development recorded in 2003. Premiums also decreased as a result of a shift in the mix of business to high deductible policies, which generally have lower premiums. Partially offsetting these declines were increased premiums across most P&C and E&S lines as a result of new business initiatives and rate increases.

The combined ratio increased 36.8 points in 2003 as compared with 2002. The loss ratio increased 25.0 points due principally to an increase in unfavorable net prior year development in 2003 as compared with 2002, as discussed below, an increase in the bad debt expense reserve for reinsurance receivables of $55 million and $110 million of catastrophe losses which occurred during 2003. Catastrophe losses were $38 million in 2002. Based on the Company’s credit exposure to reinsurance receivables, an increase in the bad debt reserve was deemed appropriate. See the Reinsurance section of this MD&A for additional information. Partially offsetting these unfavorable variances was an improvement in the current net accident year loss ratio.

Unfavorable net prior year development of $1,419 million, including $939 million of unfavorable claim and allocated claim adjustment expense reserve development and $480 million of unfavorable premium development, was recorded in 2003. Favorable net prior year development of $119 million, including $205 million of favorable claim and allocated claim adjustment expense reserve development and $86 million of unfavorable premium development, was recorded in 2002.

The discussion of the net prior year development recorded in 2003 was discussed in the “2004 compared with 2003” section above.

The following discusses net prior year development for Standard Lines recorded in 2002.

Approximately $140 million of favorable net prior year development was attributable to participation in the Workers Compensation Reinsurance Bureau (WCRB), a reinsurance pool, and residual markets. The favorable prior year reserve development for WCRB was the result of information received from the WCRB that reported the results of a recent actuarial review. This information indicated that the Company’s net required reserves for accident years 1970 through 1996 were $60 million less than the carried reserves. In addition, during 2002, the Company commuted accident years 1965 through 1969 for a payment of approximately $5 million to cover carried reserves of approximately $13 million, resulting in further favorable net prior year claim and allocated claim adjustment expense development of $8 million. The favorable residual market net prior year development was the result of lower than expected paid loss activity during recent periods for accident years dating back to 1984. The paid losses during 2002 on prior accident years were approximately 60% of the previously expected amount.

In addition, Standard Lines had favorable net prior year development, primarily in the package liability and auto liability lines of business due to the then 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, were expected to produce significant reductions in ultimate claim costs. Based on management’s best

41


estimate of the reduction in ultimate claim costs, approximately $100 million of favorable net prior year development was recorded in 2002. Approximately one-half of this favorable net prior year development was recorded in accident years prior to 1999, with the remainder of the favorable net prior year development recorded in accident years 1999 to 2001.

Approximately $50 million of favorable net prior year development during 2002 was recorded in commercial automobile liability. Most of the favorable development was from accident year 2000. An actuarial review completed during 2002 showed that underwriting actions had resulted in reducing the number of commercial automobile liability claims for then recent accident years, especially the number of large losses.

Approximately $45 million of favorable net prior year development was recorded in property lines during 2002. The favorable net prior year 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.

Offsetting these favorable net prior year developments were approximately $100 million of unfavorable premium development in middle market workers compensation, approximately $70 million of unfavorable net prior year claim and allocated claim adjustment expense development in programs written in CNA E&S, approximately $30 million of unfavorable net prior year claim and allocated claim adjustment expense development on a contractors account package policy program and approximately $20 million of unfavorable net prior year claim and allocated claim adjustment expense development on middle market general liability coverages. The unfavorable net prior year development on workers compensation was principally due to additional reinsurance premiums for accident years 1999 through 2001.

A CNA E&S program, covering facilities that provide services to developmentally disabled individuals, accounts for approximately $50 million of the unfavorable net prior year development. The net prior year development was due to an increase in the size of known claims and increases in policyholder defense costs. These increases became apparent as the result of an actuarial review completed during 2002, with most of the development from accident years 1999 and 2000. The other program which contributed to the CNA E&S development covered tow truck and ambulance operators in the 2000 and 2001 accident years. This program was started in 1999. The Company expected that loss ratios for this business would be similar to its middle market commercial automobile liability business. Reviews completed during 2002 resulted in estimated loss ratios on the tow truck and ambulance business that were 25 points higher than the middle market commercial automobile liability loss ratios.

The marine business recorded unfavorable net prior year development of approximately $15 million during 2002. The net prior year development for the marine business was due principally to unfavorable reserve development on hull and liability coverages from accident years 1999 and 2000 offset by favorable reserve development on cargo coverages recorded for accident year 2001. Reviews completed during 2002 showed additional reported losses on individual large accounts and other bluewater business that drove the unfavorable hull and liability development.

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 then recent quarterly periods, the change in reported losses was higher than prior quarters, resulting in the unfavorable reserve development.

The expense ratio increased 11.2 points due to increased expenses and decreased net earned premiums in 2003 as compared with 2002. Acquisition expenses were unfavorably impacted by an increase in the bad debt expense reserve for insurance receivables of $242 million. The increase in the bad debt provision for insurance receivables was primarily the result of a review of PEO accounts as well as certain accounts that have been turned over to third parties for collection. During 2002, Standard Lines ceased writing coverages for PEO businesses, with the last contracts expiring on June 30, 2003. The review analyzed losses and the related receivable including the associated collateral held by the Company. Upon completion of the review, it was determined that the ultimate loss estimates were larger than previously expected, which increased the amount of uncollateralized receivables. Based on these factors, an increase in the provision was recorded.

42


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 Non-Core segment.

The dividend ratio increased 0.60.2 points in 20032005 as compared with 2002 due primarily to increased unfavorable net prior year dividend development.2004. The $42 million increase in unfavorable2004 ratio was impacted by favorable dividend development, was primarilypartially offset by decreased participation in dividend plans and lower dividend amounts related to workers compensation products. A review was completed in 2003 indicating dividend development that was higher than prior expectations. This development related tothe current accident years 2002 and prior.

year.

SPECIALTY LINES

Business Overview

Specialty Lines provides professional, financial and specialty property and casualty products and services through a network of brokers, managing general underwriters and independent agencies. Specialty Lines provides solutions for managing the risks of its clients, including architects, engineers, lawyers, accountants, healthcare professionals, financial intermediaries and corporate directorspublic and officers.private corporations. Product offerings also include surety and fidelity bonds and vehicle and equipment warranty services.

Specialty Lines includes the following business groups: Professional Liability Insurance,US Specialty Lines, Surety and Warranty.

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Professional Liability InsuranceUS Specialty Lines(CNA Pro) provides management and professional liability insurance and risk management services, primarily in the United States. This unitgroup provides professional liability coverages to various professional firms, including architects, realtors, small and engineers, realtors, non-Big Fourmid-sized accounting firms, law firms and technology firms. CNA ProUS Specialty Lines also has market positions inprovides directors and officers (D&O), errors and omissions, employment practices, fiduciary and fidelity coverages. Specific areas of focus include largersmall and mid-size firms as well as privately held firms and not-for-profit organizations where CNA offers tailored products for this client segment.segment are offered. Products within CNA ProUS Specialty Lines are distributed through brokers, agents and managing general underwriters.

CNA Pro,

US Specialty Lines, through CNA HealthPro, also offers insurance products to serve the healthcare delivery system. Products, which include professional liability as well as associated standard property and casualty coverages, are distributed on a national basis through a variety of channels including brokers, agents and managing general underwriters. Key customer segments include long term care facilities, allied healthcare providers, life sciences, dental professionals and mid-size and large healthcare facilities and delivery systems.

Suretyconsists primarily of CNA Surety and its insurance subsidiaries and offers small, medium and large contract and commercial surety bonds. CNA Surety provides surety and fidelity bonds in all 50 states through a combined network of independent agencies. CNA owns approximately 64%63% of CNA Surety.

Warrantyprovides vehicle warranty service contracts that protect individuals and businesses from the financial burden associated with mechanical breakdown under-performance or maintenance of a product.

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maintenance.


The following table details results of operations for Specialty Lines.

Results of Operations
                        
      
Years ended December 31
(In millions)
 2004
 2003
 2002
Years ended December 31 2006 2005 2004 
(In millions) 
Net written premiums $2,391 $2,038 $1,574  $2,596 $2,463 $2,391 
Net earned premiums 2,277 1,840 1,451  2,555 2,475 2,277 
Income (loss) before net realized investment gains (losses) 324  (34) 90 
Net realized investment gains (losses) 54 74  (25)
Net investment income 403 281 246 
Net operating income 464 336 324 
Net realized investment gains, after-tax 18 12 54 
Net income 378 40 60  482 348 378 
 
Ratios  
Loss and loss adjustment expense  63.3%  89.6%  73.5%  60.5%  65.3%  63.3%
Expense 26.1 27.6 29.3  26.7 26.1 26.1 
Dividend 0.2 0.2 0.2  0.2 0.2 0.2 
 
 
 
 
 
 
        
 
Combined  89.6%  117.4%  103.0%  87.4%  91.6%  89.6%
 
 
 
 
 
 
        

2004

2006 Compared with 2003

Net results improved $338 million in 2004 as compared with 2003. This improvement was due primarily to decreased unfavorable net prior year development of $171 million after-tax ($264 million pretax), a decrease in the bad debt provision for reinsurance receivables of $78 million after-tax ($120 million pretax), a decrease in certain insurance related assessments of $8 million after-tax ($12 million pretax) and increased net investment income. These improvements were partially offset by decreased net realized investment gains of $20 million after-tax ($30 million pretax) and increased catastrophe losses in 2004. The impact of catastrophes was $11 million after-tax ($16 million pretax) and $3 million after-tax ($4 million pretax) in 2004 and 2003, as discussed below. See the Investments section of this MD&A for further discussion on net investment income and net realized investment gains.

2005

Net written premiums for Specialty Lines increased $353 million and net earned premiums increased $437$133 million in 20042006 as compared with 2003.2005. This increase was primarily due to rate increases and improved retention, principally in Professional Liability Insurance, and decreasedproduction across certain lines of business. Net earned premiums ceded to corporate aggregate and other reinsurance treaties of $26increased $80 million in 20042006 as compared with 2003. The 2003 ceded premiums were principally driven by2005, consistent with the unfavorable net prior year reserve development in 2003.

increased premium written.

Specialty Lines averaged flat rates for 2006, as compared to average rate increases of 9%, 29% and 31% in 2004, 2003 and 20021% for 2005 for the contracts that renewed during those periods. Retention rates of 83%, 81%87% and 77%86% were achieved for those contracts that were up for renewal. CNA expects rate achievement will moderate as competition for premiums continues to acceleraterenewal in these lines of business.

The combined ratio decreased 27.8 pointseach period.

Net income increased $134 million in 20042006 as compared with 2003. The loss ratio decreased 26.3 points due principally2005. This increase was attributable to decreased unfavorable net prior year development of $264 million, a $120 million decrease in bad debt reserves for uncollectible reinsurance and an improvement in the current net accident year loss ratio. These favorable impacts to the loss ratio were partially offset by increased catastrophe losses. Catastrophe losses of $15 million and $4 million were recorded in 2004 and 2003. The increased catastrophe losses in 2004 were due to $12 million of losses resulting from Hurricanes Charley, Frances, Ivan and Jeanne.

Unfavorable net prior year development was $30 million, including $58 million of unfavorable claim and allocated claim adjustment expense and $28 million of favorable premium development, in 2004. Unfavorable net prior year development of $294 million, including $257 million of unfavorable claim and allocated claim adjustment expense development and $37 million of unfavorable premium development, was recorded for the same period in 2003.

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The following table summarizes the gross and net carried reserves as of December 31, 2004 and 2003 for Specialty Lines.

         
Gross and Net Carried
Claim and Claim Adjustment Expense Reserves
  
     
December 31,
(In millions)
 2004
 2003
Gross Case Reserves $1,659  $1,605 
Gross IBNR Reserves  3,201   2,595 
   
 
   
 
 
Total Gross Carried Claim and Claim Adjustment Expense Reserves
 $4,860  $4,200 
   
 
   
 
 
Net Case Reserves $1,191  $1,087 
Net IBNR Reserves  2,042   1,832 
   
 
   
 
 
Total Net Carried Claim and Claim Adjustment Expense Reserves
 $3,233  $2,919 
   
 
   
 
 

In 2004, the Company finalized commutation agreements with several members of the Trenwick Group. These commutations resulted in unfavorable claim and claim adjustment expense reserve development which was more than offset by a release of a previously established allowance for uncollectible reinsurance. Additionally, unfavorable net prior year claim and allocated claim adjustment expense reserve development resulted from the increased emergence of several large D&O claims primarily in recent accident years.

The following discusses net prior year development for Specialty Lines recorded in 2003.

Approximately $50 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development recorded in 2003 was related to increased severity in excess coverages provided to facilities providing health care services. The increase in reserves was based on reviews of individual accounts where claims had been expected to be less than the point at which the Company’s coverage applied. The then current claim trends indicated that the layers of coverage provided by the Company would be impacted. The net prior year development recorded was primarily for accident years 2001 and prior.

Approximately $68 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development recorded in 2003 was for surety coverages related primarily to workers compensation bond exposure from accident years 1990 and prior and large losses for accident years 1999 and 2002. Approximately $21 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development was recorded in the surety line of business in 2003 as the result of recent developments on one large claim.

Approximately $75 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development recorded in 2003 was related to directors and officers exposures in CNA Pro. The unfavorable net prior year reserve development was primarily due to securities class action cases related to certain known corporate malfeasance cases and investment banking firms. This net prior year development recorded was primarily for accident years 2000 through 2002.

Approximately $84 million of losses were recorded during 2003 as the result of a commutation of ceded reinsurance treaties with Gerling covering CNA HealthPro, relating to accident years 1999 through 2002. Further information regarding this commutation is provided in the Reinsurance section of this MD&A.

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

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benefit was comprised of $56 million of ceded losses and $31 million of ceded premiums for accident years 2000 and 2001.

The expense ratio decreased 1.5 points primarily due to the increased earned premium base and a decrease of $12 million in certain insurance related assessments recorded in 2003. Additionally, the expense ratio was favorably impacted by decreased underwriting expenses due to the Company’s expense initiatives.

2003 Compared with 2002

Net income was $40 million in 2003 as compared with $60 million in 2002. The decreaseincreases in net results was primarily due to increased unfavorable net prior year development of $152 million after-tax ($234 million pretax), an increase in the bad debt provision for reinsurance receivables of $50 million after-tax ($77 million pretax)operating income and increased interest expense of $4 million after-tax ($5 million pretax) related to additional cessions to the corporate aggregate reinsurance treaties. The unfavorable impacts to net results were principally offset by improved current net accident year results primarily attributable to premium rate increases and increased net realized investment results.gains. See the Investments section of this MD&A for further discussion of net investment income and net realized gains (losses). investment results.

Net results for 2002 also included a $5 million after-tax ($8 million pretax) cumulative effect of a change in accounting principle charge related to goodwill impairment.

Net written premiums for Specialty Linesoperating income increased $464 million and net earned premiums increased $389$128 million in 20032006 as compared with 2002. These increases2005. This improvement was primarily driven by an increase in net investment income, a decrease in net prior year development as discussed below and reduced catastrophe impacts in 2006. Catastrophe impacts were due primarily$1 million after-tax for the year ended December 31, 2006, as compared to rate increases$16 million after-tax for the year ended December 31, 2005. Also, the 2005 results included a $59 million loss, after the impact of taxes and increased newminority interests, in the surety line of business primarilyrelated to a large national contractor. Further information related to the large national contractor is included in CNA Pro.Note S of the Consolidated Financial Statements included under Item 8.

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The combined ratio increased 14.4improved 4.2 points in 20032006 as compared with 2002.2005. The loss ratio increased 16.1improved 4.8 points, due principally to increased unfavorableimproved current accident year impacts and decreased net prior year development as discussed below. Additionally, theThe 2005 loss ratio was negativelyunfavorably impacted by surety losses of $110 million, before the impacts of minority interest, related to a $77 million increase in the bad debt provision for reinsurance receivables, a $22 million increase in ULAE reserves and $49 million ofnational contractor as discussed above. Partially offsetting this favorable impact was less favorable current accident year losses for Surety, related to large losses in 2003, and $20 million of current accident year losses for directors and officers exposures in CNA Pro, which primarily related to recent securities class action cases related to certain mutual fund firms. These items were partially offset by the improvement in the current net accident year loss ratio on theratios across several other lines of business and the impact of higher net earned premiums.

in 2006.

Unfavorable net prior year development of $294$15 million was recorded in 2006, including $10 million of favorable claim and allocated claim adjustment expense reserve development and $25 million of unfavorable premium development. Unfavorable net prior year development of $54 million, including $257$47 million of net unfavorable claim and allocated claim adjustment expense reserve development and $37$7 million of unfavorable premium development, was recorded in 20032005. Further information on Specialty Lines Net Prior Year Development for 2006 and 2005 is included in Note F of the Consolidated Financial Statements included under Item 8.
The following table summarizes the gross and net carried reserves as of December 31, 2006 and 2005 for Specialty Lines.
Gross and Net Carried
Claim and Claim Adjustment Expense Reserves
         
December 31 2006  2005 
(In millions)        
Gross Case Reserves $1,715  $1,907 
Gross IBNR Reserves  3,814   3,298 
       
         
Total Gross Carried Claim and Claim Adjustment Expense Reserves
 $5,529  $5,205 
       
         
Net Case Reserves $1,350  $1,442 
Net IBNR Reserves  2,921   2,352 
       
         
Total Net Carried Claim and Claim Adjustment Expense Reserves
 $4,271  $3,794 
       
2005 Compared with 2004
Net written premiums for Specialty Lines increased $72 million in 2005 as compared with 2004. This increase was primarily due to improved retention across most professional liability insurance lines of business. These favorable impacts were partially offset by increased ceded premiums for certain professional liability lines of business and decreased premiums for the warranty business. Due to a change in 2005 in the warranty product offering, fees related to the new warranty product are included within other revenues. Written premiums for the warranty line of business decreased $70 million in 2005 as compared to 2004. Net earned premiums increased $198 million in 2005 as compared with 2004, which reflects the increased premium written trend over several prior quarters in Specialty Lines.
Specialty Lines averaged rate increases of 1% and 9% in 2005 and 2004 for the contracts that renewed during those periods. Retention rates of 86% and 83% were achieved for those contracts that were up for renewal in each period.
Net income decreased $30 million in 2005 as compared with 2004. This decrease was due primarily to a $42 million decrease in net realized investment gains partially offset by increased net operating income. See the Investments section of this MD&A for further discussion of net investment income and net realized investment results.
Net operating income increased $12 million in 2005 as compared with 2004. This increase was primarily driven by an increase in net investment income and increased earned premiums. These increases to operating income were partially offset by decreased current accident year results. Additionally, 2004 results were favorably impacted by the release of a previously established reinsurance bad debt allowance as the result of a significant commutation. Catastrophe impacts were $16 million after-tax and $11 million after-tax for the years ended December 31, 2005 and 2004.

35


The combined ratio increased 2.0 points in 2005 as compared with 2004. The loss ratio increased 2.0 points. The 2004 loss ratio was favorably impacted by the release of reinsurance bad debt reserve as discussed above. Additionally, the 2005 loss ratio was unfavorably impacted by increased current year accident losses. This was driven by increased surety losses of $110 million related to a national contractor, before the impacts of minority interest, as discussed in further detail in Note S of the Consolidated Financial Statements included under Item 8, partially offset by improved current accident year loss ratios in several professional liability lines of business.
Unfavorable net prior year development of $60$54 million was recorded in 2005, including $14$47 million of net unfavorable claim and allocated claim adjustment expense reserve development and $46$7 million of unfavorable premium development, was recorded in 2002 for Specialty Lines.

The discussion of the net prior year development recorded in 2003 was included in the “2004 compared with 2003” section above.

The following discusses net prior year development for Specialty Lines recorded in 2002.

development. Unfavorable net prior year development of approximately $180$30 million, including $58 million of unfavorable claim and allocated claim adjustment expense reserve development and $28 million of favorable premium development, was recorded in 2004. Further information on Specialty Lines Net Prior Year Development for CNA HealthPro2005 and 2004 is included in 2002 and was driven principally by medical malpractice excess products provided to hospitals and physicians and coverages provided to long term care facilities, principally national for-profit nursing homes. Approximately $100 millionNote F of the net prior year unfavorable development was related to assumed excess products and loss portfolio transfers, and was primarily driven by unexpected increases in the number of excess claims in accident years 1999 and 2000. The percentage of total claims greater than $1 million has increased by 33%, from less than 3% of all claims to more than 4% of all claims. CNA HealthPro no longer writes assumed excess products and loss portfolio transfers.

Approximately $50 million of the unfavorable net prior year development was related to long term care facilities. The unfavorable net prior year 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-

46

Consolidated Financial Statements included under Item 8.


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 net prior year 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 net prior year 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 this unfavorable net prior year development was favorable net prior year development in CNA Pro and for Enron related exposures. Programs providing professional liability coverage to accountants, lawyers and realtors primarily drove favorable net prior year development of approximately $110 million in CNA Pro. Reviews of this business completed during 2002 showed 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 net prior year 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 was settled for less than the attachment point of this excess layer.

A $12 million underwriting benefit was recorded for cessions to the corporate aggregate reinsurance treaties in 2002. The benefit was comprised of $41 million of ceded losses and $29 million of ceded premium for accident year 2001.

The expense ratio decreased 1.7 points primarily duewas the same in 2005 as compared with 2004. The 2005 ratio was impacted by a change in estimate related to profit commissions in the warranty line of business, which was offset by the impact of the increased net earned premium base, partially offset by an increase in certain insurance related assessments of $11 million.

base.

LIFE AND GROUP NON-CORE

Business Overview

The Life and Group Non-Core segment consistsprimarily includes the results of Group Operations and Life Operations (formerly separate reportable segments) including the run-off of the related group and life products that have been combined into one reportable segment. Additionally, other run-off life and group operationslines of business that were previously reportedhave either been sold or placed in the Corporaterun-off. We sold our individual life business on April 30, 2004 and Other segment, including group reinsurance, are also included in the Life and Group Non-Core segment.our specialty medical business on January 6, 2005. The segment includes operating results for these businesses in periods prior to the sale andsales, the realized gain/loss from the sale for the group benefits business that was sold on December 31, 2003, the individual life business that was sold on April 30, 2004, the CNA Trust business that was sold on August 1, 2004sales and the effects of the shared corporate overhead expenses which continue to be allocated to the sold businesses. Additionally, 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.

Life and Group Non-Core includes the following lines of business: Life & Annuity, Health and Other.

Life & Annuityconsists primarily of individual term, universal life and permanent life insurance products, guaranteed investment contracts, as well as individual and group annuity products. As discussed above, on April 30, 2004, certain of these products were sold. The remaining businesses are being managed as a run-off operation; however certain businesses focused on institutional investors are accepting new deposits from existing customers.

Healthconsists primarily of the Group Benefits business, group long term care, individual long term care and specialty medical products and related services. On December 31, 2003, CNA completed the sale of the Group Benefits business. CNA is continuingsegment. We continue to service itsour existing group and individual long term care commitments, our payout annuity business and is managing these businesses asour pension deposit business. We also manage a run-off operation. In January of 2005, the specialty medical business was sold to Aetna. This business contributed $16 million, $9 million and $2 million of net income for 2004, 2003 and 2002.

Otherconsists primarilyblock of group reinsurance and life settlement contracts. These businesses are being managed as a run-off operation.

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Our group long term care and Index 500 products, while considered non-core, continue to be actively marketed.


The following table summarizes the results of operations for Life and Group Non-Core.

Operating Results of Operations
             
       
Years ended December 31
(In millions)
 2004
 2003
 2002
Net earned premiums $921  $2,376  $3,408 
Income (loss) before net realized investment losses  (29)  113   206 
Net realized investment losses  (385)  (108)  (115)
Net income (loss)  (414)  5   48 
             
Years ended December 31 2006 2005 2004
(In millions)            
Net earned premiums $641  $704  $921 
Net investment income  698   593   692 
Net operating loss  (14)  (51)  (29)
Net realized investment losses, after-tax  (33)  (19)  (385)
Net loss  (47)  (70)  (414)

2004

2006 Compared with 2003

2005

Net earned premiums for Life and Group Non-Core decreased $1,455$63 million in 20042006 as compared with 2003.2005. The decrease in2006 and 2005 net earned premiums was duerelate primarily to the group and individual long term care businesses.
Net results increased $23 million in 2006 as compared with 2005, driven by increased net investment income. A significant portion of the increase in net investment income was offset by a corresponding increase in the policyholders’ funds reserves supported by the trading portfolio. The portion not offset by the policyholders’ funds reserves increased by $25 million. Also impacting net results was $15 million of income related to the resolution of contingencies and the absence of premiums froma $17 million provision recorded in 2005 for estimated indemnification liabilities related to the group benefits business and reduced premiums for thesold individual life business. Net earned premiums for the sold life and group businesses were $115 million and $1,459 million for 2004 and 2003. Net earned premiums also decreased in most of the remaining lines of business which are in runoff, and this decline is expected to continue in the future. Partially offsetting this decrease was an increase in net earned premiums in the specialty medical business, which continued to issue new policies prior to its sale in January 2005.

Net results decreased by $419 million in 2004 as compared with 2003. The decrease in net results related primarily tothese favorable impacts were increased net realized investment losses includingand the realized lossabsence of approximately $389 million after-tax ($622 million pretax) fromincome related to agreements with buyers of sold businesses which ended as of December 31, 2005. In addition, the sale2005 net results included a change in estimate, which reduced a prior accrual of state premium taxes. See the individual life businessInvestments section of this MD&A for further discussion of net investment income and reduced results from the group benefits and individual life businesses. Netnet realized investment losses in 2003 include a loss recorded on the sale of the Group Benefits business of $130 million after-tax ($176 million pretax). Net results for the sold life and group businesses were losses of $427 million and $36 million, including the loss on sales and the effects of shared corporate overhead expenses, in 2004 and 2003. In addition, results for life settlement contracts declined in 2004. These items were partially offset by reduced increases in individual long term care reserves of $21 million after-tax ($32 million pretax) in 2004 as compared with 2003. Also included in the net results of 2004 and 2003 were the adverse impacts of $26 million after-tax ($40 million pretax) and $33 million after-tax ($50 million pretax) related to certain accident and health exposures (IGI Program) and the Company’s past participation in accident and health reinsurance programs.results.

36

2003


2005 Compared with 2002

2004

Net earned premiums for Life and Group Non-Core decreased $1,032$217 million in 20032005 as compared with 2002.2004. The decreasepremiums in net earned premiums was due primarily to2004 include $115 million from the transfer ofindividual life business and $165 million from the Mail Handlers Plan. The Mail Handlers Plan contributed net earned premiums of $1,151specialty medical business.
Net results improved by $344 million in 2002. This decline was partially offset by premium growth in the disability, specialty medical, life and accident and long term care products within group benefits due to increased new sales and rate increases, and higher sales of structured settlement annuities, growth in life insurance products and rate increases on the individual long term care product inforce blocks.

Net income decreased by $43 million in 20032005 as compared with 2002. Net income2004. The improvement in 2003 was adversely impacted by $130net results related primarily to a $389 million after-tax ($176 million pretax)realized loss recorded on the sale of the Group Benefitsindividual life business in 2004. Also contributing to the improvement in net results was the reduction in 2005 of significant 2004 items related to certain assumed reinsurance exposures. Additionally, 2005 results included $13 million income related to a service agreement with a purchaser for sold businesses. These agreements have expired. These results were partially offset by a decline in net investment income of $99 million. This included a decrease of approximately $64 million from the trading portfolio which was largely offset by a corresponding decrease in the policyholders’ funds reserves supported by the trading portfolio. In addition, it included the absence of favorable results from sold insurance operations. Also unfavorably impacting the 2005 results was a $17 million provision increase for estimated indemnification liabilities related to the sold individual life business and unfavorable results related to the long term care business. In 2002, net income was adversely impacted by impairment losses. See the Investments section of this MD&A for additional information. Additionally, the decrease infurther discussion of net investment income was due to unfavorableand net prior year claim and allocated claim adjustment expense reserve development of $33 million after-tax ($50 million pretax) that was recorded in relation to the Company’s past participation in several insurance pools, which is part of the group reinsurance run-off business, and increases in individual long term care reserves of $4 million after-tax ($7 million pretax) due to increased severity and claim frequency. Additionally a change in the discount rate on prior year disability and life waiver of premium reserves from 6.5% to 6.0%, resulted in a $14 million after-tax ($22 million pretax) decrease in net income. The change in discount rate reflected the decreasing portfolio yield and the then currentrealized investment environment. The decrease was also due to severance costs of $3 million after-tax ($4 million pretax) related to the individual long term care product. These items were partially offset by an improvement in net results for life settlement contracts of $25 million after-tax ($39 million pretax), increased favorable net prior year development related to a $7 million after-tax ($11 million pretax) release of WTC event reserves and the absence of the

48

results.


cumulative effect of a change in accounting principle of $8 million after-tax ($12 million pretax) recorded in 2002 relating to the write-down of impaired goodwill.

CORPORATE AND OTHER NON-CORE

Overview

Corporate and Other Non-Core includes the results of certain property and casualty lines of business placed in run-off. CNA Re, formerly a separate property and casualty operating segment, is currently in run-off and is now included in the Corporate and Other Non-Core segment. This segment also includes the results related to the centralized adjusting and settlement of APMT claims, as well as the results of CNA’sour participation in voluntary insurance pools and various other non-insurance operations. Other operations also include interest expense on corporate borrowings and intercompany eliminations.

The following table summarizes the results of operations for the Corporate and Other Non-Core segment, including APMT and intrasegment eliminations.

Operating Results of Operations
                        
      
Years ended December 31
(In millions)
 2004
 2003
 2002
Years ended December 31 2006 2005 2004
(In millions) 
Net investment income $320 $251 $246 
Revenues $353 $729 $952  305 311 358 
Net investment income 241 218 262 
Net operating income 3 9 84 
Net realized investment gains (losses), after-tax 27  (12) 39 
Net income (loss) 117  (761)   30  (3) 123 

2004

2006 Compared with 2003

2005

Revenues decreased $376$6 million in 20042006 as compared with 2003.2005. Revenues in 2006 and 2005 included interest income related to federal income tax settlements of $4 million and $121 million as further discussed in Note E to the Consolidated Financial Statements included under Item 8. This decrease was substantially offset by increased net investment income and improved realized investment results. See the Investments section of this MD&A for further discussion of net investment income and net realized investment results.
Net results increased $33 million in 2006 as compared with 2005. The improvement was primarily driven by a decrease in unfavorable net prior year development as discussed further below. Offsetting this favorable impact was an increase in current accident year losses related to mass torts, discontinuation of royalty income related to a sold business and increased interest costs related to the issuance of $750 million of senior notes in August 2006.
Unfavorable net prior year development of $88 million was recorded during 2006, including $86 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development and $2 million of unfavorable premium development. Unfavorable net prior year development of $306 million was recorded in 2005, including $291 million of unfavorable net prior year claim and allocated claim adjustment expense reserve

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development and $15 million of unfavorable premium development. Further information on Corporate and Other Non-Core’s Net Prior Year Development for 2006 and 2005 is included in Note F of the Consolidated Financial Statements included under Item 8.
The following table summarizes the gross and net carried reserves as of December 31, 2006 and 2005 for Corporate and Other Non-Core.
Gross and Net Carried
Claim and Claim Adjustment Expense Reserves
         
December 31 2006  2005 
(In millions)        
Gross Case Reserves $2,511  $3,297 
Gross IBNR Reserves  3,528   4,075 
       
         
Total Gross Carried Claim and Claim Adjustment Expense Reserves
 $6,039  $7,372 
       
         
Net Case Reserves $1,453  $1,554 
Net IBNR Reserves  1,999   1,902 
       
         
Total Net Carried Claim and Claim Adjustment Expense Reserves
 $3,452  $3,456 
       
2005 Compared with 2004
Revenues decreased $47 million in 2005 as compared with 2004. The decrease in revenues was primarily due primarily to reduced net earned premiums in CNA Re of $134 million due to the exit offrom the assumed reinsurance marketbusiness in October of 2003 and decreased realized investment gains of $62 million pretax. CNA Re had earned premiums of $125 million and $536 million in 2004 and 2003. See the Investments section of this MD&A for additional information on net realized investment gains (losses) and net investment income.

results. Partially offsetting these decreases was $121 million of interest income related to a federal income tax settlement. See Note E to the Consolidated Financial Statements included under Item 8 for further information.

Net income increased $878results decreased $126 million in 20042005 as compared with 2003.2004. The increasedecrease in net incomeresults was primarily due primarily to a $636$139 million after-tax ($978 million pretax) decreaseincrease in unfavorable net prior year development related primarily to commutations and reserve strengthening, a $168$51 million after-tax ($258 million pretax)decrease in net realized investment results and a decrease in the provision recorded for uncollectible reinsurance receivables,reinsurance. Net realized investment results for the absence inyear ended December 31, 2005 and 2004 ofincluded a $44$22 million after-tax ($67 million pretax) increase in ULAE reserves recorded in 2003 and a $16$36 million after-tax ($24 million pretax) decrease in certain insurance related assessments. Additionally, the net results were favorably impacted by $14 million after-tax ($21 million pretax) of non-recurring incomeimpairment related to a national contractor. See Note S to the Consolidated Financial Statements included under Item 8 for additional information regarding the national contractor. Partially offsetting these decreases was a $115 million after-tax benefit related to a federal income tax settlement and release of purchase accounting reserves related to real estate leases assumed in connection with the 1995 acquisition of Continental.

federal income tax reserves.

Unfavorable net prior year development of $96$306 million was recorded during 2005, including $291 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development and $15 million of unfavorable premium development. Unfavorable net prior year development of $93 million was recorded in 2004, including $87$84 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development and $9 million of unfavorable premium development. Unfavorable net prior year development of $1,074 million was recorded in 2003, including $1,048 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development and $26 million of unfavorable premium development.

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The following table summarizes the gross and net carried reserves as of December 31, 2004 and 2003 forFurther information on Corporate and Other Non-Core.

         
Gross and Net Carried    
Claim and Claim Adjustment Expense Reserves    
    
December 31,
(In millions)
 2004
 2003
Gross Case Reserves $3,803  $4,342 
Gross IBNR Reserves  4,875   5,330 
   
 
   
 
 
Total Gross Carried Claim and Claim Adjustment Expense Reserves
 $8,678  $9,672 
   
 
   
 
 
Net Case Reserves $1,485  $1,879 
Net IBNR Reserves  1,691   1,858 
   
 
   
 
 
Total Net Carried Claim and Claim Adjustment Expense Reserves
 $3,176  $3,737 
   
 
   
 
 

InNon-Core’s Net Prior Year Development for 2005 and 2004 the Company executed commutation agreements with several membersis included in Note F of the Trenwick Group. These commutationsConsolidated Financial Statements included under Item 8.

During 2005 and 2004, we commuted several significant reinsurance contracts that resulted in unfavorable net prior year claimdevelopment of $118 million and allocated claim adjustment expense reserve$39 million, which is included in the development above, and which was partially offset by athe release in 2004 of a previously established allowance for uncollectible reinsurance. The remainderThese commutations resulted in unfavorable impacts of $71 million after-tax and $5 million after-tax in 2005 and 2004. These contracts contained interest crediting provisions and maintenance charges. Interest charges associated with the unfavorable net prior year claimreinsurance contracts commuted were $13 million after-tax and allocated claim adjustment expense reserve development$11 million after-tax in 2004 resulted from several2005 and 2004. There will be no further interest crediting charges or other small commutations and increases to net reserves due to reducing ceded losses, partially offset by a release of a previously established allowance for uncollectible reinsurance.

The following discusses net prior year development for the Corporate and Other Non-Core Segment recorded during 2003.

This development was primarily driven by $795 million of unfavorable net prior year claim and allocated claim adjustment expense reserve developmentcharges related to APMT. See the APMT Reserves section of this MD&A for further discussion of APMT development.

In addition to APMT development, there was unfavorable net prior year development recordedthese commuted contracts in 2003 related to CNA Re of $149 million and $75 million related to voluntary pools.

future periods.

Unfavorable net prior year claim and allocated claim adjustment expense reserve development of approximately $25 million was recorded in CNA Re primarily for directors and officers exposures. The unfavorable net prior year development was a result of a claims review that was completed during the second quarter of 2003. The unfavorable net prior year development was primarily due to securities class action cases related to certain known corporate malfeasance cases and investment banking firms. The unfavorable net prior year development recorded was for accident years 2000 and 2001.

The CNA Re unfavorable net prior year development for 2003 was also due to a general change in the pattern of how losses emerged over time as reported by the companies that purchased reinsurance from 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 had 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 was related to professional liability exposures in accident years 2001 and prior.

Additionally, CNA Re recorded $15 million of unfavorable net prior year development for construction defect related exposures. Because of the unique nature of this exposure, losses have not followed expected development

5038


patterns. The continued reporting of claims in California, the increase in the number of claims from states other than California and a review of individual ceding companies’ exposure to this type of claim resulted in an increase in the estimated reserve.

The following premium and claim and allocated claim adjustment expense development, was recorded in 2003 as a result of the elimination of deficiencies and redundancies in the reserve positions of individual products within CNA Re. Unfavorable net prior year premium and claim and allocated claim adjustment expense development of approximately $42 million related to Surety exposures, $32 million related to excess of loss liability exposures and $12 million related to facultative liability exposures were recorded in the third quarter of 2003.

Offsetting this unfavorable net prior year development was approximately $55 million of favorable net prior year development related to the WTC event as well as a $45 million underwriting benefit from cessions to corporate aggregate reinsurance treaties recorded in 2003. The benefit from cessions to the corporate aggregate reinsurance treaties was comprised of $102 million of ceded losses and $57 million of ceded premiums for accident years 2000 and 2001. See the Reinsurance section of this MD&A for further discussion of the Company’s aggregate reinsurance treaties.

Unfavorable net prior year claim and allocated claim adjustment expense reserve development of approximately $75 million was recorded during the third quarter of 2003 related to an adverse arbitration decision involving a single large property and business interruption loss on a voluntary insurance pool. The decision was rendered against a voluntary insurance pool in which the Company was a participant. The loss was caused by a fire which occurred in 1995. The Company no longer participates in this pool.

2003 Compared with 2002

Revenues decreased $223 million in 2003 as compared with 2002. The decrease in revenues was due primarily to reduced revenues from CNA UniSource and reduced net earned premiums in CNA Re due to the decision in October of 2003 to exit the assumed reinsurance market. These unfavorable impacts to revenue were partially offset by increased realized investment gains and increased limited partnership income.

Net results declined $761 million in 2003 as compared with 2002. The decrease in net results was due primarily to a $624 million after-tax ($960 million pretax) increase in unfavorable net prior year development primarily regarding APMT, a $44 million after-tax ($67 million pretax) increase in ULAE reserves, a $12 million after-tax ($18 million pretax) increase in certain insurance related assessments, a $153 million after-tax ($236 million pretax) increase in the bad debt provision for reinsurance receivables, decreased net investment income due primarily to a reduction of invested assets resulting from the sale of CNA Re U.K. and increased interest expense of $8 million after-tax ($12 million pretax) related to additional cessions to the corporate aggregate reinsurance treaties. The 2003 net results were favorably impacted by increased net realized investment gains of $15 million after-tax ($45 million pretax) and the absences of $40 million after-tax ($62 million pretax) of eBusiness expenses and an $18 million after-tax ($27 million pretax) reduction of the accrual for restructuring and other related charges. See the Investments section of this MD&A for further discussion on net investment income and net realized gains (losses).

Unfavorable net prior year development of $1,074 million was recorded in 2003, including $1,048 million of unfavorable claim and allocated claim adjustment expense reserve development and $26 million of unfavorable premium development. Unfavorable net prior year development of $114 million, including $155 million of unfavorable claim and allocated claim adjustment expense reserve development, and $41 million of favorable premium development, was recorded in 2002.

The discussion of the net prior year development recorded in 2003 was included in the “2004 compared with 2003” section above.

The following discusses net prior year development recorded in 2002 for Corporate and Other Non-Core.

The development recorded in 2002 consisted primarily of CNA Re unfavorable net prior year development.

51


The unfavorable net prior year development recorded in 2002 related primarily to CNA Re and 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.

Additionally, during 2002, CNA Re revised its estimate of premiums and losses related to the WTC event. In estimating CNA Re’s WTC event losses, the Company performed a treaty-by-treaty analysis of exposure. The Company’s original loss estimate was based on a number of assumptions including the loss to the industry, the loss to individual lines of business and the market share of CNA Re’s cedants. Information that became available in the first quarter of 2002 resulted in CNA Re increasing its estimate of WTC event related premiums and losses on its property facultative and property catastrophe business. The impact of increasing the estimate of gross WTC event losses by $144 million was fully offset on a net of reinsurance basis (before the impact of the CCC Cover) by higher reinstatement premiums and a reduction of return premiums. Approximately $95 million of CNA Re’s net WTC loss estimate was attributable to CNA Re U.K., which was sold in 2002.

A $32 million underwriting benefit was recorded for CNA Re for the corporate aggregate reinsurance treaties in 2002. The benefit was comprised of $93 million of ceded losses and $61 million of ceded premiums for accident year 2001.

Many ceding companies have sought provisions for the collateralization of assumed reserves in the event of a financial strength ratings downgrade or other triggers. Before exiting the reinsurance market, CNA Re had been impacted by this trend and had entered into several contracts with rating or other triggers. See the Ratings section of this MD&A for more information.

Additionally, personal insurance unfavorable net prior year development of $35 million was recorded in 2002 on accident years 1997 through 1999. The unfavorable net prior year development was principally due to the then continuing policyholder defense costs associated with remaining open personal insurance claims. The unfavorable net prior year development was partially offset by favorable reserve development on other run-off business driven principally by financial and mortgage guarantee coverages from accident years 1997 and prior. The favorable net prior year development on financial and mortgage guarantee coverages resulted from a review of the underlying exposures and the outstanding losses, which showed that salvage and subrogation continues to be collected on these types of claims, thereby reducing estimated future losses net of anticipated reinsurance recoveries.

APMT Reserves

CNA’s

Our property and casualty insurance subsidiaries have actual and potential exposures related to APMTasbestos, environmental pollution and mass tort (APMT) claims.

Establishing reserves for APMT claim and claim adjustment expenses is subject to uncertainties that are greater than those presented by other claims. Traditional actuarial methods and techniques employed to estimate the ultimate cost of claims for more traditional property and casualty exposures are less precise in estimating claim and claim adjustment expense reserves for APMT, particularly in an environment of emerging or potential claims and coverage issues that arise from industry practices and legal, judicial, and social conditions. Therefore, these traditional actuarial methods and techniques are necessarily supplemented with additional estimating techniques and methodologies, many of which involve significant judgments that are required of management.on our part. Accordingly, a high degree of uncertainty remains for the Company’sour ultimate liability for APMT claim and claim adjustment expenses.

In addition to the difficulties described above, estimating the ultimate cost of both reported and unreported APMT claims is subject to a higher degree of variability due to a number of additional factors, including among others: the number and outcome of direct actions against the Company;us; coverage issues, including whether certain costs are covered under the policies and whether policy limits apply; allocation of liability among numerous parties, some of whom may be in bankruptcy proceedings, and in particular the application of “joint and several” liability to specific insurers on a risk; inconsistent court decisions and developing legal theories; increasinglycontinuing aggressive tactics of plaintiffs’ lawyers; the risks and lack of predictability inherent in major litigation; increased filings of claims in certain states; enactment of nationalstate and federal legislation to address asbestos claims; a future increasethe potential for increases and decreases in asbestos, and environmental pollution and mass tort claims which cannot now be anticipated; a future increasethe potential for increases and decreases in number ofcosts to defend asbestos, pollution and mass tort claims

52


relating to silicaclaims; the possibility of expanding theories of liability against our policyholders in environmental and silica-containing products, and the outcomemass tort matters; possible exhaustion of ongoing disputes as to coverage in relation to these claims; a further increase of claims and claims payments that may exhaust underlying umbrella and excess coverages at accelerated rates;coverage; and future developments pertaining to the Company’sour ability to recover reinsurance for asbestos, and environmental pollution claims.

CNA regularly performs ground up reviews of all open APMT accounts to evaluate the adequacy of the Company’s APMT reserves. In performing its comprehensive ground up analysis, the Company considers input from its professionals with direct responsibility for the claims, inside and outside counsel with responsibility for representation of the Company, and its actuarial staff. These professionals review, among many factors, the policyholder’s present and predicted future exposures, including such factors as claims volume, trial conditions, prior settlement history, settlement demands and defense costs; the impact of asbestos defendant bankruptcies on the policyholder; the policies issued by CNA, including such factors as aggregate or per occurrence limits, whether the policy is primary, umbrella or excess and the existence of policyholder retentions and/or deductibles; the existence of other insurance; and reinsurance arrangements.

With respect to other court cases and how they might affect the Company’s reserves and reasonable possible losses, the following should be noted. State and federal courts issue numerous decisions each year, which potentially impact losses and reserves in both a favorable and unfavorable manner. Examples of favorable developments include decisions to allocate defense and indemnity payments in a manner so as to limit carriers’ obligations to damages taking place during the effective dates of their policies; decisions holding that injuries occurring after asbestos operations are completed are subject to the completed operations aggregate limits of the policies; and decisions ruling that carriers’ loss control inspections of their insured’s premises do not give rise to a duty to warn third parties to the dangers of asbestos.

Examples of unfavorable developments include decisions limiting the application of the absolute pollution exclusion and decisions holding carriers liable for defense and indemnity of asbestos and pollution claims on a joint and several basis.

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 pollution, court decisions that continue to restrict the scope and applicability of the absolute pollution exclusion contained in policies issued by the Company after 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 pollution, 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.

claims.

Due to the inherent uncertainties in estimating reserves for APMT claim and claim adjustment expensesexpense reserves for APMT and due to the significant uncertainties previously described related to APMT claims, theour ultimate liability for these cases, both individually and in aggregate, may exceed the recorded reserves. Any such potential additional liability, or any range of potential additional amounts, cannot be reasonably estimated currently, but could be material to the Company’sour business, results of operations, equity, and insurer financial strength and debt ratings. Due to, among other things, the factors described above, it may be necessary for the Companyus to record material changes in itsour APMT claim and claim adjustment expense reserves in the future, should new information become available or other developments emerge.

We have annually performed ground up reviews of all open APMT claims to evaluate the adequacy of our APMT reserves. In performing our comprehensive ground up analysis, we consider input from our professionals with direct responsibility for the claims, inside and outside counsel with responsibility for our representation and our actuarial staff. These professionals consider, among many factors, the policyholder’s present and predicted future exposures, including such factors as claims volume, trial conditions, prior settlement history, settlement demands and defense costs; the impact of asbestos defendant bankruptcies on the policyholder; facts or allegations regarding the policies we issued or are alleged to have issued, including such factors as aggregate or per occurrence limits, whether the policy is primary, umbrella or excess, and the existence of policyholder retentions and/or deductibles; the policyholders’ allegations; the existence of other insurance; and reinsurance arrangements.
Further information on APMT Net Prior Year Development is included in Note F of the Consolidated Financial Statements included under Item 8.

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The following table provides data related to CNA’sour APMT claim and claim adjustment expense reserves.

APMT Reserves
                 
  December 31, 2006  December 31, 2005 
      Environmental      Environmental 
      Pollution and      Pollution and 
  Asbestos  Mass Tort  Asbestos  Mass Tort 
(In millions)                
Gross reserves $2,635  $647  $2,992  $680 
Ceded reserves  (1,183)  (231)  (1,438)  (257)
             
                 
Net reserves
 $1,452  $416  $1,554  $423 
             
Asbestos and Environmental Pollution and Mass Tort Reserves
                 
  December 31, 2004
 December 31, 2003
      Environmental     Environmental
      Pollution and     Pollution and
(In millions) Asbestos
 Mass Tort
 Asbestos
 Mass Tort
Gross reserves $3,218  $755  $3,347  $839 
Ceded reserves  (1,532)  (258)  (1,580)  (262)
   
 
   
 
   
 
   
 
 
Net reserves
 $1,686  $497  $1,767  $577 
   
 
   
 
   
 
   
 
 

Asbestos

CNA’s property and casualty insurance subsidiaries have exposure to asbestos-related claims. Estimation of asbestos-related claim and claim adjustment expense reserves involves limitations such as inconsistency of court decisions, specific policy provisions, allocation of liability among insurers and insureds and additional factors such as missing policies and proof of coverage. Furthermore, estimation of asbestos-related claims is difficult due to, among other reasons, the proliferation of bankruptcy proceedings and attendant uncertainties, the targeting of a broader range of businesses and entities as defendants, the uncertainty as to which other insureds may be targeted in the future and the uncertainties inherent in predicting the number of future claims.

In the past several years, CNA haswe experienced, at certain points in time, significant increases in claim counts for asbestos-related claims. The factors that led to these increases included, among other things, intensive advertising campaigns by lawyers for asbestos claimants, mass medical screening programs sponsored by plaintiff lawyers and the addition of new defendants such as the distributors and installers of products containing asbestos. During 2004In recent years, the rate of new filings appears to have decreased from the filing rates seen in the past several years.has decreased. Various challenges to mass screening claimants have been mounted. Nevertheless,successful. Historically, the Company continues to experience an overall increase in total asbestos claim counts. The majority of asbestos bodily injury claims arehave been filed by persons exhibiting few, if any, disease symptoms. Recent studiesStudies have concluded that the percentage of unimpaired claimants to total claimants ranges between 66% and up to 90%. Some courts including the federal district court responsible for pre-trial proceedings in all federal asbestos bodily injury actions, have orderedand some state statutes mandate that so-called “unimpaired” claimants may not recover unless at some point the claimant’s condition worsens to the point of impairment.

Some plaintiffs classified as “unimpaired” continue to challenge those orders and statutes. Therefore, the ultimate impact of the orders and statutes on future asbestos claims remains uncertain.

Several factors are, in management’sour view, negatively impacting asbestos claim trends. Plaintiff attorneys who previously sued entities whothat are now bankrupt are seekingcontinue to seek other viable targets. As a result, companies with few or no previous asbestos claims are becoming targets in asbestos litigation and, although they may have little or no liability, nevertheless must be defended. Additionally, plaintiff attorneys and trustees for future claimants are demanding that policy limits be paid lump-sum into the bankruptcy asbestos trusts prior to presentation of valid claims and medical proof of these claims. Various challenges to these practices are currentlyhave succeeded in litigation, and the ultimate impact or success of these tactics remains uncertain.are continuing to be litigated. Plaintiff attorneys and trustees for future claimants are also attempting to devise claims payment procedures for bankruptcy trusts that would allow asbestos claims to be paid under lax standards for injury, exposure and causation. This also presents the potential for exhausting policy limits in an accelerated fashion.

Challenges to these practices are being mounted, though the ultimate impact or success of these tactics remains uncertain.

As a result of bankruptcies and insolvencies, management haswe had in the past observed an increase in the total number of policyholders with current asbestos claims as additional defendants are added to existing lawsuits and are named in new asbestos bodily injury lawsuits. New asbestosDuring the last few years the rate of new bodily injury claims have also increased substantially in 2003, buthad moderated and most recently the new claims filing rate has decreased although the number of increase has moderated in 2004.

As of December 31, 2004 and 2003, CNA carried approximately $1,686 million and $1,767 million of claim and claim adjustment expense reserves, net of reinsurance recoverables,policyholders claiming coverage for reported and unreported asbestos-related claims. The Company recorded $54 million and $642 million of unfavorable asbestos-related net claim and claim adjustment expense reserve development for the years ended December 31, 2004 and 2003. The Company recorded

54


no asbestos related net claim and claim adjustment expense reserve development forclaims has remained relatively constant in the year ended December 31, 2002. The 2004 unfavorable net prior year development was primarily related to a commutation loss related to Trenwick. The Company paid asbestos-related claims, net of reinsurance recoveries, of $135 million, $121 million and $21 million for the years ended December 31, 2004, 2003 and 2002.

The Company recorded $1,826 million and $642 million in unfavorable gross and net prior year development for the year ended December 31, 2003 for reported and unreported asbestos-related claims, principally due to potential losses from policies issued by the Company with high attachment points, which previous exposure analysis indicated would not be reached. The Company examined the claims filing trends to determine timeframes within which high excess policies issued by the Company could be reached. Elevated claims volumes and increased claims values, together with certain adverse court decisions affecting the ability of policyholders to access excess policies, supported the conclusion that excess policies with high attachment points previously thought not to be exposed may now potentially be exposed. The ceded reinsurance arrangements on these excess policies are different from the primary policies. In general, more extensive reinsurance arrangements apply to the excess policies. As a result, the prior year development shows a higher ratio of ceded to gross amounts than the reserves established in prior periods, resulting in a higher percentage of reserves ceded as of December 31, 2003 versus prior periods.

The Company haspast several years.

We have resolved a number of itsour large asbestos accounts by negotiating settlement agreements. Structured settlement agreements provide for payments over multiple years as set forth in each individual agreement. At December 31, 2004, CNA had eleven structured settlement agreements with a reserve net of reinsurance of $175 million. As to the eleven structured settlement agreements existing at December 31, 2004, payment obligations under those settlement agreements are projected to terminate by 2016. At December 31, 2003, CNA had structured settlement agreements with nine of its policyholders for which it had future payment obligations with a reserve, net of reinsurance, of $188 million.

In 1985, 47 asbestos producers and their insurers, including CIC,The Continental Insurance Company (CIC), executed the Wellington Agreement. The agreement was intended to resolve all issues and litigation related to coverage for asbestos exposures. Under this agreement, signatory insurers committed scheduled policy limits and made the limits available to pay asbestos claims based upon coverage blocks designated by the policyholders in 1985, subject to extension by policyholders. CIC was a signatory insurer to the Wellington Agreement. At December 31, 2004, CNA had obligations for four accounts. With respect to these four remaining unpaid Wellington obligations, CNA has evaluated its exposure and the expected reinsurance recoveries under these agreements and has a recorded reserve of $17 million, net of reinsurance. At December 31, 2003, CNA had fulfilled its Wellington Agreement obligations as to all but five accounts and had a recorded reserve of $23 million, net of reinsurance.

CNA has

We have also used coverage in place agreements to resolve large asbestos exposures. Coverage in place agreements are typically agreements between CNAus and itsour 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. Coverage in place agreements are evaluated based on claims filings trends and severities. As of December 31, 2004, CNA had negotiated thirty-three coverage in place agreements. The Company has evaluated these commitments and the expected reinsurance recoveries under these agreements and has recorded a reserve of $76 million, net of reinsurance as of December 31, 2004. As of December 31, 2003, CNA had negotiated thirty-two such agreements and had established a reserve of $109 million, net of reinsurance.

40

The Company categorizes


We categorize active asbestos accounts as large or small accounts. CNA definesWe define a large account as an active account with more than $100,000$100 thousand of cumulative paid losses. The Company hasWe have made closing large accounts a significant management priority. At December 31, 2004, the Company had 180 large accounts and had established reserves of $368 million, net of reinsurance. At December 31, 2003, CNA had 160 large accounts with reserves of $405 million, net of reinsurance. Large accounts are typically accounts that have been long identified as significant asbestos exposures. In the 2003 ground up reserve study, the Company observed that underlying layers of primary, umbrella and lower layer excess policies were exhausting at accelerated rates due to increased claims volumes, claims severities and increased defense expense incurred in litigating claims. Those accounts where the Company had issued high excess policies were evaluated in the study to determine potential impairment of the high excess layers of coverage. Management concluded that high excess coverage previously thought not to be exposed could potentially be exposed should current adverse claim trends continue.

Small accounts are defined as active accounts with $100,000$100 thousand or less of cumulative paid losses. At December 31, 2004, the Company had 1,109 small accounts, approximately 83%Approximately 80% and 81% of itsour total active asbestos accounts with reserves of $141 million, net of reinsurance. Atare classified as small accounts at December 31, 2003, CNA had 1,065 small accounts2006 and established reserves of $147 million, net of reinsurance. Small accounts are typically representative of policyholders with limited connection to asbestos. As entities which were historic targets in asbestos litigation continue to file for bankruptcy protection, plaintiffs’ attorneys are seeking other viable targets. As a result, companies with few or no previous asbestos claims are becoming targets in asbestos litigation and nevertheless must be defended by CNA under its

55

2005.


policies. Bankruptcy filings and increased claims filings in the last few years could potentially increase costs incurred in defending small accounts.

The CompanyWe also evaluates itsevaluate our asbestos liabilities arising from itsour assumed reinsurance business and itsour participation in various pools. At December 31, 2004 and 2003, CNA had $148 million and $157 million of reserves, net of reinsurance, related to these asbestos liabilities arising from the Company’s assumed reinsurance obligations and CNA’s participation in pools, including Excess & Casualty Reinsurance Association (ECRA).

At December 31, 2004 and 2003, the unassigned

IBNR reserve was $707 million and $684 million, net of reinsurance. This IBNR reserve relatesreserves relate to potential development on accounts that have not settled and potential future claims from unidentified policyholders.

The tables below depict CNA’sour overall pending asbestos accounts and associated reserves at December 31, 20042006 and December 31, 2003.

2005.

Pending Asbestos Accounts and Associated Reserves

                 
      Net Paid       
      (Recovered) Losses  Net Asbestos  Percent of 
  Number of  in 2006  Reserves  Asbestos 
December 31, 2006 Policyholders  (In millions)  (In millions)  Net Reserves 
Policyholders with settlement agreements                
Structured Settlements  15  $22  $171   12%
Wellington  3   (1)  14   1 
Coverage in place  37   (18)  79   5 
Fibreboard  1      53   4 
             
                 
Total with settlement agreements  56   3   317   22 
             
                 
Other policyholders with active accounts                
Large asbestos accounts  220   76   254   17 
Small asbestos accounts  1,080   17   101   7 
             
                 
Total other policyholders  1,300   93   355   24 
             
 
Assumed reinsurance and pools     6   141   10 
Unassigned IBNR        639   44 
             
                 
Total
  1,356  $102  $1,452   100%
             

December 31, 2004

                 
      Net Paid Losses Net Asbestos Percent of
  Number of in 2004 Reserves Asbestos
  Policyholders
 (In millions)
 (In millions)
 Net Reserves
Policyholders with settlement agreements                
Structured Settlements  11  $39  $175   10%
Wellington  4   4   17   1 
Coverage in place  33   14   76   5 
Fibreboard  1      54   3 
   
 
   
 
   
 
   
 
 
Total with settlement agreements  49   57   322   19 
   
 
   
 
   
 
   
 
 
Other policyholders with active accounts                
Large asbestos accounts  180   47   368   22 
Small asbestos accounts  1,109   23   141   8 
   
 
   
 
   
 
   
 
 
Total other policyholders  1,289   70   509   30 
   
 
   
 
   
 
   
 
 
Assumed reinsurance and pools     8   148   9 
Unassigned IBNR        707   42 
   
 
   
 
   
 
   
 
 
Total
  1,338  $135  $1,686   100%
   
 
   
 
   
 
   
 
 

5641


Pending Asbestos Accounts and Associated Reserves

December 31, 2003

                                
 Net Paid Losses Net Asbestos Percent of Net Paid Losses Net Asbestos Percent of 
 Number of in 2003 Reserves Asbestos Number of in 2005 Reserves Asbestos 
 Policyholders
 (In millions)
 (In millions)
 Net Reserves
December 31, 2005 Policyholders (In millions) (In millions) Net Reserves 
Policyholders with settlement agreements  
Structured Settlements 9 $20 $188  11% 13 $30 $167  11%
Wellington 5 2 23 1  4 2 15 1 
Coverage in place 32 40 109 6  34 13 58 4 
Fibreboard 1 1 54 3  1  54 3 
 
 
 
 
 
 
 
 
          
 
Total with settlement agreements 47 63 374 21  52 45 294 19 
         
 
 
 
 
 
 
 
 
  
Other policyholders with active accounts  
Large asbestos accounts 160 35 405 23  199 68 273 17 
Small asbestos accounts 1,065 16 147 8  1,073 23 135 9 
 
 
 
 
 
 
 
 
          
 
Total other policyholders 1,225 51 552 31  1,272 91 408 26 
         
 
 
 
 
 
 
 
 
  
Assumed reinsurance and pools  7 157 9   6 143 9 
Unassigned IBNR   684 39    709 46 
 
 
 
 
 
 
 
 
          
 
Total
 1,272 $121 $1,767  100% 1,324 $142 $1,554  100%
 
 
 
 
 
 
 
 
          

Some asbestos-related defendants have asserted that their insurance policies are not subject to aggregate limits on coverage. CNA hasWe have such claims from a number of insureds. Some of these claims involve insureds facing exhaustion of products liability aggregate limits in their policies, who have asserted that their asbestos-related claims fall within so-called “non-products” liability coverage contained within their policies rather than products liability coverage, and that the claimed “non-products” coverage is not subject to any aggregate limit. It is difficult to predict the ultimate size of any of the claims for coverage purportedly not subject to aggregate limits or predict to what extent, if any, the attempts to assert “non-products” claims outside the products liability aggregate will succeed. The Company’sOur policies also contain other limits applicable to these claims and the Company haswe have additional coverage defenses to certain claims. The Company hasWe have attempted to manage itsour asbestos exposure by aggressively seeking to settle claims on acceptable terms. There can be no assurance that any of these settlement efforts will be successful, or that any such claims can be settled on terms acceptable to CNA.us. Where CNAwe cannot settle a claim on acceptable terms, the Companywe aggressively litigateslitigate the claim. A recent court ruling by the United States Court of Appeals for the Fourth Circuit has supported certain of the Company’s positions with respect to coverage for “non-products” claims. However, adverse developments with respect to such matters could have a material adverse effect on CNA’sour results of operations and/or equity.

Certain asbestos litigation in which CNA is currently engaged is described below:

As more fully discussed in Note F of the Consolidated Financial Statements included under Item 8 under the heading “APMT Reserves” and in this MD&A under the headings “Asbestos” and “Reserves—Estimates and Uncertainties,” the ultimate cost of reported claims, and in particular APMT claims, is subject to a great many uncertainties, including future developments of various kinds that CNA does not control and that are difficult or impossible to foresee accurately. With respect to the litigation identified below in particular, numerous factual and legal issues remain unresolved. Rulings on those issues by the courts are critical to the evaluation of the ultimate cost to the Company. The outcome of the litigation cannot be predicted with any reliability. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.

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 is required to pay $74 million, net of reinsurance recoveries, over a ten year period commencing after the final approval of a bankruptcy plan of reorganization. The settlement resolves CNA’s liabilities for all pending and

57


future asbestos claims involving A.P. Green Industries, Bigelow — Liptak Corporation and related subsidiaries, including alleged “non-products” exposures. The settlement received initial bankruptcy court approval on August 18, 2003 and CNA expects to procure confirmation of a bankruptcy plan containing an injunction to protect CNA from any future claims.

CNA is engaged in insurance coverage litigation, filed in 2003, with underlying plaintiffs who have asbestos bodily injury claims against the former Robert A. Keasbey Company (Keasbey) in New York state court (Continental Casualty Co. v. Employers Ins. of Wausau et al., No. 601037/03 (N.Y. County)). Keasbey, a currently dissolved corporation, was a seller and installer of asbestos-containing insulation products in New York and New Jersey. Thousands of plaintiffs have filed bodily injury claims against Keasbey; however, Keasbey’s involvement at a number of work sites is a highly contested issue. Therefore, the defense disputes the percentage of valid claims against Keasbey. CNA issued Keasbey primary policies for 1970-1987 and excess policies for 1972-1978. CNA has paid an amount substantially equal to the policies’ aggregate limits for products and completed operations claims. Claimants against Keasbey allege, among other things, that CNA owes coverage under sections of the policies not subject to the aggregate limits, an allegation CNA vigorously contests in the lawsuit. In the litigation, CNA and the claimants seek declaratory relief as to the interpretation of various policy provisions. The court dismissed a claim alleging bad faith and seeking unspecified damages on March 21, 2004; that ruling is now being appealed. With respect to this litigation in particular, numerous factual and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. These factors include, among others: (a) whether the Company has any further responsibility to compensate claimants against Keasbey under its policies and, if so, under which policies; (b) whether the Company’s responsibilities extend to a particular claimants’ entire claim or only to a limited percentage of the claim; (c) whether the Company’s responsibilities under its policies are limited by the occurrence limits or other provisions of the policies; (d) whether certain exclusions in some of the policies apply to exclude certain claims; (e) the extent to which claimants can establish exposures to asbestos materials as to which Keasbey has any responsibility; (f) the legal theories which must be pursued by such claimants to establish the liability of Keasbey and whether such theories can, in fact, be established; (g) the diseases and damages claimed by such claimants; (h) and the extent that such liability would be shared with other responsible parties. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.

CNA has insurance coverage disputes related to asbestos bodily injury claims against Burns & Roe Enterprises, Inc. (Burns & Roe). Originally raised in litigation, now stayed, these disputes are currently part ofIn re: Burns & Roe Enterprises, Inc., pending in the U.S. Bankruptcy Court for the District of New Jersey, No. 00-41610. Burns & Roe provided engineering and related services in connection with construction projects. At the time of its bankruptcy filing, on December 4, 2000, Burns & Roe faced approximately 11,000 claims alleging bodily injury resulting from exposure to asbestos as a result of construction projects in which Burns & Roe was involved. CNA allegedly provided primary liability coverage to Burns & Roe from 1956-1969 and 1971-1974, along with certain project-specific policies from 1964-1970. The parties in the litigation are seeking a declaration of the scope and extent of coverage, if any, afforded to Burns & Roe for its asbestos liabilities. The litigation has been stayed since May 14, 2003 pending resolution of the bankruptcy proceedings. With respect to the Burns & Roe litigation and the pending bankruptcy proceeding, numerous unresolved factual and legal issues will impact the ultimate exposure to the Company. With respect to this litigation, numerous factual and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. These factors include, among others: (a) whether the Company has any further responsibility to compensate claimants against Burns & Roe under its policies and, if so, under which; (b) whether the Company’s responsibilities under its policies extend to a particular claimants’ entire claim or only to a limited percentage of the claim; (c) whether the Company’s responsibilities under its policies are limited by the occurrence limits or other provisions of the policies; (d) whether certain exclusions, including professional liability exclusions, in some of the Company’s policies apply to exclude certain claims; (e) the extent to which claimants can establish exposures to asbestos materials as to which Burns & Roe has any responsibility; (f) the legal theories which must be pursued by such claimants to establish the liability of Burns & Roe and whether such theories can, in fact, be established; (g) the diseases and damages claimed by such claimants; (h) the extent that any liability of Burns & Roe would be shared with other potentially responsible parties; (i) and the impact of bankruptcy proceedings on claims and coverage issue resolution. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.

CIC issued certain primary and excess policies to Bendix Corporation (Bendix), now part of Honeywell International, Inc. (Honeywell). Honeywell faces approximately 75,400 pending asbestos bodily injury claims resulting from alleged

58


exposure to Bendix friction products. CIC’s primary policies allegedly covered the period from at least 1939 (when Bendix began to use asbestos in its friction products) to 1983, although the parties disagree about whether CIC’s policies provided product liability coverage before 1940 and from 1945 to 1956. CIC asserts that it owes no further material obligations to Bendix under any primary policy. Honeywell alleges that two primary policies issued by CIC covering 1969-1975 contain occurrence limits but not product liability aggregate limits for asbestos bodily injury claims. CIC has asserted, among other things, even if Honeywell’s allegation is correct, which CNA denies, its liability is limited to a single occurrence limit per policy or per year, and in the alternative, a proper allocation of losses would substantially limit its exposure under the 1969-1975 policies to asbestos claims. These and other issues are being litigated inContinental Insurance Co., et al. v. Honeywell International Inc., No. MRS-L-1523-00 (Morris County, New Jersey) which was filed on May 15, 2000. In the litigation, the parties are seeking declaratory relief of the scope and extent of coverage, if any, afforded to Bendix under the policies issued by the Company. With respect to this litigation, numerous factual and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. These factors include, among others: (a) whether certain of the primary policies issued by the Company contain aggregate limits of liability; (b) whether the Company’s responsibilities under its policies extend to a particular claimants’ entire claim or only to a limited percentage of the claim; (c) whether the Company’s responsibilities under its policies are limited by the occurrence limits or other provisions of the policies; (d) whether some of the claims against Bendix arise out of events which took place after expiration of the Company’s policies; (e) the extent to which claimants can establish exposures to asbestos materials as to which Bendix has any responsibility; (f) the legal theories which must be pursued by such claimants to establish the liability of Bendix and whether such theories can, in fact, be established; (g) the diseases and damages claimed by such claimants; (h) the extent that any liability of Bendix would be shared with other responsible parties; and (i) whether Bendix is responsible for reimbursement of funds advanced by the Company for defense and indemnity in the past. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.

Suits have also been initiated directly against CNA and other insurers in four jurisdictions: Ohio, Texas, West Virginia and Montana. In the two Ohio actions, plaintiffs allege the defendants negligently performed duties undertaken to protect workers and the public from the effects of asbestos (Varner v. Ford Motor Co., et al. (Cuyahoga County, Ohio, filed on June 12, 2003) andPeplowski v. ACE American Ins. Co., et al. (U.S. D. C. N.D. Ohio, filed on April 1, 2004)). The state trial court granted insurers, including CNA, summary judgment against a representative group of plaintiffs, ruling that insurers had no duty to warn plaintiffs about the dangers of asbestos. The summary judgment ruling is on appeal. With respect to this litigation in particular, numerous factual and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. These factors include: (a) the speculative nature and unclear scope of any alleged duties owed to individuals exposed to asbestos and the resulting uncertainty as to the potential pool of potential claimants; (b) the fact that imposing such duties on all insurer and non-insurer corporate defendants would be unprecedented and, therefore, the legal boundaries of recovery are difficult to estimate; (c) the fact that many of the claims brought to date are barred by various Statutes of Limitation and it is unclear whether future claims would also be barred; (d) the unclear nature of the required nexus between the acts of the defendants and the right of any particular claimant to recovery; (e) the existence of hundreds of co-defendants in some of the suits and the applicability of the legal theories pled by the claimants to thousands of potential defendants. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.

Similar lawsuits have also been filed in Texas against CNA beginning in 2002, and other insurers and non-insurer corporate defendants asserting liability for failing to warn of the dangers of asbestos (Boson v. Union Carbide Corp., et al. (District Court of Nueces County, Texas)). During 2003, many of the Texas claims have been dismissed as time-barred by the applicable Statute of Limitations. In other claims, the Texas courts have ruled that the carriers did not owe any duty to the plaintiffs or the general public to advise on the effects of asbestos thereby dismissing these claims. Certain of the Texas courts’ rulings have been appealed. With respect to this litigation in particular, numerous factual and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. These factors include: (a) the speculative nature and unclear scope of any alleged duties owed to individuals exposed to asbestos and the resulting uncertainty as to the potential pool of potential claimants; (b) the fact that imposing such duties on all insurer and non-insurer corporate defendants would be unprecedented and, therefore, the legal boundaries of recovery are difficult to estimate; (c) the fact that many of the claims brought to date are barred by various Statutes of Limitation and it is unclear whether future claims would also be barred; (d) the unclear nature of the required nexus between the acts of the defendants and the right of any

59


particular claimant to recovery; (e) the existence of hundreds of co-defendants in some of the suits and the applicability of the legal theories pled by the claimants to thousands of potential defendants. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.

CNA was named inAdams v. Aetna, Inc., et al. (Circuit Court of Kanawha County, West Virginia, filed June 23, 2002), a purported class action against CNA and other insurers, alleging that the defendants violated West Virginia’s Unfair Trade Practices Act in handling and resolving asbestos claims against their policyholders. The Adams litigation had been stayed pending disposition of two cases in the West Virginia Supreme Court of Appeals. Those cases were decided in June, 2004. The Adams case also involves proceedings and mediation in the Bankruptcy Court in New York with jurisdiction over the Manville Bankruptcy. In those proceedings issues have been raised concerning the preclusive effect of the Manville Bankruptcy settlements with insurers and resulting injunctions against claims. Those issues are now on appeal to the United States District Court for the Eastern District of New York. With respect to this litigation in particular, numerous factual and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. These factors include: (a) the legal sufficiency of the novel statutory and common law claims pled by the claimants; (b) the applicability of claimants’ legal theories to insurers who neither defended nor controlled the defense of certain policyholders; (c) the possibility that certain of the claims are barred by various Statutes of Limitation; (d) the fact that the imposition of duties would interfere with the attorney client privilege and the contractual rights and responsibilities of the parties to the Company’s insurance policies; (e) the potential and relative magnitude of liabilities of co-defendants. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.

On March 22, 2002, a direct action was filed in Montana (Pennock, et al. v. Maryland Casualty, et al. First Judicial District Court of Lewis & Clark County, Montana) by eight individual plaintiffs (all employees of W.R. Grace & Co. (W.R. Grace)) and their spouses against CNA, Maryland Casualty and the State of Montana. This action alleges that the carriers failed to warn of or otherwise protect W.R. Grace employees from the dangers of asbestos at a W.R. Grace vermiculite mining facility in Libby, Montana. The Montana direct action is currently stayed because of W.R. Grace’s pending bankruptcy. With respect to this litigation in particular, numerous factual and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. These factors include: (a) the unclear nature and scope of any alleged duties owed to people exposed to asbestos and the resulting uncertainty as to the potential pool of potential claimants; (b) the potential application of Statutes of Limitation to many of the claims which may be made depending on the nature and scope of the alleged duties; (c) the unclear nature of the required nexus between the acts of the defendants and the right of any particular claimant to recovery; (d) the diseases and damages claimed by such claimants; (e) and the extent that such liability would be shared with other potentially responsible parties; and, (f) the impact of bankruptcy proceedings on claims resolution. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.

CNA is vigorously defending these and other cases and believes that it has meritorious defenses to the claims asserted. However, there are numerous factual and legal issues to be resolved in connection with these claims, and it is extremely difficult to predict the outcome or ultimate financial exposure represented by these matters. Adverse developments with respect to any of these matters could have a material adverse effect on CNA’s business, insurer financial strength and debt ratings and results of operations and/or equity.

As a result of the uncertainties and complexities involved, reserves for asbestos claims cannot be estimated with traditional actuarial techniques that rely on historical accident year loss development factors. In establishing asbestos reserves, CNA evaluateswe evaluate the exposure presented by each insured. As part of this evaluation, CNA considerswe consider the available insurance coverage; limits and deductibles; the potential role of other insurance, particularly underlying coverage below any CNAof our excess liability policies; and applicable coverage defenses, including asbestos exclusions. Estimation of asbestos-related claim and claim adjustment expense reserves involves a high degree of judgment on theour part of management and consideration of many complex factors, including:

inconsistency of court decisions, jury attitudes and future court decisions; specific policy provisions; allocation of liability among insurers and insureds; missing policies and proof of coverage; the proliferation of bankruptcy proceedings and attendant uncertainties; novel theories asserted by policyholders and their counsel; the targeting of a broader range of businesses and entities as defendants; the uncertainty as to which other insureds may be targeted in the future and the uncertainties inherent in predicting the number of future claims; volatility in claim numbers and settlement demands; increases in the number of non-impaired claimants and the extent to which they can be precluded from making claims; the efforts by insureds to obtain coverage not subject to aggregate limits; long latency period between asbestos exposure and disease manifestation and the resulting potential for involvement of multiple policy periods for individual claims; medical inflation trends; the mix of asbestos-related diseases presented and the ability to recover reinsurance.

•  inconsistency of court decisions, jury attitudes and future court decisions
•  specific policy provisions

6042


•  allocation of liability among insurers and insureds
•  missing policies and proof of coverage
•  the proliferation of bankruptcy proceedings and attendant uncertainties
•  novel theories asserted by policyholders and their counsel
•  the targeting of a broader range of businesses and entities as defendants
•  the uncertainty as to
We are involved in significant asbestos-related claim litigation, which other insureds may be targeted in the future and the uncertainties inherent in predicting the number of future claims
•  volatility in claim numbers and settlement demands
•  increases in the number of non-impaired claimants and the extent to which they can be precluded from making claims
•  the efforts by insureds to obtain coverage not subject to aggregate limits
•  long latency period between asbestos exposure and disease manifestation and the resulting potential for involvement of multiple policy periods for individual claims
•  medical inflation trends
•  the mix of asbestos-related diseases presented and
•  the ability to recover reinsurance.

The Company is also monitoring possible legislative reforms ondescribed in Note F of the state and national level, including possible federal legislation to create a national privately financed trust financed by contributions from insurers such as CNA, industrial companies and others, which if established, could replace litigation of asbestos claims with payments to claimants from the trust. It is uncertain at the present time whether such legislation will be enacted or, if it is, its impact on the Company.

Consolidated Financial Statements included under Item 8.

Environmental Pollution and Mass Tort

Environmental pollution cleanup is the subject of both federal and state regulation. By some estimates, there are thousands of potential waste sites subject to cleanup. The insurance industry is involved in extensive litigation regarding coverage issues. Judicial interpretations in many cases have expanded the scope of coverage and liability beyond the original intent of the policies. The Comprehensive Environmental Response Compensation and Liability Act of 1980 (Superfund) and comparable state statutes (mini-Superfunds) govern the cleanup and restoration of toxic waste sites and formalize the concept of legal liability for cleanup and restoration by “Potentially Responsible Parties” (PRPs). Superfund and the mini-Superfunds establish mechanisms to pay for cleanup of waste sites if PRPs fail to do so and assign liability to PRPs. The extent of liability to be allocated to a PRP is dependent upon a variety of factors. Further, the number of waste sites subject to cleanup is unknown. To date, approximately 1,500 cleanup sites have been identified by the Environmental Protection Agency (EPA) and included on its National Priorities List (NPL). State authorities have designated many cleanup sites as well.

Many policyholders have made claims against various CNA insurance subsidiariesus 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’sour adoption of the Simplified Commercial General Liability coverage form, which includes what is referred to in the industry as an absolute pollution exclusion. CNAWe and the insurance industry are disputing coverage for many such claims. Key coverage issues include whether

61


cleanup costs are considered damages under the policies, trigger of coverage, allocation of liability among triggered policies, applicability of pollution exclusions and owned property exclusions, the potential for joint and several liability and the definition of an occurrence. To date, courts have been inconsistent in their rulings on these issues.

A number of proposals to modify Superfund

We have been made by various parties. However, no modifications were enacted by Congress during 2004 or 2003, and it is unclear what positions Congress or the Administration will take and what legislation, if any, will result in the future. 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, 2004 and 2003, CNA carried approximately $497 million and $577 million of claim and claim adjustment expense reserves, net of reinsurance recoverables, for reported and unreported environmental pollution and mass tort claims. There was $1 million and $153 million of environmental pollution and mass tort net claim and claim adjustment expense reserve development recorded for the years ended December 31, 2004 and 2003. There was no environmental pollution and mass tort net claim and claim adjustment expense reserve development recorded for the year ended December 31, 2002. Additionally, the Company recorded $15 million of current accident year losses related to mass tort in 2004. The Company paid environmental pollution-related claims and mass tort-related claims, net of reinsurance recoveries, of $96 million, $93 million and $116 million for the years ended December 31, 2004, 2003 and 2002.

CNA has made resolution of large environmental pollution exposures a management priority. The Company hasWe have resolved a number of itsour large environmental accounts by negotiating settlement agreements. In itsour settlements, CNAwe sought to resolve those exposures and obtain the broadest release language to avoid future claims from the same policyholders seeking coverage for sites or claims that had not emerged at the time CNAwe settled with itsour policyholder. While the terms of each settlement agreement vary, CNAwe sought to obtain broad environmental releases that include known and unknown sites, claims and policies. The broad scope of the release provisions contained in those settlement agreements should, in many cases, prevent future exposure from settled policyholders. It remains uncertain, however, whether a court interpreting the language of the settlement agreements will adhere to the intent of the parties and uphold the broad scope of language of the agreements.

The Company classifies its

We classify our environmental pollution accounts into several categories, which include structured settlements, coverage in place agreements and active accounts. Structured settlement agreements provide for payments over multiple years as set forth in each individual agreement. At December 31, 2004, CNA had two structured settlement agreements and has established reserves of $5 million, net of reinsurance, to fund future payment obligations under the agreements. At December 31, 2003, CNA had a structured settlement agreement with one of its policyholders for which it had future payment obligations with a recorded reserve of $12 million, net of reinsurance.

CNA has

We have also used coverage in place agreements to resolve pollution exposures. Coverage in place agreements are typically agreements between CNAus and itsour policyholders identifying the policies and the terms for payment of pollution related liabilities. Claims payments are contingent on presentation of adequate documentation of damages

62


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, 2004, CNA had negotiated fifteen coverage in place agreements and had established a reserve of $16 million, net of reinsurance. At December 31, 2003, CNA had six such agreements with a recorded reserve of $8 million, net of reinsurance.

The Company categorizes

We categorize active accounts as large or small accounts in the pollution area. CNA definesWe define a large account as an active account with more than $100,000$100 thousand cumulative paid losses. At December 31, 2004, the Company had 134 large accounts with a collective reserve of $75 million, net of reinsurance. The Company hasWe have made closing large accounts a significant management priority. CNA had 144 large accounts with a collective reserve of $86 million, net of reinsurance, at December 31, 2003. Small accounts are defined as active accounts with $100,000$100 thousand or less cumulative paid losses. At December 31, 2004, CNA had 405 small accounts with a collective reserve of $47 million, net of reinsurance. CNA had 432 small accounts with a collective reserve of $53 million, net of reinsurance, at December 31, 2003.

The Company

We also evaluates itsevaluate our environmental pollution exposures arising from itsour assumed reinsurance and itsour participation in various pools, including ECRA. CNA has a reserve of $36 million and $38 million related to these liabilities for the years ended December 31, 2004 and 2003.

At December 31, 2004, the Company’s

We carry unassigned IBNR reserve was $163 million, net of reinsurance. At December 31, 2003, CNA’s unassigned IBNR reservereserves for environmental pollution was $197 million, net of reinsurance. This IBNR reserve relatespollution. These reserves relate to potential development on accounts that have not settled and potential future claims from unidentified policyholders.

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The chartstables below depict CNA’sour overall pending environmental pollution accounts and associated reserves at December 31, 20042006 and 2003.

2005.
Pending Environmental Pollution Accounts and Associated Reserves
                 
          Net    
          Environmental  Percent of 
      Net Paid Losses  Pollution  Environmental 
  Number of  in 2006  Reserves  Pollution Net 
December 31, 2006 Policyholders  (In millions)  (In millions)  Reserve 
Policyholders with Settlement Agreements                
Structured settlements  11  $16  $9   3%
Coverage in place  18   5   14   5 
             
Total with Settlement Agreements  29   21   23   8 
                 
Other Policyholders with Active Accounts                
Large pollution accounts  115   20   58   20 
Small pollution accounts  346   9   46   17 
             
Total Other Policyholders  461   29   104   37 
                 
Assumed Reinsurance & Pools     1   32   11 
Unassigned IBNR        126   44 
             
                 
Total
  490  $51  $285   100%
             
Pending Environmental Pollution Accounts and Associated Reserves
                 
          Net    
          Environmental  Percent of 
      Net Paid Losses  Pollution  Environmental 
  Number of  in 2005  Reserves  Pollution Net 
December 31, 2005 Policyholders  (In millions)  (In millions)  Reserve 
Policyholders with Settlement Agreements                
Structured settlements  6  $10  $17   5%
Coverage in place  16   10   23   7 
             
Total with Settlement Agreements  22   20   40   12 
                 
Other Policyholders with Active Accounts                
Large pollution accounts  120   18   63   19 
Small pollution accounts  362   15   50   15 
             
Total Other Policyholders  482   33   113   34 
                 
Assumed Reinsurance & Pools     3   33   10 
Unassigned IBNR        150   44 
             
Total
  504  $56  $336   100%
             

At December 31, 2004

                 
          Net  
          Environmental Percent of
      Net Paid Losses Pollution Environmental
  Number of in 2004 Reserves Pollution Net
  Policyholders
 (In millions)
 (In millions)
 Reserve
Policyholders with Settlement Agreements                
Structured settlements  2  $14  $5   1%
Coverage in place  15   5   16   5 
   
 
   
 
   
 
   
 
 
Total with Settlement Agreements  17   19   21   6 
Other Policyholders with Active Accounts                
Large pollution accounts  134   18   75   22 
Small pollution accounts  405   14   47   14 
   
 
   
 
   
 
   
 
 
Total Other Policyholders  539   32   122   36 
Assumed Reinsurance & Pools     2   36   10 
Unassigned IBNR        163   48 
   
 
   
 
   
 
   
 
 
Total
  556  $53  $342   100%
   
 
   
 
   
 
   
 
 

6344


At December 31, 2003INVESTMENTS
                 
          Net  
          Environmental Percent of
      Net Paid Losses Pollution Environmental
  Number of in 2003 Reserves Pollution Net
  Policyholders
 (In millions)
 (In millions)
 Reserve
Policyholders with Settlement Agreements                
Structured settlements  1  $17  $12   3%
Coverage in place  6   3   8   2 
   
 
   
 
   
 
   
 
 
Total with Settlement Agreements  7   20   20   5 
Other Policyholders with Active Accounts                
Large pollution accounts  144   21   86   22 
Small pollution accounts  432   14   53   13 
   
 
   
 
   
 
   
 
 
Total Other Policyholders  576   35   139   35 
Assumed Reinsurance & Pools     2   38   10 
Unassigned IBNR        197   50 
   
 
   
 
   
 
   
 
 
Total
  583  $57  $394   100%
   
 
   
 
   
 
   
 
 

In 2003, CNA observed a marked increase in silica claims frequency in Mississippi, where plaintiff attorneys appear to have filed claims to avoid the effect of tort reform. In 2004, silica claims frequency in Mississippi has moderated notably due to implementation of tort reform measures and favorable court decisions. To date, the most significant silica exposures identified included a relatively small number of accounts with significant numbers of new claims reported in 2003 that continued at a lesser rate in 2004. Establishing claim and claim adjustment expense reserves for silica claims is subject to uncertainties because of disputes concerning medical causation with respect to certain diseases, including lung cancer, geographical concentration of the lawsuits asserting the claims, and the large rise in the total number of claims without underlying epidemiological developments suggesting an increase in disease rates or plaintiffs. Moreover, judicial interpretations regarding application of various tort defenses, including application of various theories of joint and several liabilities, impede the Company’s ability to estimate its ultimate liability for such claims.

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INVESTMENTS

CNA adopted Statement of Position 03-01,Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts (SOP 03-01) as of January 1, 2004. The assets and liabilities of certain guaranteed investment contracts and indexed group annuity contracts that were previously segregated and reported as separate accounts no longer qualify for separate account presentation. Prior to the adoption of SOP 03-01, the asset and liability presentation of these affected contracts were categorized as separate account assets and liabilities within the Consolidated Balance Sheet. The results of operations from separate account business were primarily classified as other revenue in the Consolidated Statement of Operations. In accordance with the provisions of SOP 03-01, the classification and presentation of certain balance sheet and income statement items have been modified. Accordingly, certain investment securities previously classified as separate account assets have now been reclassified on the balance sheet to the general account and are reported as available-for-sale or trading securities. The investment portfolio supporting the indexed group annuity contracts is classified as held for trading purposes, and is carried at fair value, with both the net realized and unrealized gains (losses) included within net investment income in the Consolidated Statement of Operations. Consistent with the requirements of SOP 03-01, prior year amounts have not been conformed to the current year presentation.

Beginning in the fourth quarter of 2004, the Company has designated new purchases related to a specific investment strategy, that primarily includes convertible bond securities, as held for trading purposes. These securities in the trading portfolio are carried at fair value, with both the net realized and unrealized gains (losses) included within net investment income in the Consolidated Statements of Operations.

Net Investment Income

The significant components of net investment income are presented in the following table.

Net Investment Income
                        
      
Years ended December 31
(In millions)
 2004
 2003
 2002
Years ended December 31 2006 2005 2004 
(In millions) 
Fixed maturity securities $1,571 $1,651 $1,854  $1,842 $1,608 $1,571 
Short term investments 56 63 62  248 147 56 
Limited partnerships 212 221  (34) 288 254 212 
Equity securities 14 19 66  23 25 14 
Income from trading portfolio (a) 110    103 47 110 
Interest on funds withheld and other deposits  (267)  (344)  (239)  (68)  (166)  (261)
Other 18 85 81  18 20 18 
 
 
 
 
 
 
        
 
Gross investment income 1,714 1,695 1,790  2,454 1,935 1,720 
Investment expense  (40)  (48)  (60)  (42)  (43)  (40)
 
 
 
 
 
 
        
 
Net investment income
 $1,674 $1,647 $1,730  $2,412 $1,892 $1,680 
 
 
 
 
 
 
        

(a)There was no change in net unrealized gains (losses) on trading securities included in net investment income for the year ended December 31, 2006. The change in net unrealized gains (losses) on trading securities included in net investment income was $(7) million and $2 million for the years ended December 31, 2005 and 2004.
Net investment income was $2increased by $520 million for the year ended December 31, 2004.

The Company experienced slightly higher net investment income in 2004 as2006 compared with 2003. This2005. The improvement was primarily driven by interest rate increases across fixed maturity securities and short term investments, an increase was due primarily toin the reducedoverall invested asset base resulting from improved cash flow and a reduction of interest expense on funds withheld and other deposits. TheDuring 2006 and 2005, we commuted several significant finite reinsurance contracts which contained interest costscrediting provisions and as a result, interest expense on funds withheld has declined significantly. No further interest expense is due on the funds withheld on the commuted contracts. The pretax interest expense on funds withheld related to these significant commuted contracts was $14 million, $84 million and other deposits increased in 2003$146 million for December 31, 2006, 2005 and 2004, and was reflected as a resultcomponent of additional cessions toNet investment income in our Consolidated Statements of Operations. The 2005 and 2004 amounts include the corporate aggregate reinsurance and other treaties due to adverse net prior year development (seeinterest charges associated with the Reinsurance sectioncontract commuted in 2006. See Note H of this MD&Athe Consolidated Financial Statements included under Item 8 for additional information for interest costs on funds withheld and other deposits).deposits. Also impacting net investment income was increased income from the trading portfolio of approximately $56 million. The increased income from the trading portfolio was largely offset by a corresponding increase in the policyholders’ funds reserves supported by the trading portfolio, which is included in Insurance claims and policyholders’ benefits on the Consolidated Statements of Operations.

Net investment income increased by $212 million for 2005 compared with 2004. This improvementincrease was offset partly by decreases in investment incomedue to the reduced interest expense on funds withheld and other deposits discussed above and improved results across all other available-for-sale asset classes, which is largelyespecially short term investments, due to the result of the impacts of the Group Benefits and Individual Life sales transactions that are describedimproved period over period yields. This improvement was partly offset by decreases in Note P — Significant Transactions. Also, the net investment income offrom the trading portfolio positively impacted results for 2004.

The Company experienced lower net investment income in 2003 as compared with 2002. This decrease was due primarily to lower investment yields on fixed maturity securities and increased costs on funds withheld and other deposits. The interest costs on funds withheld and other deposits increased principally as a result of additional cessions to the corporate aggregate reinsurance and other treaties due to adverse net prior year development

65

portfolio.


recorded in 2003. This decrease in net investment income in 2003 was partially offset by increased limited partnership income. Limited partnership income increased as a result of improving equity markets and favorable conditions in the fixed income markets.

The bond segment of the investment portfolio yielded 5.6% in 2006, 4.9% in 2005 and 4.6% in 2004, 5.1% in 2003 and 6.0% in 2002.2004.

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Net Realized Investment Gains (Losses)

The components of net realized investment results for available-for-sale securities are presented in the following table.

Net Realized Investment Gains (Losses)
                        
      
Years ended December 31
(In millions)
 2004
 2003
 2002
Years ended December 31 2006 2005 2004 
(In millions) 
Realized investment gains (losses):  
Fixed maturity securities:  
U.S. Government bonds $10 $(70) $392  $62 $(33) $10 
Corporate and other taxable bonds 123 380  (557)  (98)  (86) 123 
Tax-exempt bonds 42 97 48  53 12 42 
Asset-backed bonds 53 42 36   (9) 14 53 
Redeemable preferred stock 19  (12)  (28)  (3) 3 19 
 
 
 
 
 
 
        
 
Total fixed maturity securities 247 437  (109) 5  (90) 247 
Equity securities 202 114  (158) 16 38 202 
Derivative securities  (84) 78  (52) 18 49  (84)
Short-term investments  (3) 3 12 
Other, including dispositions of businesses, net of participating policyholders’ interest  (601)  (168) 53 
Short term investments  (5)   (3)
Other, including dispositions of businesses net of participating policyholders’ interest 53  (10)  (601)
       
 
 
 
 
 
 
  
Realized investment gains (losses) before allocation to participating policyholders’ and minority interests  (239) 464  (254) 87  (13)  (239)
Allocated to participating policyholders’ and minority interests  (9)  (4) 2   (1) 3  (9)
 
Income tax (expense) benefit 95  (175) 103   (19)  95 
       
 
 
 
 
 
 
  
Net realized investment gains (losses), net of participating policyholders’ and minority interests
 $(153) $285 $(149) $67 $(10) $(153)
 
 
 
 
 
 
        

Net realized investment results decreased $438increased by $77 million after-tax in 2004 asfor 2006 compared with 2003. This decrease2005. The increase in net realized investment results was primarily duedriven by improved results in fixed maturity securities, partially offset by increases in interest rate related other-than-temporary impairment (OTTI) losses for which we did not assert an intent to hold until an anticipated recovery in value. For 2006, OTTI losses of $112 million were recorded primarily in the corporate and other taxable bonds sector. Other realized investment gains (losses) for the year ended December 31, 2006, included a $37 million pretax gain related to a settlement received as a result of bankruptcy litigation of a major telecommunications corporation.
Net realized investment results improved $143 million in 2005 compared with 2004. This improvement was primarily the result of a 2004 loss of $389 million on the sale of the individual life insurance business, of $389 million after-tax ($622 million pretax), losses on derivatives of $55 million after-tax ($84 million pretax) and reduced fixed maturity gains. These decreases were partly offset by reduced gains for equities securities. Equity results in 2004 included a gain of $105 million after-tax ($162 million pretax) gain on the disposition of the Company’s equity holdings ofrelated to our investment in Canary Wharf Group PLC, (Canary Wharf), a London-based real estate company, and a reductioncompany. Also impacting results for 2005 versus 2004 were decreased results in impairment losses for other-than-temporary declines in market values forthe overall fixed maturity and equity securities. Impairmentasset class partly offset by improved results for the derivatives asset class. OTTI losses of $60$70 million after-tax ($93 million pretax) were recorded in 20042005 across various sectors, including an after-tax impairmentOTTI loss of $36$22 million ($56 million pretax) related to loans made under a credit facility to a national contractor, that are classified as fixed maturities. In 2003, impairmentOTTI losses of $209$60 million after-tax ($321 million pretax) were recorded in 2004 across various sectors, including an OTTI loss of $36 million related to loans to the airline, healthcare and energy industries.

The derivative securities losses recorded in 2004 were primarily duenational contractor. For additional information on loans to derivative securities held to mitigate the effect of changes in long term interest rates on the valuenational contractor, see Note S of the fixed maturity portfolio.

NetConsolidated Financial Statements included under Item 8. Other realized investment results increased $434 million after-tax in 2003 as compared with 2002. This change was due primarily to $209 million after-tax ($321 million pretax) impairmentgains (losses) for the year ended December 31, 2005 and 2004 include gains and losses for other-than-temporary declines in market values for fixed maturity and equity securities recorded in 2003 as compared to $578 million after-tax ($890 million pretax) recorded in 2002. The impairment losses recorded in 2002 related primarily to the telecommunications sector. Also contributing to the increase was improved realized results related to fixed maturity and derivative securitiessales of certain operations or affiliates that are described in 2003. These increases were partially offset by the $130 million after-tax ($176 million pretax) loss recorded in 2003 on the saleNote P of the Group Benefits business.

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Consolidated Financial Statements included under Item 8.


A primary objective in the management of the fixed maturity and equity portfolios is to maximize totaloptimize return relative to underlying liabilities and respective liquidity needs. The Company’sOur views on the current interest rate environment, tax regulations, asset class valuations, specific security issuer and broader industry segment conditions, and the domestic and global economic conditions, are some of the factors that may enter into a decision to move between asset classes. Based on the Company’s consideration of these factors, in the course of normalan investment activity the Company may, in pursuit of the total return objective, be willing to sell securities that, in its analysis, are overvalued on a risk adjusted basis relative to other opportunities that are available at the time in the market; in turn the Company may purchase other securities that, according to its analysis, are undervalued in relation to other securities in the market. In making these value decisions, securities may be bought and sold that shift the investment portfolio between asset classes. The Companydecision. We also continually monitorsmonitor exposure to issuers of securities held and broader industry sector exposures and may from time to time reduceadjust such exposures based on itsour views of a specific issuer or industry sector. These activities will produce realized gains or losses.

The investment portfolio is periodically analyzed for changes in duration and related price change risk. Additionally, the Companywe periodically reviewsreview the sensitivity of the portfolio to the level of foreign exchange rates orand other

46


factors that contribute to market price changes. A summary of these risks and specific analysis on changes is included in Item 7A Quantitative and Qualitative Disclosures about Market RisksRisk included herein. Under
We invest in certain economic conditions, including but not limitedderivative financial instruments primarily to a changingreduce our exposure to market risk (principally interest rate, environment, hedgingequity price and foreign currency risk) and credit risk (risk of nonperformance of underlying obligor). Derivative securities are recorded at fair value at the value of the investment portfolioreporting date. We also use derivatives to mitigate market risk by utilizing derivative strategies, which is discussedpurchasing S&P 500â index futures in greater detail in Notes A and Ca notional amount equal to the Consolidated Financial Statements, may be utilized.

contract liability relating to Life and Group Non-Core indexed group annuity contracts. We provided collateral to satisfy margin deposits on exchange-traded derivatives totaling $27 million as of December 31, 2006. For over-the-counter derivative transactions we utilize International Swaps and Derivatives Association (ISDA) Master Agreements that specify certain limits over which collateral is exchanged. As of December 31, 2006, we provided $31 million of cash as collateral for over-the-counter derivative instruments.

A further consideration in the management of the investment portfolio is the characteristics of the underlying liabilities and the ability to align the duration of the portfolio to those liabilities to meet future liquidity needs, minimize interest rate risk and maintain a level of income sufficient to support the underlying insurance liabilities. For portfolios where future liability cash flows are determinable and long term in nature, the Company segregateswe segregate assets for asset liability management purposes.

CNA classifies its

We classify our fixed maturity securities (bonds and redeemable preferred stocks) and itsour equity securities as either available-for-sale or trading, 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 is included in net investment income. Changes in fair value related to available-for-sale securities are reported as a component of other comprehensive income. Changes in fair value of trading securities are reported within net investment income.

The following table provides further detail of gross realized gains and gross realized losses on available-for-sale fixed maturity securities and equity securities.

securities, which include OTTI losses.

Realized Gains and Losses
                        
      
Years ended December 31
(In millions)
 2004
 2003
 2002
Years ended December 31 2006 2005 2004 
(In millions) 
Net realized gains (losses) on fixed maturity securities and equity securities:  
Fixed maturity securities:  
Gross realized gains $704 $1,244 $1,009  $382 $361 $704 
Gross realized losses  (457)  (807)  (1,118)  (377)  (451)  (457)
 
 
 
 
 
 
        
 
Net realized gains (losses) on fixed maturity securities 247 437  (109) 5  (90) 247 
       
 
 
 
 
 
 
  
Equity securities:  
Gross realized gains 225 143 251  24 73 225 
Gross realized losses  (23)  (29)  (409)  (8)  (35)  (23)
 
 
 
 
 
 
        
Net realized gains (losses) on equity securities 202 114  (158)
 
Net realized gains on equity securities 16 38 202 
       
 
 
 
 
 
 
  
Net realized gains (losses) on fixed maturity and equity securities
 $449 $551 $(267) $21 $(52) $449 
 
 
 
 
 
 
        

6747


The following table provides details of the largest realized losses from sales of securities aggregated by issuer including: the fair value of the securities at date of sale, date, the amount of the loss recorded and the period of time that the security had been in an unrealized loss position prior to sale. The period of time that the security had been in an unrealized loss position prior to sale can vary due to the timing of individual security purchases. Also included is a narrative providing the industry sector along with the facts and circumstances giving rise to the loss.

Largest Realized Losses from Securities Sold at a Loss

Year ended December 31, 2006
             
  Fair      Months in 
  Value at      Unrealized 
  Date of  Loss  Loss Prior 
Issuer Description and Discussion Sale  On Sale  To Sale (a) 
(In millions)            
Various notes and bonds issued by the United States Treasury. Securities sold due to outlook on interest rates and inflation. $4,529  $18   0-6 
             
State issued revenue bonds. Positions were sold as part of a broader initiative to reduce municipal holdings.  289   6   0-12 
             
Financial services group that provides property and casualty, managed care, life, and various other insurance products in the United States. Position was sold to reduce exposure to the issuer and sector.  56   5   0-6 
             
Company is in the advertising industry, utilizing various venues including television, radio, outdoor displays, and live entertainment. The company has entered into an agreement to be acquired. Position was reduced in response to the announced transaction.  66   5   0-12+ 
             
Company develops and operates broadband cable communication networks, high speed internet service and digital video applications. Position was sold in response to newly issued debt.  92   5   0-6 
           
  $5,032  $39     
           
(a)Represents the range of consecutive months the various positions were in an unrealized loss prior to sale. 0-12+ means certain positions were less than 12 months, while others were greater than 12 months.

             
  Fair     Months in
Year ended December 31, 2004 Value     Unrealized
  Date of Loss Loss Prior
Issuer Description and Discussion
 Sale
 On Sale
 To Sale
(In millions)      
Issues and sells mortgage backed securities. Issuer was charted by United States Congress to facilitate housing ownership for low to middle income Americans. Loss was incurred as a result of unfavorable interest rate change. $4,766  $19   0-12 
Company acquires, sells and operates power generation facilities. The loss reflects intense competition and price pressure in the sector.  120   18   0-24+
Various notes and bonds issued by the United States Treasury. Volatility of interest rates prompted movement to other asset classes.  4,092   15   0-12 
Municipal issuer of revenue bonds that authorizes the financing of water facilities. Loss was incurred as a result of unfavorable interest rate change.  309   13   0-12 
Company provides networking telecommunications services worldwide. The company is under price/profit pressure as a result of excess capacity in the industry.  97   11   0-12 
Municipal issuer of special obligation bonds for school financing. Loss was incurred as a result of unfavorable interest rate change.  152   8   0-6, 13-24 
Municipal issuer of revenue bonds that supports transportation services. Loss was incurred as a result of unfavorable interest rate change.  296   7   0-12 
Municipal issuer of revenue bonds that authorizes the financing of sewer facilities. Loss was incurred as a result of unfavorable interest rate change.  113   7   0-6 
Municipal issuer of revenue bonds that authorizes the financing of water facilities. Loss was incurred as a result of unfavorable interest rate change.  200   7   0-12 
Air transportation carrier for passengers, freight and mail both domestic and international. Company was subject to higher fuel costs and union negotiations.  24   6   0-6 
Municipal issuer of revenue bonds that authorizes bridge and tunnel facilities. Loss was incurred as a result of unfavorable interest rate change.  103   6   0-12 
State issuer of general obligation bonds. Loss was incurred as a result of unfavorable interest rate change.  222   5   0-12 
State issuer of general obligation bonds for the purpose of public improvements. Loss was incurred as a result of unfavorable interest rate change.  270   5   0-12 
   
 
   
 
     
  $10,764  $127     
   
 
   
 
     

6848


Valuation and Impairment of Investments

The following table details the carrying value of CNA’sour general account investment portfolios.

investments.

Carrying Value of Investments
                
                 December 31, December 31,   
 December 31, December 31,   2006 % 2005 % 
(In millions) 2004
 %
 2003
 %
 
General account investments:  
Fixed maturity securities available-for-sale:  
U.S. Treasury securities and obligations of government agencies $4,346  11% $1,900  5% $5,138  12% $1,469  4%
Asset-backed securities 7,788 20 8,757 23  13,677 31 12,859 32 
States, municipalities and political subdivisions — tax-exempt 8,857 22 7,970 21 
States, municipalities and political subdivisions – tax-exempt 5,146 12 9,209 23 
Corporate securities 6,513 17 6,482 17  7,132 16 6,165 15 
Other debt securities 3,053 8 3,264 9  3,642 8 3,044 8 
Redeemable preferred stock 146  104   912 2 216 1 
Options embedded in convertible debt securities 234 1 201     1  
 
 
 
 
 
 
 
 
          
 
Total fixed maturity securities available-for-sale 30,937 79 28,678 75  35,647 81 32,963 83 
         
 
 
 
 
 
 
 
 
  
Fixed maturity securities trading:  
U.S. Treasury securities and obligations of government agencies 27     2  4  
Asset-backed securities 125     55  87  
Corporate securities 199 1    133 1 154 1 
Other debt securities 35     14  26  
Redeemable preferred stock 4    
         
 
 
 
 
 
 
 
 
  
Total fixed maturity securities trading 390 1    204 1 271 1 
 
 
 
 
 
 
 
 
          
 
Equity securities available-for-sale:  
Common stock 260 1 383 1  452 1 289 1 
Non-redeemable preferred stock 150  144  
Preferred stock 145  343 1 
         
 
 
 
 
 
 
 
 
  
Total equity securities available-for-sale 410 1 527 1  597 1 632 2 
 
 
 
 
 
 
 
 
          
 
Total equity securities trading 46     60  49  
         
 
 
 
 
 
 
 
 
  
Short term investments available-for-sale 5,404 14 7,538 20  5,538 13 3,870 9 
Short term investments trading 459 1    172  368 1 
Limited partnerships 1,549 4 1,117 3  1,852 4 1,509 4 
Other investments 36  240 1  26  33  
 
 
 
 
 
 
 
 
          
 
Total general account investments
 $39,231  100% $38,100  100% $44,096  100% $39,695  100%
 
 
 
 
 
 
 
 
          

The Company’s

Our general account investment portfolio consistsinvestments consist primarily of publicly traded government bonds, asset-backed and mortgage-backed securities, short-termcorporate securities, short term investments, municipal bonds and corporate bonds.

U.S. treasury securities.

A significant judgment in the valuation of investments is the determination of when an OTTI has occurred. We analyze securities on at least a quarterly basis. Part of this analysis is to monitor the length of time and severity of the decline below book value for those securities in an unrealized loss position. Information on our OTTI process is set forth in Note B of the Consolidated Financial Statements included under Item 8.
Investments in the general account had a total net unrealized gain of $1,197$966 million at December 31, 20042006 compared with $1,348$787 million at December 31, 2003.2005. The unrealized position at December 31, 20042006 was composedcomprised of a net unrealized gain of $1,061$716 million for fixed maturities, a net unrealized gain of $249 million for equity securities, and a net unrealized gain of $136$1 million for equityshort term securities. The unrealized position at December 31, 20032005 was composedcomprised of a net unrealized gain of $1,114$618 million for fixed maturities, and a net unrealized gain of $234$170 million for equity securities, and a net unrealized loss of $1 million for short term securities.

See Note B of the Consolidated Financial Statements included under Item 8 for further detail on the unrealized position of our general account investment portfolio.

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Unrealized Gains (Losses) on Fixed Maturity and Equity Securities

                     
  Cost or Gross Gross Unrealized Losses Net 
  Amortized Unrealized Less than Greater than Unrealized 
December 31, 2004
(In millions)
 Cost
 Gains
 12 Months
 12 Months
 Gain/(Loss)
 
Fixed maturity securities available-for-sale:                    
U.S. Treasury securities and obligations of government agencies $4,233  $126  $13  $  $113 
Asset-backed securities  7,706   105   19   4   82 
States, municipalities and political subdivisions – tax-exempt  8,699   189   28   3   158 
Corporate securities  6,093   477   52   5   420 
Other debt securities  2,769   295   11      284 
Redeemable preferred stock  142   6      2   4 
Options embedded in convertible debt securities  234             
   
 
   
 
   
 
   
 
   
 
 
Total fixed maturity securities available-for-sale  29,876   1,198   123   14   1,061 
   
 
   
 
   
 
   
 
   
 
 
Total fixed maturity securities trading  390             
   
 
   
 
   
 
   
 
   
 
 
Equity securities available-for-sale:                    
Common stock  148   112         112 
Non-redeemable preferred stock  126   24         24 
   
 
   
 
   
 
   
 
   
 
 
Total equity securities available-for-sale  274   136         136 
   
 
   
 
   
 
   
 
   
 
 
Total equity securities trading  46             
   
 
   
 
   
 
   
 
   
 
 
Total fixed maturity and equity securities
 $30,586  $1,334  $123  $14  $1,197 
   
 
   
 
   
 
   
 
   
 
 

Unrealized Gains (Losses) on Fixed Maturity and Equity Securities

                     
  Cost or Gross Gross Unrealized Losses Net 
  Amortized Unrealized Less than Greater than Unrealized 
December 31, 2003
(In millions)
 Cost
 Gains
 12 Months
 12 Months
 Gain/(Loss)
 
Fixed maturity securities:                    
U.S. Treasury securities and obligations of government agencies $1,823  $91  $10  $4  $77 
Asset-backed securities  8,634   146   22   1   123 
States, municipalities and political subdivisions – tax-exempt  7,787   207   22   2   183 
Corporate securities  6,061   475   40   14   421 
Other debt securities  2,961   311   4   4   303 
Redeemable preferred stock  97   7         7 
Options embedded in convertible debt securities  201             
   
 
   
 
   
 
   
 
   
 
 
Total fixed maturity securities  27,564   1,237   98   25   1,114 
   
 
   
 
   
 
   
 
   
 
 
Equity securities:                    
Common stock  163   222   2      220 
Non-redeemable preferred stock  130   16   2      14 
   
 
   
 
   
 
   
 
   
 
 
Total equity securities  293   238   4      234 
   
 
   
 
   
 
   
 
   
 
 
Total fixed maturity and equity securities
 $27,857  $1,475  $102  $25  $1,348 
   
 
   
 
   
 
   
 
   
 
 

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The Company’sOur investment policies for both the general account and separate accountsaccount emphasize high credit quality and diversification by industry, issuer and issue. Assets supporting interest rate sensitive liabilities are segmented within the general account to facilitate asset/liability duration management.

At December 31, 2004, the carrying value of the general account fixed maturities was $31,327 million, representing 80% of the total investment portfolio. The net unrealized gain of this fixed maturity portfolio was $1,061 million, comprising gross unrealized gains of $1,198 million and gross unrealized losses of $137 million. Gross unrealized losses were across various sectors, the largest of which was corporate bonds. Within corporate bonds, the largest industry sectors were financial and consumer-cyclical, which as a percentage of total gross unrealized losses were 40% and 28%. Gross unrealized losses in any single issuer were less than 0.1% of the carrying value of the total general account fixed maturity portfolio.

The following table provides the composition of fixed maturity securities with an unrealized loss at December 31, 20042006 in relation to the total of all fixed maturity securities with an unrealized loss by contractual maturities.

Contractual Maturity

         
  Percent of Percent of
  Market Unrealized
  Value
 Loss
Due in one year or less  8%  2%
Due after one year through five years  25   18 
Due after five years through ten years  25   24 
Due after ten years  15   40 
Asset-backed securities  27   16 
   
 
   
 
 
Total
  100%  100%
   
 
   
 
 

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The following table summarizes for fixed maturity and equity securities in an unrealized loss positionprofile. Securities not due at December 31, 2004 and 2003, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position.

Unrealized Loss Aging

                 
  December 31, 2004
 December 31, 2003
      Gross     Gross
  Estimated Unrealized Estimated Unrealized
(In millions) Fair Value
 Loss
 Fair Value
 Loss
Fixed maturity securities:                
Investment grade:                
0-6 months $7,742  $53  $4,138  $50 
7-12 months  2,448   59   834   36 
13-24 months  368   12   76   11 
Greater than 24 months  2      51   3 
   
 
   
 
   
 
   
 
 
Total investment grade  10,560   124   5,099   100 
   
 
   
 
   
 
   
 
 
Non-investment grade:                
0-6 months  188   7   134   5 
7-12 months  69   4   60   7 
13-24 months  20   2   16   1 
Greater than 24 months        105   10 
   
 
   
 
   
 
   
 
 
Total non-investment grade  277   13   315   23 
   
 
   
 
   
 
   
 
 
Total fixed maturity securities  10,837   137   5,414   123 
   
 
   
 
   
 
   
 
 
Equity securities:                
0-6 months  4      23   2 
7-12 months  1      10   2 
13-24 months  1      3    
Greater than 24 months  3      6    
   
 
   
 
   
 
   
 
 
Total equity securities  9      42   4 
   
 
   
 
   
 
   
 
 
Total fixed maturity and equity securities
 $10,846  $137  $5,456  $127 
   
 
   
 
   
 
   
 
 

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.

When a security is placed on the watch list, it is monitored for further fair value changes and additional news related to the issuer’s financial condition. The focus is on objective evidence that may influence the evaluation of impairment factors.

The decision to impair a security incorporates both quantitative criteria and qualitative information. The Impairment Committee considers a number of factors including, but not limited to: (a) the length of time and the extent to which the fair value has been less than book value, (b) the financial condition and near term prospects of the issuer, (c) the intent and ability of the Company to retain its investment for a period of time sufficient to allow for any anticipated recovery in value, (d) whether the debtor is current on interest and principal payments and (e) general market conditions and industry or sector specific factors.

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The Impairment Committee’s decision to impair a security is primarilysingle date are allocated based on whether the security’s fair value is likely to remain significantly below its book value in light of all of the factors considered. For securities that are impaired, the security is written down to fair value and the resulting losses are recognized in realized gains/losses in the Consolidated Statements of Operations.

Realized investment losses included $93 million, $321 million and $890 million of pretax impairment losses for the three years ended December 31, 2004, 2003 and 2002. The 2003 and 2002 impairments 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, 2004, the impairment losses recorded related largely to an after-tax impairment loss related to loans made under a credit facility to a national contractor, that are classified as fixed maturities. See the Loans to National Contractor section of the MD&A.

For 2003, the impairment losses recorded related primarily to corporate bonds in the airline, healthcare and energy industries.

For 2002, the impairment losses recorded related primarily to corporate bonds in the communications industry sectors including $129 million related to WorldCom Inc., $74 million related to Adelphia Communication Corporation, $60 million for Charter Communications, $57 million for AT&T Canada and $53 million for Telewest PLC. During 2002, the Company reduced the impairment loss related to the sale of CNA Re U.K. by approximately $39 million after-tax.

The Company’sweighted average life.

Maturity Profile
         
  Percent of  Percent of 
  Market  Unrealized 
  Value  Loss 
Due in one year or less  5%  3%
Due after one year through five years  44   50 
Due after five years through ten years  33   24 
Due after ten years  18   23 
       
         
Total
  100%  100%
       
Our non-investment grade fixed maturity securities heldavailable-for-sale as of December 31, 20042006 that were in ana gross unrealized loss position had a fair value of $277$622 million. As discussed previously, a significant judgment in the valuation of investments is the determination of when an other-than-temporary impairment has occurred. The Company’s Impairment Committee analyzes securities placed on the watch list on at least a quarterly basis. Part of this analysis is to monitor the length of time and severity of the decline below book value of the watch list securities. The following table summarizestables summarize the fair value and gross unrealized loss of non-investment grade securities categorized by the length of time those securities have been in a continuous unrealized loss position and further categorized by the severity of the unrealized loss position in 10% increments as of December 31, 20042006 and 2003.

2005.

Unrealized Loss Aging for Non-investment Grade Securities
                                                
 Estimated Fair Value as a Percentage of Book Value
 Unrealized Fair Value as a Percentage of Book Value   
December 31, 2004
(In millions)
 Fair Value
 90-99%
 80-89%
 70-79%
 <70%
 Loss
 Gross 
 Estimated Unrealized 
December 31, 2006 Fair Value 90-99% 80-89% 70-79% <70% Loss 
(In millions) 
Fixed maturity securities:  
Non-investment grade:  
0-6 months $188 $6 $1 $ $ $7  $509 $2 $ $ $ $2 
7-12 months 69 3 1   4  87 1 1   2 
13-24 months 20 1 1   2  24      
Greater than 24 months        2      
 
 
 
 
 
 
 
 
 
 
 
 
              
 
Total non-investment grade $277 $10 $3 $ $ $13  $622 $3 $1 $ $ $4 
 
 
 
 
 
 
 
 
 
 
 
 
              

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Unrealized Loss Aging for Non-investment Grade Securities

                                                
 Estimated Fair Value as a Percentage of Book Value
 Unrealized Fair Value as a Percentage of Book Value   
December 31, 2003
(In millions)
 Fair Value
 90-99%
 80-89%
 70-79%
 <70%
 Loss
 Gross 
 Estimated Unrealized 
December 31, 2005 Fair Value 90-99% 80-89% 70-79% <70% Loss 
(In millions) 
Fixed maturity securities:  
Non-investment grade:  
0-6 months $134 $2 $1 $ $2 $5  $632 $20 $8 $1 $ $29 
7-12 months 60 1 6   7  118 4 6   10 
13-24 months 16 1    1  122 3    3 
Greater than 24 months 105 4 1 5  10  2      
 
 
 
 
 
 
 
 
 
 
 
 
              
 
Total non-investment grade $315 $8 $8 $5 $2 $23  $874 $27 $14 $1 $ $42 
 
 
 
 
 
 
 
 
 
 
 
 
              

As part of the ongoing impairmentOTTI monitoring process, the Impairment Committee haswe evaluated the facts and circumstances based on available information for each of the non-investment grade securities and determined that no further impairmentsthe securities presented in the above tables were appropriatetemporarily impaired when evaluated at December 31, 2004.2006 and 2005. This determination was based on a number of factors that the Impairment Committeewe regularly considersconsider including, but not limited to: the issuers’ ability to meet current and

50


future interest and principal payments, an evaluation of the issuers’ financial condition and near term prospects, andour assessment of the Company’s sector outlook and estimates of the fair value of any underlying collateral. In all cases where a decline in value is judged to be temporary, the Company haswe have the intent and ability to hold these securities for a period of time sufficient to recover the book value of itsour investment through aan anticipated recovery in the fair value of such securities or by holding the securities to maturity. In many cases, the securities held are matched to liabilities as part of ongoing asset/liability duration management. As such, the Impairment Committeewe continually assesses itsassess our ability to hold securities for a time sufficient to recover any temporary loss in value or until maturity. The Company maintainsWe believe we have sufficient levels of liquidity so as to not impact the asset/liability management process.

The Company’s

Our equity securities heldclassified as available-for-sale as of December 31, 20042006 that were in an unrealized loss position had a fair value of $9$14 million and unrealized losses of $1 million. The Company’s Impairment Committee, underUnder the same process as followed for fixed maturity securities, monitorswe monitor the equity securities for other-than-temporary declines in value. In all cases where a decline in value is judged to be temporary, we have the Company expectsintent and ability to hold these securities for a period of time sufficient to recover the book value of itsour investment through aan anticipated recovery in the fair value of the security.

such securities.

Invested assets are exposed to various risks, such as interest rate, market and credit risk. 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 these risks in the near term, including increases in interest rates, could have an adverse material impact on the Company’sour results of operations or equity.

The general account portfolio consists primarily of high quality bonds, 93%91% and 92% of which were rated as investment grade (BBB(rated BBB or higher) at December 31, 20042006 and 2003.2005. The following table summarizes the ratings of CNA’sour general account bond portfolio at carrying value.

74


General Account Bond Ratings

                                
December 31
(In millions)
 2004
 %
 2003
 %
December 31 2006 % 2005 % 
(In millions) 
U.S. Government and affiliated agency securities $4,640  15% $2,818  10% $5,285  15% $1,628  5%
Other AAA rated 14,628 47 12,779 45  16,311 47 18,233 55 
AA and A rated 5,597 18 6,329 22  5,222 15 6,046 18 
BBB rated 4,072 13 4,631 16  4,933 14 4,499 14 
Non investment-grade 2,240 7 2,017 7  3,188 9 2,612 8 
 
 
 
 
 
 
 
 
          
 
Total
 $31,177  100% $28,574  100% $34,939  100% $33,018  100%
 
 
 
 
 
 
 
 
          

At December 31, 20042006 and 2003,2005, approximately 99%96% and 97%95% of the general account portfolio was issued by U.S. Government and affiliated 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.

us.

The following table summarizes the bond ratings of the investments supporting those separate account products which guarantee principal and a specified rate of interest.

Separate Account Bond Ratings
                                
December 31
(In millions)
 2004
 %
 2003
 %
December 31 2006 % 2005 % 
(In millions) 
U.S. Government and affiliated agency securities $  0% $166  9% $  % $  %
Other AAA rated 156 32 737 41  111 26 120 26 
AA and A rated 184 38 374 21  242 56 193 41 
BBB rated 117 24 443 24  75 17 142 31 
Non investment-grade 29 6 89 5  6 1 11 2 
 
 
 
 
 
 
 
 
          
 
Total
 $486  100% $1,809  100% $434  100% $466  100%
 
 
 
 
 
 
 
 
          

At December 31, 20042006 and 2003,2005, 100% and 98% of the separate account portfolio was issued by U.S. Government and affiliated agencies or was rated by S&P or Moody’s. The remaining bonds were rated by other rating agencies or Company management.us.

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Non investment-grade bonds, as presented in the tables above, are high-yield securities rated below BBB by bond rating agencies, as well as other unrated securities that, in theour opinion, of management, are below investment-grade. High-yield securities generally involve a greater degree of risk than investment-grade securities. However, expected returns should compensate for the added risk. This risk is also considered in the interest rate assumptions for the underlying insurance products.

The carrying value of non-traded securities that are either subject to trading restrictions or trade in illiquid private placement markets at December 31, 20042006 was $199$191 million, which represents 0.5%0.4% of the Company’sour total investment portfolio. These securities were in a net unrealized gain position of $68$143 million at December 31, 2004.2006. Of the non-tradedthese securities, 54%80% are priced by unrelated third party sources.

Included in CNA’sour general account fixed maturity securities at December 31, 2004 are $7,9132006 were $13,732 million of asset-backed securities, at fair value, consisting of approximately 70%63% in collateralized mortgage obligations (CMOs), 16%21% in corporate asset-backed obligations, 14% in corporate mortgage-backed pass-through certificates 10% in corporate asset-backed obligations and 4%2% in U.S. Government agency issued pass-through certificates. The majority of CMOs held are actively traded in liquid markets and are primarily priced by broker-dealers.

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a third party pricing service.


The carrying value of the components of the general account short term investment portfolio is presented in the following table.

Short-termShort term Investments
        
         December 31, December 31, 
 December 31, December 31, 2006 2005 
(In millions) 2004
 2003
 
Short-term investments available-for-sale: 
Short term investments available-for-sale: 
Commercial paper $923 $1,906 
U.S. Treasury securities 1,093 251 
Money market funds 196 294 
Other, including collateral held related to securities lending 3,326 1,419 
     
 
Total short term investments available-for-sale 5,538 3,870 
     
 
Short term investments trading: 
Commercial paper $1,655 $4,458  43 94 
U.S. Treasury securities 2,382 1,068  2 64 
Money market funds 174 1,230  127 200 
Other 1,193 782   10 
 
 
 
 
      
Total short-term investments available-for-sale 5,404 7,538 
 
 
 
 
  
Short-term investments trading: 
Commercial paper 46  
U.S. Treasury securities 300  
Money market funds 99  
Other 14  
Total short term investments trading 172 368 
 
 
 
 
      
Total short-term investments trading 459  
 
 
 
 
  
Total short-term investments
 $5,863 $7,538 
Total short term investments
 $5,710 $4,238 
 
 
 
 
      

CNA invests in certain derivative financial instruments primarily to reduce its exposure to market risk (principally interest rate, equity price and foreign currency risk) and credit risk (risk of nonperformance of underlying obligor). Derivative securities are recorded at

The fair value of collateral held related to securities lending, included in other short term investments, was $2,851 million and $767 million at the reporting date. The Company also uses derivatives to mitigate market risk by purchasing S&P 500â index futures in a notional amount equal to the contract liability relating to LifeDecember 31, 2006 and Group Non-Core indexed group annuity contracts.2005.

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LIQUIDITY AND CAPITAL RESOURCES

Cash Flows

The

Our principal operating cash flow sources of CNA’s property and casualty and life insurance subsidiaries are premiums and investment income. Theincome from our insurance subsidiaries. Our primary operating cash flow uses are payments for claims, policy benefits and operating expenses.

For 2004,2006, net cash provided by operating activities was $1,607$2,250 million as compared to $1,760$2,169 million in 2003. The decrease in cash2005. Cash provided by operating activities was primarily drivenfavorably impacted by a decrease inincreased net sales of trading securities to fund policyholder withdrawals of investment contract products issued by us and increased investment income receipts. Policyholder fund withdrawals are reflected as financing cash flows. Cash provided by operating activities was unfavorably impacted by decreased premium collections, related to the dispositions of the lifeincreased tax payments, and group businesses and CNA Re. Offsetting the decrease in premium collections were decreased paid claims and a federal tax refund received in 2004.

increased loss payments.

For 2003,2005, net cash provided by operating activities was $1,760$2,169 million as compared with net cash provided of $1,040to $1,968 million in 2002.2004. The increase in cash provided by operating activities relatedoperations was primarily todriven by a decreasereduction in paid claims and increasedexpense payments, including the impact of $446 million related to commutations. Also impacting operating cash flows were net premium collectionstax payments of $164 million in 20032005 as compared with 2002.

net tax refunds of $627 million in 2004. In addition, we received cash of $121 million related to interest on a federal income tax settlement in 2005.

Cash flows from investing activities include purchasesthe purchase and salessale of financial instruments, as well as the purchase and sale of businesses, land, buildings, equipment and other assets not generally held for resale. The change in cash collateral exchanged as part of the securities lending activity is included as a cash flow from investing activities.

For 2004, net

Net cash used for investing activities was $2,019$1,646 million, as compared with $2,133$1,316 million, in 2003.and $2,084 million for 2006, 2005, and 2004. Cash flows used by investing activities were related principally to increased purchases of fixed maturity securities in 2004 as compared to 2003.

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For 2003, net cash used for investing activities was $2,133 million as compared with net cash used of $1,488 million in 2002. Cash flows used for investing related principally to purchases of fixed maturity securities.

securities and short term investments.

The cash flow from investing activities is impacted by various factors such as the anticipated payment of claims, financing activity, asset/liability management and individual security buy and sell decisions made in the normal course of portfolio management. A consideration in management of the portfolio is the characteristics of the underlying liabilities and the ability to align the duration of the portfolio to those liabilities to meet future liquidity needs and minimize interest rate risk. For portfolios where future liability cash flows are determinable and are generally long term in nature, management segregates assets and related liabilities for asset/liability management purposes. The asset/liability management strategy is used to mitigate valuation changes due to interest rate risk in those specific portfolios. Another consideration in the asset/liability matched portfolios is to maintain a level of income sufficient to support the underlying insurance liabilities.

For those securities in the portfolio that are not part of a segregated asset/liability management strategy, the Companywe typically managesmanage the portfolio to a target duration range dictated by the underlying insurance liabilities. In managing these portfolios, securities are bought and sold based on individual security value assessments made, but with the overall goal of meeting the duration targets.

Cash flows from financing activities include proceeds from the issuance of debt and equity securities, outflows for dividends or repayment of debt, and outlays to reacquire equity instruments.

instruments, and deposits and withdrawals related to investment contract products issued by us.

For the year ended December 31, 2004,2006 and 2005, net cash used for financing activities was $605 million and $837 million as compared with net cash provided from financing activities was $368 million as compared with $386of $61 million in 2003. For the year ended December 31, 2003, net2004. Net cash provided fromflows used by financing activities was $386 million as compared with $432 million in 2002.

The Company is closely managing the cash flows related to claims and reinsurance recoverables from the WTC event. It is anticipated that there will be a significant lag between the time claim payments are made and the receipt of the corresponding reinsurance recoverables. The Company has not suffered any liquidity problems resulting from these payments. As of December 31, 2004, the Company has paid $876 million in claims and of that amount has recovered $486 million from reinsurers.

CNA’s estimated gross pretax losses for the WTC event, recorded in 2001,2006 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%, 59% and 29% of the reinsurance recoverables on the estimated lossesprimarily related to the WTC event are from companies with S&P ratingsreturn of AAA, AA or A.

The Company believesinvestment contract balances. Additionally, we issued long-term debt and common stock, the proceeds of which were used to repurchase the Series H Cumulative Preferred Stock Issue (Series H Issue) and to repay our 6.75% notes. See the Loews section below for further discussion.

We believe that itsour present cash flows from operations, investing activities and financing activities are sufficient to fund itsour working capital needs.

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Debt

Debt is composed of the following obligations.

Debt

         
December 31
(In millions)
 2004
 2003
Variable rate debt:        
Credit facility – CNA Surety, due September 30, 2005 $25  $30 
Term loan – CNA Surety, due through September 30, 2005  10   20 
Debenture – CNA Surety, face amount of $31, due April 29, 2034  30    
Credit facility – CNAF, due April 30, 2004     250 
Senior notes:        
6.500%, face amount of $493, due April 15, 2005  493   492 
6.750%, face amount of $250, due November 15, 2006  249   249 
6.450%, face amount of $150, due January 15, 2008  149   149 
6.600%, face amount of $200, due December 15, 2008  199   199 
8.375%, face amount of $70, due August 15, 2012  69   69 
5.850%, face amount of $549, due December 15, 2014  546    
6.950%, face amount of $150, due January 15, 2018  149   149 
Debenture, 7.250%, face amount of $243, due November 15, 2023  241   241 
Capital leases, 10.400%-11.500%, due through December 31, 2011     33 
Other debt, 1.000%-11.5%, due through 2019  47   23 
Surplus notes:        
Encompass Insurance Company of America (EICA) surplus note, face amount of $50, due March 31, 2006  50    
   
 
   
 
 
Total debt
 $2,257  $1,904 
   
 
   
 
 
Short term debt $531  $263 
Long term debt  1,726   1,641 
   
 
   
 
 
Total debt
 $2,257  $1,904 
   
 
   
 
 

In December of 2004, CNA acquired three buildings, which previously were leased under capital leases. As part of the transaction, CNA directly assumed the underlying debt obligation which the lessor of the three buildings owed to a third party. By directly assuming the lessor’s debt obligation, CNA reduced its overall debt obligation by $5 million.

On December 15, 2004, CNAF completed the sale of $549 million of 5.85% ten-year senior notes in a public offering. The Company contributed approximately $47 million of the net proceeds to its subsidiary CCC for CCC to repurchase its outstanding Group Surplus Note due 2024 and intends to use approximately $498 million of the net proceeds of this offering to repay at maturity all of its outstanding 6.5% notes due April 15, 2005.

During 2004, Encompass Insurance Company of America (EICA), a wholly owned subsidiary of the Company, sold a $50 million surplus note to Allstate Insurance Company. The EICA note bears interest semi-annually at 2.5% per annum and is due on March 31, 2006.

In May of 2004, CNA Surety issued privately, through a wholly-owned trust, $30 million of preferred securities through two pooled transactions. These securities bear interest at a rate of LIBOR plus 337.5 basis points with a thirty-year term and are redeemable after five years. The securities were issued by CNA Surety Capital Trust I (Issuer Trust). The sole asset of the Issuer Trust consists of a $31 million junior subordinated debenture issued by CNA Surety to the Issuer Trust. The subordinated debenture bears interest at a rate of LIBOR plus 337.5 basis points and matures in April of 2034. As of December 31, 2004, the interest rate on the junior subordinated debenture was 5.7%.

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On September 30, 2003, CNA Surety entered into a $50 million credit agreement, which consisted of a $30 million two-year revolving credit facility and a $20 million two-year term loan, with semi-annual principal payments of $5 million. The credit agreement isWe have an amendment to a $65 million credit agreement, extending the revolving loan termination date from September 30, 2003 to September 30, 2005. The new revolving credit facility was fully utilized at inception. In June of 2004, CNA Surety reduced the outstanding borrowings under the credit facility by $10 million, and in September of 2004, CNA Surety increased the outstanding borrowings under the credit facility by $5 million to fund the semi-annual term loan payment.

Under the amended credit facility agreement, CNA Surety pays a facility fee of 35.0 basis points on the revolving credit portion of the facility, interest at LIBOR plus 90 basis points, and for utilization greater than 50% of the amount available to borrow an additional fee of 5.0 basis points. On the term loan, CNA Surety pays interest at LIBOR plus 62.5 basis points. At December 31, 2004, the weighted-average interest rate on the $35 million of outstanding borrowings under the credit agreement, including facility fees and utilization fees, was 3.3%. Effective January 30, 2003, CNA Surety entered into a swap agreement on the term loan portion of the agreement which uses the 3-month LIBOR to determine the swap increment. As a result, the effective interest rate on the $10 million in outstanding borrowings on the term loan was 2.77% at December 31, 2004. On the $25 million revolving credit agreement, the effective interest rate at December 31, 2004 was 3.49%.

Related Parties

CNA reimburses Loews, or pays directly, for management fees, travel and related expenses and expenses of investment facilities and services provided to CNA. The amounts reimbursed or paid by CNA were approximately $21 million, $21 million and $19 million for the years ended December 31, 2004, 2003 and 2002.

CNA and its eligible subsidiaries are included in the consolidated federal income tax return of Loews and its eligible subsidiaries. For the years ended December 31, 2004 and 2003, CNA received $631 million and $369 million from Loews related to federal income taxes.

CNA previously sponsored a stock ownership plan whereby the Company financed the purchase of Company common stock by certain officers, including executive officers. Interest charged on the principal amount of these outstanding stock purchase loans is generally equivalent to the long term applicable federal rate, compounded semi-annually, in effect on the disbursement date of the loan. Loans made pursuant to the plan are generally full recourse with a ten-year term and are secured by the stock purchased. The balance of the loans as of December 31, 2004 exceeds the fair value of the related common stock collateral by $35 million.

CNA Surety has provided significant surety bond protection for a large national contractor that undertakes projects for the construction of government and private facilities, a substantial portion of which have been reinsured by CCC. In order to help this contractor meet its liquidity needs and complete projects which had been bonded by CNA Surety, commencing in 2003 CNAF has provided loans to the contractor through a credit facility. In December of 2004, the credit facility was amended to increase the maximum available loans to $106 million from $86 million. The amendment also provides that CNAF may in its sole discretion further increase the amounts available for loans under the credit facility, up to an aggregate maximum of $126 million. As of December 31, 2004 and 2003, there were $99 million and $80 million of total debt outstanding under the credit facility. Additional loans in January and February of 2005 brought the total debt outstanding under the credit facility, less accrued interest, to $104 million as of February 24, 2005. Loews, through a participation agreement with CNAF, provided funds for and owned a participation of $29 million and $25 million of the loans outstanding as of December 31, 2004 and 2003 and has agreed to participation of one-third of any additional loans which may be made above the original $86 million credit facility limit up to the $126 million maximum available line.

In connection with the amendment to increase the maximum available line under the credit facility in December of 2004, the term of the loan under the credit facility was extended to mature in March of 2009 and the interest rate was reduced prospectively from 6% over prime rate to 5% per annum, effective as of December 27, 2004, with an additional 3% interest accrual when borrowings under the facility are at or below the original $86 million limit. Loans under the credit facility are secured by a pledge of substantially all of the assets of the contractor and certain of its affiliates. In connection with the credit facility, CNAF has also guaranteed or provided collateral for letters of credit which are charged against the maximum available line and, if drawn upon, would be treated as loans under the

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credit facility. As of December 31, 2004 and 2003, these guarantees and collateral obligations aggregated $13 million and $7 million.

As of December 31, 2004, the aggregate amount of outstanding principal and accrued interest under the credit facility was $70 million, net of participation by Loews in the amount of $29 million.

The contractor implemented a restructuring plan intended to reduce costs and improve cash flow, and appointed a chief restructuring officer to manage execution of the plan. In the course of addressing various expense, operational and strategic issues, however, the contractor has decided to substantially reduce the scope of its original business and to concentrate on those segments determined to be potentially profitable. As a consequence, operating cash flow, and in turn the capacity to service debt, has been reduced below previous levels. Restructuring plans have also been extended to accommodate these circumstances. In light of these developments, CNA has taken an impairment charge of $56 million pretax ($36 million after-tax) for the fourth quarter of 2004, net of the participation by Loews, with respect to amounts loaned under the facility. Any draws under the credit facility beyond $106 million or further changes in the national contractor’s business plan or projections may necessitate further impairment charges.

As a result of the impairment taken in the fourth quarter of 2004, CNAF plans to recognize income using the effective interest rate method starting in the first quarter of 2005. Under this method, interest income recognized will be accrued on the net carrying amount of the loan at the effective interest rate used to discount the impaired loan’s estimated future cash flows. The excess of the cash received over the interest income recognized will reduce the carrying amount of the loan. The change in present value, if any, of the loan that is attributable to changes in the amount or timing of future cash flows will be recorded similar to the impairment charges previously recorded.

CNA Surety has advised that it intends to continue to provide surety bonds on behalf of the contractor during this extended restructuring period, subject to the contractor’s initial and ongoing compliance with CNA Surety’s underwriting standards and ongoing management of CNA Surety’s exposure to the contractor. All bonds written for the national contractor are issued by CCC and its affiliates, other than CNA Surety, and are subject to underlying reinsurance treaties pursuant to which all bonds on behalf of CNA Surety are 100% reinsured to one of CNA Surety’s insurance subsidiaries. This arrangement underlies the more limited reinsurance coverages discussed below.

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, with CCC to incur 100% of losses above that level. For bonds written on or subsequent to November 1, 2003, CNA Surety’s exposure is limited to $14.5 million per bond, subject to a per principal retention of $60 million and an aggregate limit of $150 million, under all facultative insurance coverage and two excess of loss treaties between CNA Surety and CCC. The first excess of loss contract, $40 million excess of $60 million, provides CNA Surety coverage exclusively for the national contractor, while the second excess of loss contract, $50 million excess of $100 million, provides CNA Surety with coverage for the national contractor as well as other CNA Surety risks. For bonds written prior to September 30, 2002 there is no facultative reinsurance and CCC retains 100% of the losses above the per principal retention of $60 million.

Renewals of both excess of loss contracts were effective January 1, 2005. CCC and CNA Surety are presently discussing a possible restructuring of the reinsurance arrangements described in the paragraph above,shelf registration statement under which all bonds written for the national contractor would be reinsured by CCC under an excess of $60 million treaty and other CNA Surety accounts would be covered by a separate $50 million excess of $100 million treaty.

CCC and CNA Surety continue to engage in periodic discussions with insurance regulatory authorities regarding the level of bonds provided for this principal and will continue to apprise those authorities regarding their ongoing exposure to this account.

Indemnification and subrogation rights, including rights to contract proceeds on construction projects in the event of default, exist that reduce CNA Surety’s and ultimately the Company’s exposure to loss. While CNAF believes that the contractor’s continuing restructuring effortswe may be successful and provide sufficient cash flow for its operations, the contractor’s failure to ultimately achieve its extended restructuring planissue debt or perform its contractual obligations under the credit facility or under the Company’s surety bonds could have a material adverse effect on the Company’s results of operations and/ or equity. If such failures occur, the Company estimates the surety loss, net of indemnification and subrogation recoveries, but before the effects of minority interest, to be approximately

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equity securities.


$200 million pretax. In addition, such failures could cause the remaining unimpaired amount due under the credit facility to be uncollectible.

Commitments, Contingencies, and Guarantees

In

We have various commitments, contingencies and guarantees which we become involved with during the normalordinary course of business, CNA has obtained letters of credit in favor of various unaffiliated insurance companies, regulatory authorities and other entities. At December 31, 2004 and 2003, there were approximately $47 million and $58 million of outstanding letters of credit.

business. The Company has provided guarantees related to irrevocable standby letters of credit for certain of its subsidiaries. Certainimpact of these subsidiaries have been sold; however, the irrevocable standby letter of creditcommitments, contingencies and guarantees remain in effect. The Company wouldshould be required to make payment on the letters of credit in question if the primary obligor drew down on these letters of creditconsidered when evaluating our liquidity 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, 2004.

As of December 31, 2004 and 2003, the Company had committed approximately $104 million and $154 million to future capital calls from various third-party limited partnership investments in exchange for an ownership interest in the related partnerships.

resources.

In the normal course of investing activities, CCC had committed approximately $51 million as of December 31, 2004 to future capital calls from certain of its unconsolidated affiliates in exchange for an ownership interest in such affiliates.

The Company holds an investment in a real estate joint venture. In the normal course of business, CNA on a joint and several basis with other unrelated insurance company shareholders have committed to continue funding any operating deficits of this joint venture. Additionally, CNA and the other unrelated shareholders, on a joint and several basis, have guaranteed an operating lease for an office building, which expires in 2016. The guarantee of the operating lease is a parallel guarantee to the commitment to fund operating deficits; consequently, the separate guarantee to the lessor is not expected to be triggered as long as the joint venture continues to be funded by its shareholders and continues to make its annual lease payments.

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, 2004 that the Company could be required to pay under this guarantee is approximately $312 million. If CNA were required to assume the entire lease obligation, the Company would have the right to pursue reimbursement from the other shareholders and would have the right to all sublease revenues.

The Company invests in multiple bank loan participations as part of its overall investment strategy and has committed to additional future purchases and sales. The purchase and sale of these investments are recorded on the date that the legal agreements are finalized and cash settlement is made. As of December 31, 2004, the Company had commitments to purchase $41 million and commitments to sell $2 million of various bank loan participations.

In the course of selling business entities and assets to third parties, the Company has agreed to indemnify purchasers for losses arising out of breaches of representation and warranties with respect to the business entities or assets being sold, including, in certain cases, losses arising from undisclosed liabilities or certain named litigation. Such indemnification provisions generally survive for periods ranging from nine months following the applicable closing date to the expiration of the relevant statutes of limitation. As of December 31, 2004, the aggregate amount of quantifiable indemnification agreements in effect for sales of business entities, assets and third party loans was $950 million.

In addition, the Company has agreed to provide indemnification to third party purchasers for certain losses associated with sold business entities or assets that are not limited by a contractual monetary amount. As of December 31, 2004, the Company had outstanding unlimited indemnifications in connection with the sales of certain

8153


of its business entities or assets for tax liabilities arising prior to a purchaser’s ownership of an entity or asset, defects in title at the time of sale, employee claims arising prior to closing and in some cases losses arising from certain litigation and undisclosed liabilities. These indemnification agreements survive until the applicable statutes of limitation expire, or until the agreed upon contract terms expire. Additionally, the Company has provided a contingent guarantee to the lenders of two third parties, related to loans extended by their lenders. As of December 31, 2004, the Company has recorded approximately $21 million of liabilities related to these indemnification agreements.

Cash and securities with carrying values of approximately $18 million and $23 million were deposited with financial institutions as collateral for letters of credit as of December 31, 2004 and 2003. In addition, cash and securities were deposited in trusts with financial institutions to secure reinsurance obligations with various third parties. The carrying values of these deposits were approximately $329 million and $254 million as of December 31, 2004 and 2003.

A summary of the Company’sour commitments as of December 31, 20042006 is presented in the following table.

Contractual Commitments
                                                
December 31, 2004
(In millions)
 2005
 2006
 2007
 2008
 2009
 Thereafter
 Total
December 31, 2006 Total Less than 1 year 1-3 years 3-5 years More than 5 years 
(In millions) 
Debt (a) $660 $416 $106 $442 $74 $1,619 $3,317  3,364 143 604 636 1,981 
Lease obligations 64 55 46 33 23 72 293  234 49 78 56 51 
Claim and claim expense reserves (b) 8,008 5,794 4,168 2,931 2,123 10,429 33,453  31,398 7,147 9,341 4,810 10,100 
Future policy benefits reserves (c) 195 179 173 174 170 8,325 9,216  10,803 346 348 337 9,772 
Policyholder funds reserves (c) 502 845 152 33 10 164 1,706  994 382 454 9 149 
Guaranteed payment contracts (d) 19 11 6    36  15 12 3   
 
 
 
 
 
 
 
 
 
 
 
 
 
 
            
 
Total
 $9,448 $7,300 $4,651 $3,613 $2,400 $20,609 $48,021  $46,808 $8,079 $10,828 $5,848 $22,053 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
            

(a) Includes estimated future interest payments, but does not include original issue discount.
 
(b)(b) Claim and claim adjustment expense reserves are not discounted and represent the Company’sour estimate of the amount and timing of the ultimate settlement and administration of claims based on itsour assessment of facts and circumstances known as of December 31, 2004.2006. See the Reserves Estimates and Uncertainties section of this MD&A for further information. Claim and claim adjustment expense reserves of $21$12 million related to business which has been 100% ceded to unaffiliated parties in connection with the individual life sale are not included.
 
(c)(c) Future policy benefits and policyholder funds reserves are not discounted and represent the Company’sour estimate of the ultimate amount and timing of the ultimate settlement of benefits based on itsour assessment of facts and circumstances known as of December 31, 2004.2006. Future policy benefit reserves of $1,013$891 million and policyholder fund reserves of $60$47 million related to business which has been 100% ceded to unaffiliated parties in connection with the individual life sale are not included. Additional information on future policy benefits and policyholder funds reserves is included in Note A of the Consolidated Financial Statements included under Item 8.
 
(d)(d) Primarily relating to telecommunications and software services.

Further information on our commitments, contingencies and guarantees is provided in Notes B, F, G, I and K of the Consolidated Financial Statements included under Item 8.
Off-Balance Sheet Arrangements
In the course of selling business entities and assets to third parties, we have agreed to indemnify purchasers for losses arising out of breaches of representation and warranties with respect to the business entities or assets being sold, including, in certain cases, losses arising from undisclosed liabilities or certain named litigation. Such indemnification provisions generally survive for periods ranging from nine months following the applicable closing date to the expiration of the relevant statutes of limitation. As of December 31, 2006, the aggregate amount of quantifiable indemnification agreements in effect for sales of business entities, assets and third party loans was $933 million.
In addition, we have agreed to provide indemnification to third party purchasers for certain losses associated with sold business entities or assets that are not limited by a contractual monetary amount. As of December 31, 2006, we had outstanding unlimited indemnifications in connection with the sales of certain of our business entities or assets that included tax liabilities arising prior to a purchaser’s ownership of an entity or asset, defects in title at the time of sale, employee claims arising prior to closing and in some cases losses arising from certain litigation and undisclosed liabilities. These indemnification agreements survive until the applicable statutes of limitation expire, or until the agreed upon contract terms expire. As of December 31, 2006, we have recorded approximately $28 million of liabilities related to these indemnification agreements.
Other than the items discussed above, we do not have any other off-balance sheet arrangements.
Regulatory Matters

The Company has

We previously established a plan to reorganize and streamline itsour U.S. property and casualty insurance legal entity structure. Onestructure in order to realize capital, operational, and cost efficiencies. Another phase of this multi-year plan washas been completed during 2003. This phasewith the mergers of thirteen of our U.S. property and casualty insurance entities into other CNA insurance entities. Effective December 31, 2006, twelve companies merged, either directly or indirectly, with and into CIC, and one company merged directly into CCC. We also reduced the number of states in which these entities

54


are domiciled as part of this phase. Previous phases of this plan served to consolidate the Company’sour U.S. property and casualty insurance risks into CCC, as well as realign the capital supporting these risks. As part of this phase, the Company implemented in the fourth quarter of 2003 a 100% quota share reinsurance

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agreement, effective January 1, 2003, ceding all of the net insurance risks of CIC and its 14 affiliated insurance companies (CIC Group) to CCC. Additionally, the ownership of the CIC Group was transferred to CCC during 2003 in order to align the insurance risks with the supporting capital. In subsequent phases of this plan, the Company will continue its efforts to reduce both the number of U.S. property and casualty insurance entities it maintains and the number of states in which such entities are domiciled. In order to facilitate the execution of this plan, the Company, CCC and CICwe have agreed to participate in a working group consisting of several states of the National Association of Insurance Commissioners.

In connection with the approval process for aspects of the reorganization plan, the Company agreed to undergo a state regulatory financial examination of CCC and CIC as of December 31, 2003, including a review of insurance reserves by an independent actuarial firm. These state regulatory financial examinations are currently underway. The Company is presently engaged in discussions related to the examination with state regulatory agencies. Final examination reports are expected to be issued in the first half of 2005 by the state authorities.

Commissioners (NAIC). Pursuant to itsour participation in thethis working group, referenced above, the Company haswe have agreed to certain time frames and informational provisions in relation to the reorganization plan. The Company has also agreed that any proceeds from the sale of any member of the CIC pool, net of transaction expenses, will be retained in CIC or one of its subsidiaries until the dividend stipulation discussed below expires.

Along with other companies in the industry, the Company haswe have received subpoenas, interrogatories and interrogatories:inquiries from: (i) from California, Connecticut, Delaware, Florida, Hawaii, Illinois, Michigan, Minnesota, New Jersey, New York, North Carolina, Ohio, Pennsylvania, andSouth Carolina, West Virginia and the Canadian Council of Insurance Regulators concerning investigations into practices including contingent compensation arrangements, fictitious quotes and tying arrangements; (ii) from the Securities and Exchange Commission and(SEC), the New York State Attorney General, the United States Attorney for the Southern District of New York, the Connecticut Attorney General, the Connecticut Department of Insurance, the Delaware Department of Insurance, the Georgia Office of Insurance and Safety Fire Commissioner and the California Department of Insurance concerning reinsurance products and finite insurance products purchased and sold by us; (iii) the Company;Massachusetts Attorney General and (iii) fromthe Connecticut Attorney General concerning investigations into anti-competitive practices; and (iv) the New York State Attorney General concerning declinations of attorney malpractice insurance.

Ratings

Ratings We continue to respond to these subpoenas, interrogatories and inquiries to the extent they are an important factor in establishing the competitive position of insurance companies. CNA’s insurance company subsidiaries are rated by major rating agencies, and these ratings reflect the rating agency’s opinionstill open.

Subsequent to receipt of the insurance company’s financial strength, operating performance, strategic positionSEC subpoena, we produced documents and ability to meet its obligations to policyholders. Agency ratings are not a recommendation to buy, sell or hold any security,provided additional information at the SEC’s request. In addition, the SEC and may be revised or withdrawn at any time by the issuing organization. Each agency’s rating should be evaluated independently of any other agency’s rating. One or more of these agencies could take action in the future to change the ratings of CNA’s insurance subsidiaries.

The actions that can be taken by rating agencies are changes in ratings or modifiers. “On Review,” “Credit Watch” and “Rating Watch” are modifiers used by the ratings agencies to alert those parties relying on the Company’s ratingsrepresentatives of the possibilityUnited States Attorney’s Office for the Southern District of a rating change in the near term. Modifiers are utilized when the agencies are uncertain asNew York conducted interviews with several of our current and former executives relating to the impactrestatement of a Company action or initiative, which could prove to be material toour financial results for 2004, including our relationship with and accounting for transactions with an affiliate that were the current rating level. Modifiers are generally used to indicate a possible change in rating within 90 days. “Outlooks” accompanied with ratings are additional modifiers used by the rating agencies to alert those parties relying on the Company’s ratings of the possibility of a rating change in the longer term. The time frame referenced in an outlook is not necessarily limited to ninety days as defined in the Credit-Watch category.

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The table below reflects the various group ratings issued by A.M. Best, Fitch, Moody’s and Standard and Poor’s as of February 16, 2005basis for the Property and Casualty and Life companies.restatement. The tableSEC also includes the ratingsrequested information relating to our restatement in 2006 of prior period results. It is possible that our analyses of, or accounting treatment for, CNAF’s senior debt and Continental senior debt.

Insurance Financial Strength Ratings
Debt Ratings
Property & Casualty (a)
Life
CNAF
Continental
CCCCICSeniorSenior
Group
Group
CAC (b)
Debt
Debt
A.M. BestAAA-bbbNot Rated
FitchA-A-A-BBB-BBB-
Moody’sA3A3Baa1Baa3Baa3
S&PA-A-BBB+BBB-BBB-

(a)  All outlooks for the Property & Casualty companies’ financial strength and holding company debt ratings are negative.
(b)  A.M. Best and Moody’s have a stable outlook while Fitch and S&P have negative outlooks on the CAC rating.

If CNA’s property and casualty insurance financial strength ratings were downgraded below current levels, CNA’s business and results offinite reinsurance contracts or discontinued operations could be materially adversely affected. The severityquestioned or disputed by regulatory authorities. As a result, further restatements of the impact on CNA’s business is dependent on the level of downgrade and, for certain products, which rating agency takes the rating action. Among the adverse effects in the event of such downgrades would be the inability to obtain a material volume of business from certain major insurance brokers, the inability to sell a material volume of the Company’s insurance products to certain markets, and the required collateralization of certain future payment obligations or reserves.

In addition, the Company believes that a lowering of the debt ratings of Loews by certain of these agencies could result in an adverse impact on CNA’s ratings, independent of any change in circumstances at CNA. Each of the major rating agencies which rates Loews currently maintains a negative outlook, but none currently has Loews on negative Credit Watch.

The Company has entered into several settlement agreements and assumed reinsurance contracts that require collateralization of future payment obligations and assumed reserves if the Company’s ratings or other specific criteria fall below certain thresholds. The ratings triggersour financial results are generally more than one level below the Company’s February 16, 2005 ratings.

possible.

Dividends from Subsidiaries

CNAF’s

Our ability to pay dividends and other credit obligations is significantly dependent on receipt of dividends from itsour subsidiaries. The payment of dividends to CNAFus by itsour insurance subsidiaries without prior approval of the insurance department of each subsidiary’s domiciliary jurisdiction is limited by formula. Dividends in excess of these amounts are subject to prior approval by the respective state insurance departments.

Dividends

Further information on our dividends from CCC are subjectsubsidiaries is provided in Note L of the Consolidated Financial Statements included under Item 8.
Loews
In December 2002, we sold $750 million of a new issue of preferred stock, the Series H Issue, to Loews. The Series H Issue accrued cumulative dividends at an initial rate of 8% per year, compounded annually. In August 2006, we repurchased the Series H Issue from Loews for approximately $993 million, a price equal to the insurance holding company lawsliquidation preference. The Series H Issue dividend amounts through the repurchase date for the years ended December 31, 2006, 2005 and 2004 have been subtracted from Income from Continuing Operations to determine income from continuing operations available to common stockholders in the calculation of earnings per share.
We financed the repurchase of the StateSeries H Issue with the proceeds from our sales of: (i) 7.0 million shares of Illinois,our common stock in a public offering for approximately $235.5 million; (ii) $400 million of new 6.0% five-year senior notes and $350 million of new 6.5% ten-year senior notes in a public offering; and (iii) 7.86 million shares of our common stock to Loews in a private placement for approximately $264.5 million. We used the domiciliary state of CCC. Under these laws, ordinary dividends, or dividends that do not require prior approvalproceeds in excess of the Illinois Departmentamount used to repurchase the Series H Issue to fund the repayment of Financialour $250 million outstanding 6.75% senior notes in November 2006.
Ratings
Ratings are an important factor in establishing the competitive position of insurance companies. Our insurance company subsidiaries are rated by major rating agencies, and Professional Regulation — Divisionthese ratings reflect the rating agency’s opinion of Insurance (the Department),the insurance company’s financial strength, operating performance, strategic position and ability to meet our obligations to policyholders. Agency ratings are not a recommendation to buy, sell or hold any security, and may be paid only from earned surplus, which is calculated by removing unrealized gains from unassigned surplus. As of December 31, 2004, CCC is in a negative earned surplus position. In December of 2004, the Department approved extraordinary dividend capacity of $125 million to be used to fund CNAF’s 2005 debt service requirements. It is anticipated that CCC will be in a positive earned surplus position at the end of the first quarter of 2005 and be able to begin paying ordinary dividends in the second quarter of 2005 as a result of a $500 million dividend received from its subsidiary, CAC, on February 11, 2005.

revised or

By agreement with the New Hampshire Insurance Department, the CIC Group may not pay dividends to CCC until after January 1, 2006.

CNA’s domestic insurance subsidiaries are subject to risk-based capital requirements. Risk-based capital is a method developed by the NAIC to determine the minimum amount of statutory capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The formula for determining the amount of risk-based capital specifies various factors, weighted based on the perceived degree of risk, which are applied to certain financial balances and financial activity. The adequacy of a company’s actual

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capital is evaluated by a comparison to the risk-based capital results, as determined

withdrawn at any time by the formula. Companiesissuing organization. Each agency’s rating should be evaluated independently of any other agency’s rating. One or more of these agencies could take action in the future to change the ratings of our insurance subsidiaries.
The table below minimum risk-based capital requirements are classified within certain levels, eachreflects the various group ratings issued by A.M. Best, Fitch, Moody’s and S&P as of which requires specified corrective action. As of December 31, 2004January 24, 2007 for the Property and 2003, all of CNA’s domestic insurance subsidiaries exceededCasualty and Life companies. The table also includes the minimum risk-based capital requirements.

Loews

During 2003, CNA completed a strategic review of its operationsratings for our senior debt and decided to concentrate efforts on itsContinental senior debt.

Insurance Financial Strength
Ratings (a)Debt Ratings (a)
Property &
CasualtyLifeCNAFContinental
CCCCACSeniorSenior
GroupDebtDebt
A.M. BestAA-bbbNot rated
FitchA-A-BBB-BBB-
Moody’sA3Baa1Baa3Baa3
S&PA-BBB+BBB-BBB-
(a)A.M. Best, Fitch, Moody’s and Standard & Poor’s outlooks are stable for our debt and insurance financial strength ratings.
If our property and casualty business. As a resultinsurance financial strength ratings were downgraded below current levels, our business and results of this review, and 2003 charges of $1,849 million after-tax ($2,845 million pretax) related to unfavorable net prior year development and a $396 million after-tax ($610 million pretax) increase in the provision for reinsurance and insurance receivables, a capital plan was developed to replenish statutory capitaloperations could be materially adversely affected. The severity of the propertyimpact on our business is dependent on the level of downgrade and, casualty subsidiaries adversely impacted by these charges. A summary offor certain products, which rating agency takes the capital plan, related actions, and other significant 2003 business decisions is discussed below:

In November of 2003,rating action. Among the Company established a capital plan to replenish statutory capital impacted by the strategic review and charges for prior year development and related matters. Under the capital plan, in November of 2003, CNAF sold to Loews $750 million of a new series of convertible preferred stock which converted into 32,327,015 shares of CNAF common stock on April 20, 2004, and received commitments from Loews for additional capital support of up to $650 million through the purchase of surplus notes of CCC, CNA’s principal insurance subsidiaryadverse effects in the event of such downgrades would be the inability to obtain a material volume of business from certain additionsmajor insurance brokers, the inability to CCC’s statutory capital were not achieved through asset sales. Assell a resultmaterial volume of this commitment, Loews purchased $300 million principal amountour insurance products to certain markets and the required collateralization of surplus notes in February of 2004 in relation to CNA’s salecertain future payment obligations or reserves.

In addition, we believe that a lowering of the individual life business and $46 million principal amountdebt ratings of surplus notesLoews by certain of these agencies could result in Februaryan adverse impact on our ratings, independent of 2004any change in relation to the saleour circumstances. None of the group benefits business.major rating agencies which rates Loews currently maintains a negative outlook or has Loews on negative Credit Watch.
We have entered into several settlement agreements and assumed reinsurance contracts that require collateralization of future payment obligations and assumed reserves if our ratings or other specific criteria fall below certain thresholds. The $300 million surplus note was repaid in June of 2004, and the $46 million surplus note was repaid in December of 2004, thereby fulfilling all of the commitments under the capital plan.

The Series H Cumulative Preferred Issue (Series H) 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 Series H Issue have been paid. CNAF may not issue any equity securities ranking senior to or on par with the Series H Issue without the consent of a majority of its stockholders. The Series H 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.

ratings triggers are generally more than one level below our current ratings.

Accounting Pronouncements

In December of 2004,September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) No. 123 (revised 2004),157,Share-Based PaymentFair Value Measurement (SFAS 123R),157). SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosures about fair value measurements. SFAS 157 retains the exchange price notion in the definition of fair value and clarifies that amends Statement of Financial Accounting Standard No. 123 (SFAS 123), as originally issuedthe exchange price is the price in May of 1995. SFAS 123R addressesan orderly transaction between market participants to sell the accounting for share-based payment transactionsasset or transfer the liability in the market in which the reporting entity would transact for the asset or liability. SFAS 157 emphasizes that fair value is a market-based measurement, not an enterprise receives employee services in exchange for (a) equity instruments ofentity-specific measurement and the enterprise or (b) liabilities that arefair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. SFAS 157 expands disclosures surrounding the use of fair value to measure assets and liabilities and specifically focuses on the sources used to measure fair value. In instances of recurring use of fair value measures using unobservable inputs, SFAS 157 requires separate disclosure of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS 123R supercedes Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees (APB 25). After the effective date of this standard, entities will not be permitted to use the intrinsic value method specified in APB 25 to measure compensation expense and generally would be required to measure compensation expense using a fair-value based method. Public companies are to apply this standard using either the modified prospective method or the modified retrospective method. The modified prospective method requires a company to (a) record compensation expense for all awards it grants after the date it adopts the standard and (b) record compensation expenseeffect on earnings for the unvested portion of previously granted awards that remain outstanding at the date of adoption. The modified retrospective method requires companies to record compensation expense to either (a) all prior yearsperiod. SFAS 157 is effective for which SFAS 123 was effective (i.e.financial statements issued for all fiscal years beginning after DecemberNovember 15, 2004) or (b) only to prior2007, and interim periods inwithin the year of initial adoption ifadoption. We are currently evaluating the effective date ofimpact that adopting SFAS 123R does not coincide with the beginning of the fiscal year. SFAS 123R is effective for interim or annual periods beginning after June 15, 2005. Adoption of this standard is not expected to157 will have a material impact on the Company’sour results of operations and/or equity.

and financial condition.
In January 2006, the FASB issued SFAS No. 155,Accounting for Certain Hybrid Financial Instruments (SFAS 155). SFAS 155 amends SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities (SFAS 133), and SFAS No. 140,Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (SFAS 140). SFAS 155 also resolves issues addressed in SFAS 133 Implementation Issue No. D1,

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In March

Application of 2004,Statement 133 to Beneficial Interests in Securitized Financial Assets. SFAS 155 will improve financial reporting by eliminating the Emerging Issues Task Force (EITF) reached consensus on the guidance providedexemption from applying SFAS 133 to interests in EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (EITF 03-1), as applicable to debt and equity securitiescertain securitized financial assets so that are within the scope of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities (SFAS 115) and equity securities thatsimilar instruments are accounted for usingin the cost method specified in Accounting Principles Board Opinion No. 18, The Equity Methodsame manner regardless of Accounting for Investments in Common Stock. Under EITF 03-1 an investment is impaired if the form of the instruments. SFAS 155 will also improve financial reporting by allowing a preparer to elect fair value measurement at acquisition, at issuance, or when a previously recognized financial instrument is subject to a remeasurement (new basis) event, on an instrument-by-instrument basis. SFAS 155 is effective for all financial instruments acquired or issued after the beginning of the investment is less than its cost including adjustments for amortization, accretion, foreign exchange, and hedging. An impairment would be considered other-than-temporary unless a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for the recovery of theentity’s first fiscal year that begins after September 15, 2006. The fair value up to (or beyond) the costelection provided for in paragraph 4(c) of the investment and b) evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. This new guidance for determining whether impairment is other-than-temporary was toSFAS 155 may also be effective for reporting periods beginning after June 15, 2004. In September of 2004, the FASB issued FASB Staff Position EITF Issue 03-1-1, which suspended the effective date for the measurement and recognition guidance included in EITF Issue 03-1 related to other-than-temporary impairment until additional implementation guidance is provided. Pendingapplied upon adoption of the final rule, the Company continuedSFAS 155 for hybrid financial instruments that had been bifurcated under paragraph 12 of SFAS 133 prior to apply existing accounting literature for determining when a decline in fair value is other-than-temporary.

The Company continues to evaluate the impact of this new accounting standard on its process for determining other-than-temporary impairment of equity and fixed maturity securities, including the potential impacts from any revisions to the original guidance issued. Adoption of this standard as originally issued may cause the Company to recognize impairment losses in the Consolidated Statements of Operations which would not have been recognized under the current guidance or to recognize such losses in earlier periods, especially those due to increases in interest rates, and could also impact the recognition of investment income on impaired securities. Such an impact would likely increase earnings volatility in future periods. However, since fluctuations in the fair value for available-for-sale securities are already recorded in Accumulated Other Comprehensive Income, adoption of this standardStatement. Provisions of SFAS 155 may be applied to instruments that an entity holds at the date of adoption on an instrument-by-instrument basis. Adoption of SFAS 155 is not expected to have a significant impact on equity.

the carrying value of securities currently held or acquired subsequent to January 1, 2007.

In January 2007, the FASB released SFAS 133 Implementation Issue No. B40,Embedded Derivatives: Application of Paragraph 13(b) to Securitized Interests in Prepayable Financial Assets (Issue B40). Issue B40 provides a narrow scope exception from paragraph 13(b) of SFAS 133 for securitized interests that meet certain criteria and contain only an embedded derivative that is tied to the prepayment risk of the underlying prepayable financial assets. Issue B40 shall be applied upon adoption of SFAS 155. Adoption of Issue B40 in conjunction with SFAS 155 is not expected to have a significant impact on the carrying value of securities currently held or acquired subsequent to January 1, 2007.
In September 2005, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position (SOP) No. 05-1,Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts (SOP 05-1). SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in SFAS No. 97,Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments. SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights, or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. SOP 05-1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006. Adoption of SOP 05-1 is not expected to have a significant impact on our results of operations or financial condition.
See Note A of the Consolidated Financial Statements included under Item 8 for additional information regarding accounting pronouncements.
FORWARD-LOOKING STATEMENTS

This report contains a number of forward-looking statements which relate to anticipated future events rather than actual present conditions or historical events. You can identify forward-looking statements because generally they include words such as “believes,” “expects,” “intends,” “anticipates,” “estimates,” and similar expressions. Forward-looking statements in this report include any and all statements regarding expected developments in the Company’sour insurance business, including losses and loss reserves for asbestos, environmental pollution and mass tort claims which are more uncertain, and therefore more difficult to estimate than loss reserves respecting traditional property and casualty exposures; the impact of routine ongoing insurance reserve reviews the Company iswe are conducting; the ongoing state regulatory examinations of the Company’s primary insurance company subsidiaries, and the Company’s responses to the results of those reviews and examinations; the Company’sour expectations concerning itsour revenues, earnings, expenses and investment activities; expected cost savings and other results from the Company’sour expense reduction and restructuring activities; and the Company’sour proposed actions in response to trends in itsour business. Forward-looking statements, by their nature, are subject to a variety of inherent risks and uncertainties that could cause actual results to differ materially from the results projected in the forward-looking statement. ManyWe cannot control many of these risks and uncertainties cannot be controlled by the Company.uncertainties. Some examples of these risks and uncertainties are:

 general economic and business conditions, including inflationary pressures on medical care costs, construction costs and other economic sectors that increase the severity of claims;
 
 changes in financial markets such as fluctuations in interest rates, long-termlong term periods of low interest rates, credit conditions and currency, commodity and stock prices;
 
 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 officersD&O and errors and omissions coverages;

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 changes in foreign or domestic political, social and economic conditions;

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 regulatory initiatives and compliance with governmental regulations, judicial decisions, including interpretation of policy provisions, decisions regarding coverage and theories of liability, trends in litigation and the outcome of any litigation involving the Company,us, and rulings and changes in tax laws and regulations;
 
 effects upon insurance markets and upon industry business practices and relationships of current litigation, investigations and regulatory activity by the New York State Attorney General’s office and other authorities concerning contingent commission arrangements with brokers and bid solicitation activities;
 
 legal and regulatory activities with respect to certain non-traditional and finite-risk insurance products, and possible resulting changes in accounting and financial reporting rules in relation to such products;products, including our restatement of financial results in May of 2005 and our relationship with an affiliate, Accord Re Ltd., as disclosed in connection with that restatement;
 
 regulatory limitations, impositions and restrictions upon the Company,us, including the effects of assessments and other surcharges for guaranty funds and second-injury funds and other mandatory pooling arrangements;
 
 the impact of competitive products, policies and pricing and the competitive environment in which the Company operates,we operate, including changes in the Company’sour book of business;
 
 product and policy availability and demand and market responses, including the level of ability to obtain rate increases and decline or non-renew of under priced accounts, to achieve premium targets and profitability and to realize growth and retention estimates;
 
 development of claims and the impact on loss reserves, including changes in claim settlement policies;
 
 the effectiveness of current initiatives by claims management to reduce loss and expense ratioratios through more efficacious claims handling techniques;
 
 the performance of reinsurance companies under reinsurance contracts with the Company;us;
 
 results of financing efforts, including the availability of bank credit facilities;
 
changes in the Company’sour composition of operating segments;
 
 weather and other natural physical events, including the severity and frequency of storms, hail, snowfall and other winter conditions, as well as of natural disasters such as hurricanes and earthquakes;earthquakes, as well as climate change, including effects on weather patterns, greenhouse gases, sea, land and air temperatures, sea levels, rain and snow;
 
 man-made disasters, including the possible occurrence of terrorist attacks and the effect of the absence or insufficiency of applicable terrorism legislation on coverages;
 
 the possibility thatunpredictability of the nature, targets, severity or frequency of potential terrorist events, as well as the uncertainty as to our ability to contain our terrorism exposure effectively, notwithstanding the extension through December 31, 2007 of the Terrorism Risk Insurance Act of 2002 will not be extended beyond the end of 2005, as a result of which the Company could incur substantial additional exposure to losses resulting from terrorist attacks, which could be increased by current state regulatory restrictions on terrorism policy exclusions and by regulatory unwillingness to approve such exclusions prospectively;2002;
 
 the occurrence of epidemics;
 
 exposure to liabilities due to claims made by insureds and others relating to asbestos remediation and health-based asbestos impairments, as well as exposure to liabilities for environmental pollution, mass tort, and construction defect claims;claims and exposure to liabilities due to claims made by insureds and others relating to lead-based paint;
 
 whether a national privately financed trust to replace litigation of asbestos claims with payments to claimants from the trust will be established or approved through federal legislation, or, if established and approved, whether it will contain funding requirements in excess of the Company’sour established loss reserves or carried loss reserves;
 
 the sufficiency of the Company’sour loss reserves and the possibility of future increases in reserves;
 
 regulatory limitations and restrictions, including limitations upon the Company’sour ability to receive dividends from itsour insurance subsidiaries imposed by state regulatory agencies and minimum risk-based capital standards established by the National Association of Insurance Commissioners;

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 the risks and uncertainties associated with the Company’sour loss reserves as outlined in the Critical Accounting Estimates and the Reserves – Estimates and Uncertainties sectionsections of this Management’s Discussion and Analysis of Financial Condition and Results of Operations;MD&A;

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 the level of success in integrating acquired businesses and operations, and in consolidating, or selling existing ones;
 
 the possibility of further changes in the Company’sour ratings by ratings agencies, including the inability to access certain markets or distribution channels and the required collateralization of future payment obligations as a result of such changes, and changes in rating agency policies and practices; and
 
 the actual closing of contemplated transactions and agreements.

The Company’s

Our forward-looking statements speak only as of the date on which they are made and the Company doeswe do not haveundertake any obligation to update or revise any forward-looking statement to reflect events or circumstances after the date of the statement, even if the Company’sour expectations or any related events or circumstances change.

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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk is a broad term related to changes in the fair value of a financial instrument. Discussions herein regarding market risk focus on only one element of market risk-pricerisk, which is price risk. Price risk relates to changes in the level of prices due to changes in interest rates, equity prices, foreign exchange rates or other factors that relate to market volatility of the rate, index or price underlying the financial instrument. The Company’sOur primary market risk exposures are due to changes in interest rates, although the Company haswe have certain exposures to changes in equity prices and foreign currency exchange rates. The fair value of the financial instruments is adversely affected when interest rates rise, equity markets decline and the dollar strengthens against foreign currency.

Active management of market risk is integral to the Company’sour operations. The CompanyWe may use the following tools to manage itsour exposure to market risk within defined tolerance ranges: (1) change the character of future investments purchased or sold, (2) use derivatives to offset the market behavior of existing assets and liabilities or assets expected to be purchased and liabilities to be incurred, or (3) rebalance itsour existing asset and liability portfolios.

In accordance with the provisions of SOP 03-01, the classification and presentation of certain balance sheet and income statement items have been modified. Accordingly, the investment securities previously classified as separate account assets have now been reclassified to the general account and will be reported based on their investment classification whether available-for-sale or trading securities. The investment portfolio for the indexed group annuity contracts is classified as held for trading purposes and is carried at fair value, with both the net realized and unrealized gains (losses) included within net investment income in the Consolidated Statement of Operations. Consistent with the requirements of SOP 03-01, prior year amounts have not been conformed to the current year presentation.

Beginning in the fourth quarter of 2004, the Company has designated new purchases related to a specific investment strategy, that primarily includes convertible bond securities, as held for trading purposes. These securities in the trading portfolio are carried at fair value, with both the net realized and unrealized gains (losses) included within net investment income in the Consolidated Statements of Operations included under Item 8.

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Sensitivity Analysis

CNA monitors its

We monitor our sensitivity to interest rate risk by evaluating the change in the value of financial assets and liabilities due to fluctuations in interest rates. The evaluation is performed by applying an instantaneous change in interest rates of varying magnitudes on a static balance sheet to determine the effect such a change in rates would have on the Company’sour fair value at risk and the resulting effect on stockholders’ equity. The analysis presents the sensitivity of the fair value of the Company’sour financial instruments to selected changes in market rates and prices. The range of change chosen reflects the Company’sour view of changes that are reasonably possible over a one-year period. The selection of the range of values chosen to represent changes in interest rates should not be construed as the Company’sour prediction of future market events, but rather an illustration of the impact of such events.

The sensitivity analysis estimates the decline in the fair value of the Company’sour interest sensitive assets and liabilities that were held on December 31, 20042006 and December 31, 20032005 due to instantaneous parallel increases in the period end yield curve of 100 and 150 basis points.

The sensitivity analysis also assumes an instantaneous 10% and 20% decline in the foreign currency exchange rates versus the United States dollar from their levels at December 31, 20042006 and December 31, 2003,2005, with all other variables held constant.

Equity price risk was measured assuming an instantaneous 10% and 25% decline in the S&P 500 Index (Index) from its level at December 31, 20042006 and December 31, 2003,2005, with all other variables held constant. The Company’sOur equity holdings were assumed to be highly and positively correlated with the Index. At December 31, 2004,2006, a 10% and 25% decrease in the Index would result in a $214$265 million and $534$662 million decrease compared to a $245$227 million and $612$567 million decrease at December 31, 2003,2005, in the market value of the Company’sour equity investments.

Of these amounts, under the 10% and 25% scenarios, $5$4 million and $14$10 million at December 31, 20042006 and $168$4 million and $418$11 million at December 31, 20032005 pertained to decreases in the marketfair value of the separate account investments. These decreases would substantially be offset by decreases in related separate account liabilities to customers. Similarly, increases in the marketfair value of the separate account equity investments would also be offset by increases in the same related separate account liabilities by the same approximate amounts.

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The following tables present the estimated effects on the fair value of the Company’sour financial instruments at December 31, 20042006 and December 31, 2003,2005, due to an increase in interest rates of 100 basis points, a 10% decline in foreign currency exchange rates and a 10% decline in the Index.

Market Risk Scenario 1
                                
 Increase (Decrease)
 Increase (Decrease) 
 Fair Interest Currency Equity Market Interest Currency Equity 
December 31, 2004
(In millions)
 Value
 Rate Risk
 Risk
 Risk
December 31, 2006 Value Rate Risk Risk Risk 
(In millions) 
General account:  
Fixed maturity securities available-for-sale $30,937 $(1,824) $(88) $(26) $35,647 $(1,959) $(98) $(91)
Fixed maturity securities trading 390  (4)  (1)  (3) 204  (2)   (2)
Equity securities available-for-sale 410   (9)  (41) 597   (9)  (60)
Equity securities trading 46    (5) 60    (6)
Short term investments available-for-sale 5,404  (7)  (10)   5,538  (5)  (32)  
Short term investments trading 459     172    
Limited partnerships 1,549 6   (18) 1,852 1   (37)
Other invested assets 42     23    
Interest rate swaps  (8) 8    1 190   
Equity index futures for trading  2   (116)
Equity index futures trading  1   (65)
Other derivative securities 2 7  (21)   2 1  (2)  
 
 
 
 
 
 
 
 
          
 
Total general account 39,231  (1,812)  (129)  (209) 44,096  (1,773)  (141)  (261)
         
 
 
 
 
 
 
 
 
  
Separate accounts:  
Fixed maturity securities 486  (24)    434  (21)   
Equity securities 55    (5) 41    (4)
Short term investments 20     21    
 
 
 
 
 
 
 
 
          
 
Total separate accounts 561  (24)   (5) 496  (21)   (4)
         
 
 
 
 
 
 
 
 
  
Total securities
 $39,792 $(1,836) $(129) $(214) $44,592 $(1,794) $(141) $(265)
 
 
 
 
 
 
 
 
          
 
Debt (carrying value)
 $2,257 $(97) $ $  $2,156 $(122) $ $ 
 
 
 
 
 
 
 
 
          

9061


Market Risk Scenario 1
                                
 Increase (Decrease)
 Increase (Decrease) 
 Fair Interest Currency Equity Market Interest Currency Equity 
December 31, 2003
(In millions)
 Value
 Rate Risk
 Risk
 Risk
Held for Other Than Trading Purposes: 
December 31, 2005 Value Rate Risk Risk Risk 
(In millions) 
General account:  
Fixed maturity securities $28,678 $(1,979) $(35) $(13)
Equity securities 527   (26)  (51)
Short term investments 7,538  (5)  (16)  
Fixed maturity securities available-for-sale $32,963 $(1,897) $(89) $(22)
Fixed maturity securities trading 271  (2)  (1)  (2)
Equity securities available-for-sale 632   (6)  (63)
Equity securities trading 49    (5)
Short term investments available-for-sale 3,870  (4)  (37)  
Short term investments trading 368    
Limited partnerships 1,117 5   (13) 1,509 1   (29)
Other invested assets 233     30    
Interest rate swaps  (5) 3     66   
Equity index futures trading  2   (102)
Other derivative securities 12  (108) 1   3 3 10  
 
 
 
 
 
 
 
 
          
 
Total general account 38,100  (2,084)  (76)  (77) 39,695  (1,831)  (123)  (223)
         
 
 
 
 
 
 
 
 
  
Separate accounts:  
Fixed maturity securities 1,809  (113)    466  (23)   
Equity securities 117    (12) 44    (4)
Short term investments 82     36    
Other invested assets 415    (41)
         
 
 
 
 
 
 
 
 
  
Total separate accounts 2,423  (113)   (53) 546  (23)   (4)
 
 
 
 
 
 
 
 
          
Total securities held for other than trading purposes 40,523  (2,197)  (76)  (130)
 
 
 
 
 
 
 
 
 
Held for Trading Purposes: 
Separate accounts: 
Fixed maturity securities 304  (4)   (1)
Short term investments 414    
Limited partnerships 419 2   (3)
Equity indexed futures  2   (111)
Other derivative securities   (1)   
 
 
 
 
 
 
 
 
 
Total securities held for trading purposes 1,137  (1)   (115)
 
 
 
 
 
 
 
 
  
Total securities
 $41,660 $(2,198) $(76) $(245) $40,241 $(1,854) $(123) $(227)
 
 
 
 
 
 
 
 
          
 
Debt (carrying value)
 $1,904 $(70) $ $  $1,690 $(92) $ $ 
 
 
 
 
 
 
 
 
          

9162


The following tables present the estimated effects on the fair value of the Company’sour financial instruments at December 31, 20042006 and December 31, 2003,2005, due to an increase in interest rates of 150 basis points, a 20% decline in foreign currency exchange rates and a 25% decline in the Index.

Market Risk Scenario 2
                                
 Increase (Decrease)
 Increase (Decrease) 
 Fair Interest Currency Equity Market Interest Currency Equity 
December 31, 2004
(In millions)
 Value
 Rate Risk
 Risk
 Risk
December 31, 2006 Value Rate Risk Risk Risk 
(In millions) 
General account:  
Fixed maturity securities available-for-sale $30,937 $(2,703) $(177) $(63) $35,647 $(2,925) $(197) $(227)
Fixed maturity securities trading 390  (6)  (1)  (8) 204  (3)   (5)
Equity securities available-for-sale 410   (18)  (103) 597   (18)  (149)
Equity securities trading 46    (11) 60    (15)
Short term investments available-for-sale 5,404  (11)  (20)   5,538  (7)  (64)  
Short term investments trading 459     172    
Limited partnerships 1,549 9   (46) 1,852 1   (93)
Other invested assets 42     23    
Interest rate swaps  (8) 12    1 279   
Equity index futures for trading  3   (289)
Equity index futures trading  2   (162)
Other derivative securities 2 10  (38)   2 1  (4)  (1)
 
 
 
 
 
 
 
 
          
 
Total general account 39,231  (2,686)  (254)  (520) 44,096  (2,652)  (283)  (652)
         
 
 
 
 
 
 
 
 
  
Separate accounts:  
Fixed maturity securities 486  (35)    434  (31)   
Equity securities 55    (14) 41    (10)
Short term investments 20     21    
 
 
 
 
 
 
 
 
          
 
Total separate accounts 561  (35)   (14) 496  (31)   (10)
         
 
 
 
 
 
 
 
 
  
Total securities
 $39,792 $(2,721) $(254) $(534) $44,592 $(2,683) $(283) $(662)
 
 
 
 
 
 
 
 
          
 
Debt (carrying value)
 $2,257 $(141) $ $  $2,156 $(180) $ $ 
 
 
 
 
 
 
 
 
          

9263


Market Risk Scenario 2
                                
 Increase (Decrease)
 Increase (Decrease) 
 Fair Interest Currency Equity Market Interest Currency Equity 
December 31, 2003
(In millions)
 Value
 Rate Risk
 Risk
 Risk
Held for Other Than Trading Purposes: 
December 31, 2005 Value Rate Risk Risk Risk 
(In millions) 
General account:  
Fixed maturity securities $28,678 $(2,896) $(71) $(32)
Equity securities 527   (52)  (129)
Short term investments 7,538  (7)  (32)  
Fixed maturity securities available-for-sale $32,963 $(2,827) $(178) $(54)
Fixed maturity securities trading 271  (4)  (1)  (4)
Equity securities available-for-sale 632   (11)  (158)
Equity securities trading 49    (12)
Short term investments available-for-sale 3,870  (6)  (74)  
Short term investments trading 368    
Limited partnerships 1,117 7   (33) 1,509 1   (72)
Other invested assets 233     30    
Interest rate caps  1   
Interest rate swaps  (5) 4     95   
Equity index futures trading  3  (1)  (255)
Other derivative securities 12  (184) 3   3 5 20  (1)
 
 
 
 
 
 
 
 
          
 
Total general account 38,100  (3,075)  (152)  (194) 39,695  (2,733)  (245)  (556)
         
 
 
 
 
 
 
 
 
  
Separate accounts:  
Fixed maturity securities 1,809  (165)    466  (34)   
Equity securities 117    (29) 44    (11)
Short term investments 82     36    
Other invested assets 415    (103)
         
 
 
 
 
 
 
 
 
  
Total separate accounts 2,423  (165)   (132) 546  (34)   (11)
 
 
 
 
 
 
 
 
          
Total securities held for other than trading purposes 40,523  (3,240)  (152)  (326)
 
 
 
 
 
 
 
 
 
Held for Trading Purposes: 
Separate accounts: 
Fixed maturity securities 304  (6)   (2)
Short term investments 414  (1)   
Limited partnerships 419 3   (7)
Equity indexed futures  4   (277)
Other derivative securities   (1)   
 
 
 
 
 
 
 
 
 
Total securities held for trading purposes 1,137  (1)   (286)
 
 
 
 
 
 
 
 
  
Total securities
 $41,660 $(3,241) $(152) $(612) $40,241 $(2,767) $(245) $(567)
 
 
 
 
 
 
 
 
          
 
Debt (carrying value)
 $1,904 $(102) $ $  $1,690 $(135) $ $ 
 
 
 
 
 
 
 
 
          

9364


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CNA Financial Corporation
Consolidated Statements of Operations

             
       
Years ended December 31
(In millions, except per share data)
 2004
 2003
 2002
Revenues:
            
Net earned premiums $8,209  $9,214  $10,213 
Net investment income  1,674   1,647   1,730 
Realized investment gains (losses), net of participating policyholders’ and minority interests  (248)  460   (252)
Other revenues  295   395   595 
   
 
   
 
   
 
 
Total revenues  9,930   11,716   12,286 
   
 
   
 
   
 
 
Claims, Benefits and Expenses:
            
Insurance claims and policyholders’ benefits  6,446   10,287   8,420 
Amortization of deferred acquisition costs  1,680   1,965   1,791 
Other operating expenses  1,183   1,686   1,621 
Restructuring and other related charges        (37)
Interest  124   130   150 
   
 
   
 
   
 
 
Total claims, benefits and expenses  9,433   14,068   11,945 
   
 
   
 
   
 
 
Income (loss) from continuing operations before income tax and minority interest  497   (2,352)  341 
Income tax (expense) benefit  (29)  913   (68)
Minority interest  (27)  6   (26)
   
 
   
 
   
 
 
Income (loss) from continuing operations  441   (1,433)  247 
Loss from discontinued operations, net of tax of $9        (35)
   
 
   
 
   
 
 
Income (loss) before cumulative effect of change in accounting principle  441   (1,433)  212 
Cumulative effect of change in accounting principle, net of tax of $7        (57)
   
 
   
 
   
 
 
Net income (loss)
 $441  $(1,433) $155 
   
 
   
 
   
 
 
Basic and diluted earnings (loss) per share:
            
Income (loss) from continuing operations $1.47  $(6.58) $1.10 
Loss from discontinued operations, net of tax        (0.16)
   
 
   
 
   
 
 
Income (loss) before cumulative effect of change in accounting principle  1.47   (6.58)  0.94 
Cumulative effect of change in accounting principle, net of tax        (0.26)
   
 
   
 
   
 
 
Basic and diluted earnings (loss) per share available to common stockholders
 $1.47  $(6.58) $0.68 
   
 
   
 
   
 
 
Weighted average outstanding common stock and common stock equivalents
  256.0   227.0   223.6 
   
 
   
 
   
 
 
             
Years ended December 31 2006  2005  2004 
(In millions, except per share data)            
Revenues
            
Net earned premiums $7,603  $7,569  $8,209 
Net investment income  2,412   1,892   1,680 
Realized investment gains (losses), net of participating policyholders’ and minority interests  86   (10)  (248)
Other revenues  275   411   283 
          
             
Total revenues  10,376   9,862   9,924 
          
             
Claims, Benefits and Expenses
            
Insurance claims and policyholders’ benefits  6,047   6,999   6,445 
Amortization of deferred acquisition costs  1,534   1,543   1,680 
Other operating expenses  1,027   1,034   1,174 
Restructuring and other related charges  (13)     (3)
Interest  131   124   124 
          
             
Total claims, benefits and expenses  8,726   9,700   9,420 
          
             
Income before income tax and minority interest  1,650   162   504 
Income tax (expense) benefit  (469)  105   (31)
Minority interest  (44)  (24)  (27)
          
             
Income from continuing operations  1,137   243   446 
Income (loss) from discontinued operations, net of income tax (expense) benefit of $7, $(2) and $(1)  (29)  21   (21)
          
             
Net income
 $1,108  $264  $425 
          
             
Basic Earnings Per Share
            
             
Income from continuing operations $4.17  $0.68  $1.49 
Income (loss) from discontinued operations  (0.11)  0.08   (0.09)
          
             
Basic earnings per share available to common stockholders $4.06  $0.76  $1.40 
          
             
Diluted Earnings Per Share
            
             
Income from continuing operations $4.16  $0.68  $1.49 
Income (loss) from discontinued operations  (0.11)  0.08   (0.09)
          
             
Diluted earnings per share available to common stockholders $4.05  $0.76  $1.40 
          
             
Weighted Average Outstanding Common Stock and Common Stock Equivalents
            
             
Basic  262.1   256.0   256.0 
          
Diluted  262.3   256.0   256.0 
          

The accompanying Notes are an integral part of these Consolidated Financial Statements.

9465


CNA Financial Corporation
Consolidated Balance Sheets

                
    
December 31
(In millions, except share data)
 2004
 2003
December 31 2006 2005 
(In millions, except share data) 
Assets
  
Investments:  
Fixed maturity securities at fair value (amortized cost of $30,266 and $27,564) $31,327 $28,678 
Equity securities at fair value (cost of $320 and $293) 456 527 
Fixed maturity securities at fair value (amortized cost of $35,135 and $32,616) $35,851 $33,234 
Equity securities at fair value (cost of $408 and $511) 657 681 
Limited partnership investments 1,549 1,117  1,852 1,509 
Other invested assets 36 240  26 33 
Short-term investments, at fair value which approximates cost 5,863 7,538 
Short term investments 5,710 4,238 
 
 
 
 
      
Total investments
 39,231 38,100  44,096 39,695 
Cash 95 139  84 96 
Reinsurance receivables (less allowance for uncollectible receivables of $531 and $573) 15,463 15,681 
Insurance receivables (less allowance for doubtful accounts of $517 and $375) 2,050 2,707 
Reinsurance receivables (less allowance for uncollectible receivables of $469 and $519) 9,478 11,917 
Insurance receivables (less allowance for doubtful accounts of $368 and $445) 2,108 2,096 
Accrued investment income 297 323  313 312 
Receivables for securities sold 496 836  303 565 
Deferred acquisition costs 1,268 2,533  1,190 1,197 
Prepaid reinsurance premiums 1,128 1,361  342 340 
Federal income taxes recoverable (includes $7 and $594 due from Loews Corporation)  607 
Federal income taxes recoverable (includes $0 and $68 due from Loews Corporation)  62 
Deferred income taxes 692 600  855 1,105 
Property and equipment at cost (less accumulated depreciation of $524 and $727) 235 314 
Property and equipment at cost (less accumulated depreciation of $571 and $546) 277 197 
Goodwill and other intangible assets 162 162  142 146 
Other assets 815 1,571  592 737 
Separate account business 568 3,678  503 551 
 
 
 
 
      
Total assets
 $62,500 $68,612  $60,283 $59,016 
 
 
 
 
      
 
Liabilities and Stockholders’ Equity
 
Liabilities: 
Insurance reserves: 
Claim and claim adjustment expenses $29,636 $30,938 
Unearned premiums 3,784 3,706 
Future policy benefits 6,645 6,297 
Policyholders’ funds 1,015 1,495 
Collateral on loaned securities 2,851 767 
Payables for securities purchased 221 129 
Participating policyholders’ funds 50 53 
Short term debt  252 
Long term debt 2,156 1,438 
Federal income taxes payable (includes $38 and $0 due to Loews Corporation) 40  
Reinsurance balances payable 539 1,636 
Other liabilities 2,740 2,513 
Separate account business 503 551 
     
Total liabilities
 50,180 49,775 
     
 
Commitments and contingencies (Notes B, F, G, I and K) 
Minority interest 335 291 
 
Stockholders’ equity: 
Preferred stock (12,500,000 shares authorized) 
Series H Issue (no par value; $100,000 stated value; no shares and 7,500 shares issued; held by Loews Corporation)  750 
Common stock ($2.50 par value; 500,000,000 shares authorized; 273,040,543 and 258,177,285 shares issued; and 271,108,780 and 256,001,968 shares outstanding) 683 645 
Additional paid-in capital 2,166 1,701 
Retained earnings 6,486 5,621 
Accumulated other comprehensive income 549 359 
Treasury stock (1,931,763 and 2,175,317 shares), at cost  (58)  (67)
     
 9,826 9,009 
Notes receivable for the issuance of common stock  (58)  (59)
     
Total stockholders’ equity
 9,768 8,950 
     
Total liabilities and stockholders’ equity
 $60,283 $59,016 
     

95


         
  2004
 2003
Liabilities and Stockholders’ Equity
        
Liabilities:        
Insurance reserves:        
Claim and claim adjustment expenses $31,520  $31,730 
Unearned premiums  4,522   5,000 
Future policy benefits  5,883   8,161 
Policyholders’ funds  1,725   601 
Collateral on loaned securities  918   442 
Payables for securities purchased  288   1,902 
Participating policyholders’ funds  63   118 
Short term debt  531   263 
Long term debt  1,726   1,641 
Reinsurance balances payable  3,043   3,432 
Other liabilities  2,231   2,436 
Separate account business  568   3,678 
   
 
   
 
 
Total liabilities
  53,018   59,404 
   
 
   
 
 
Commitments and contingencies (Notes F, G, I and K)        
Minority interest  275   256 
Stockholders’ equity:        
Preferred stock (12,500,000 shares authorized)        
Series H Issue (no par value; $100,000 stated value; 7,500 shares issued; held by Loews Corporation)  750   750 
Series I Issue (no par value; $23,200 stated value; 32,327 shares issued; held by Loews Corporation)     750 
Common stock ($2.50 par value; 500,000,000 shares authorized; 258,177,285 and 225,850,270 shares issued; and 255,953,958 and 223,617,337 shares outstanding)  645   565 
Additional paid-in capital  1,701   1,031 
Retained earnings  5,601   5,160 
Accumulated other comprehensive income  650   841 
Treasury stock (2,223,327 and 2,232,933 shares), at cost  (69)  (69)
   
 
   
 
 
   9,278   9,028 
Notes receivable for the issuance of common stock  (71)  (76)
   
 
   
 
 
Total stockholders’ equity
  9,207   8,952 
   
 
   
 
 
Total liabilities and stockholders’ equity
 $62,500  $68,612 
   
 
   
 
 

The accompanying Notes are an integral part of these Consolidated Financial Statements.

9666


CNA Financial Corporation
Consolidated Statements of Cash Flows

            
                  
Years ended December 31 2004 2003 2002 2006 2005 2004 
(In millions) 
 
 
 
Cash Flows from Operating Activities:
  
Net income (loss) $441 $(1,433) $155 
Adjustments to reconcile net income (loss) to net cash flows provided by operating activities: 
Cumulative effect of change in accounting principles, net of tax   57 
Changes in bad debt provision for insurance and reinsurance receivables 87 602 40 
Loss on disposal of property and equipment 36 22 24 
Net income $1,108 $264 $425 
Adjustments to reconcile net income to net cash flows provided by operating activities: 
(Income) loss from discontinued operations 29  (21) 21 
Loss (gain) on disposal of property and equipment   (1) 36 
Minority interest 27  (6) 26  44 24 27 
Deferred income tax provision 35 67 7  173  (220) 37 
Net purchases of trading securities  (5)   
Trading securities activity 374 164  (93)
Realized investment (gains) losses, net of participating policyholders’ and minority interests 248  (460) 252   (86) 10 248 
Equity method (income) loss  (214)  (220) 25 
Realized loss from discontinued operations, net of tax   37 
Undistributed earnings of equity method investees  (170)  (45)  (67)
Amortization of bond (discount) premium 9  (79)  (143)  (274)  (153) 9 
Depreciation 75 86 98  48 54 75 
Changes in:  
Receivables, net  (439)  (3,529) 995  2,427 3,531  (545)
Deferred acquisition costs 194  (62)  (162) 7 71 194 
Accrued investment income  (12)  (49) 69   (1)  (15)  (12)
Federal income taxes recoverable/payable 596  (642) 655  102  (62) 596 
Prepaid reinsurance premiums 233  (15)  (124)  (2) 788 233 
Reinsurance balances payable  (355) 670 145   (1,097)  (1,344)  (318)
Insurance reserves 766 6,818  (931)  (771)  (943) 1,075 
Other assets 142  (16) 335 
Other liabilities 306 55 105 
Other, net  (115)  (10)  (185)  (98) 75  (397)
       
 
 
 
 
 
 
  
Total adjustments 1,166 3,193 885  1,153 1,952 1,559 
 
 
 
 
 
 
        
Net cash flows provided by operating activities
 $1,607 $1,760 $1,040 
 
Net cash flows provided by operating activities-continuing operations
 $2,261 $2,216 $1,984 
       
Net cash flows used by operating activities-discontinued operations
 $(11) $(47) $(16)
       
Net cash flows provided by operating activities-total
 $2,250 $2,169 $1,968 
       
 
 
 
 
 
 
  
Cash Flows from Investing Activities:
  
Purchases of fixed maturity securities $(58,963) $(61,419) $(63,167) $(48,757) $(62,990) $(58,379)
Proceeds from fixed maturity securities:  
Sales 48,678 52,805 61,919  42,433 55,611 48,427 
Maturities, calls and redemptions 4,929 6,435 3,108  4,310 4,579 4,800 
Purchases of equity securities  (625)  (281)  (814)  (340)  (482)  (351)
Proceeds from sales of equity securities 787 578 1,197  221 316 522 
Purchases of mortgage loans and real estate  (27)   
Change in short term investments 2,044  (845)  (3,249)  (1,331) 1,627 2,021 
Change in collateral on loaned securities and derivatives 476  (111)  (371)
Change in collateral on loaned securities 2,084  (151) 476 
Change in other investments 100 300 167   (195) 86  (30)
Purchases of property and equipment  (41)  (65)  (88)  (131)  (45)  (41)
Dispositions 647 422  (178) 8 57 647 
Other, net  (24) 48  (12) 16 56  (194)
 
 
 
 
 
 
        
Net cash flows used by investing activities
 $(2,019) $(2,133) $(1,488)
 
 
 
 
 
 
  
Net cash flows used by investing activities-continuing operations
 $(1,682) $(1,336) $(2,102)
       
Net cash flows provided by investing activities-discontinued operations
 $36 $20 $18 
       
Net cash flows used by investing activities-total
 $(1,646) $(1,316) $(2,084)
       

97


             
  2004
 2003
 2002
Cash Flows from Financing Activities:
            
Issuance of preferred stock $  $750  $750 
Principal payments on debt  (619)  (387)  (341)
Proceeds from issuance of debt  972      65 
Receipt (return) of policyholder account balances on investment contracts  10   25   (44)
Receipts from investment contracts credited to policyholder account balances     1   1 
Other  5   (3)  1 
   
 
   
 
   
 
 
Net cash flows provided by financing activities
  368   386   432 
   
 
   
 
   
 
 
Net change in cash  (44)  13   (16)
Cash, beginning of year
  139   126   142 
   
 
   
 
   
 
 
Cash, end of year
 $95  $139  $126 
   
 
   
 
   
 
 
Supplemental Disclosures of Cash Flow Information:
            
Cash paid (received):            
Interest $216  $134  $195 
Federal income taxes  (627)  (369)  (612)
Non-cash transactions:            
Notes receivable for the issuance of common stock     4   4 

The accompanying Notes are an integral part of these Consolidated Financial Statements.

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  2006  2005  2004 
Cash Flows from Financing Activities:
            
Proceeds from the issuance of long term debt $759  $  $972 
Principal payments on debt  (294)  (568)  (618)
Return of investment contract account balances  (589)  (281)  (479)
Receipts of investment contract account balances  4   7   181 
Payment to repurchase Series H Issue preferred stock  (993)      
Proceeds from the issuance of common stock  499       
Stock options exercised  10   2    
Other, net  (1)  3   5 
          
             
Net cash flows (used) provided by financing activities-continuing operations
 $(605) $(837) $61 
          
Net cash flows provided by financing activities-discontinued operations
 $  $  $ 
          
Net cash flows (used) provided by financing activities-total
 $(605) $(837) $61 
          
             
Net change in cash  (1)  16   (55)
Net cash transactions from continuing operations to discontinued operations  14   (42)  13 
Net cash transactions from discontinued operations to continuing operations  (14)  42   (13)
             
Cash, beginning of year
  125   109   164 
          
             
Cash, end of year
 $124  $125  $109 
          
             
Cash-continuing operations $84  $96  $95 
Cash-discontinued operations  40   29   14 
          
Cash-total
 $124  $125  $109 
          

CNA Financial Corporation Consolidated Statements of Stockholders’ Equity

                                 
          Additional     Accumulated
Other
     Notes
Receivable
 Total
  Preferred Common Paid-in Retained Comprehensive Treasury Related to Stockholders’
(In millions) Stock
 Stock
 Capital
 Earnings
 Income (Loss)
 Stock
 Common Stock
 Equity
Balance, January 1, 2002
 $  $565  $1,031  $6,438  $226  $(70) $(68) $8,122 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Comprehensive income:                                
Net income           155            155 
Other comprehensive income              378         378 
Total comprehensive income                              533 
Issuance of Series H preferred stock  750                     750 
Increase in notes receivable related to common stock                    (4)  (4)
   
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Balance, December 31, 2002
  750   565   1,031   6,593   604   (70)  (72)  9,401 
Comprehensive income:                                
Net loss           (1,433)           (1,433)
Other comprehensive income              237         237 
Total comprehensive loss                              (1,196)
Issuance of Series I preferred stock  750                     750 
Stock options exercised                 1      1 
Increase in notes receivable related to common stock                    (4)  (4)
   
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Balance, December 31, 2003
  1,500   565   1,031   5,160   841   (69)  (76)  8,952 
Comprehensive income:                                
Net income           441            441 
Other comprehensive loss              (191)        (191)
Total comprehensive income                              250 
Conversion of Series I preferred stock to common stock  (750)  80   670                
Decrease in notes receivable related to common stock                    5   5 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 
Balance, December 31, 2004
 $750  $645  $1,701  $5,601  $650  $(69) $(71) $9,207 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
   
 
 

The accompanying Notes are an integral part of these Consolidated Financial Statements.

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CNA Financial Corporation
Consolidated Statements of Stockholders’ Equity
                                 
                  Accumulated      Notes    
          Additional      Other      Receivable for  Total 
  Preferred  Common  Paid-in  Retained  Comprehensive  Treasury  the Issuance of  Stockholders’ 
(In millions) Stock  Stock  Capital  Earnings  Income (Loss)  Stock  Common Stock  Equity 
Balance, January 1, 2004
 $1,500  $565  $1,031  $4,932  $852  $(69) $(76) $8,735 
                         
                                 
Comprehensive income:                                
Net income           425            425 
Other comprehensive loss              (191)        (191)
                                
Total comprehensive income                              234 
Conversion of Series I preferred stock to common stock  (750)  80   670                
Decrease in notes receivable for the issuance of common stock                    5   5 
                         
                                 
Balance, December 31, 2004
  750   645   1,701   5,357   661   (69)  (71)  8,974 
                                 
Comprehensive income:                                
Net income           264            264 
Other comprehensive loss              (302)        (302)
                                
Total comprehensive loss                              (38)
Stock options exercised                 2      2 
Decrease in notes receivable for the issuance of common stock                    12   12 
                         
                                 
Balance, December 31, 2005
  750   645   1,701   5,621   359   (67)  (59)  8,950 
                                 
Comprehensive income:                                
Net income           1,108            1,108 
Other comprehensive income              236         236 
                                
Total comprehensive income                              1,344 
Liquidation preference in excess of par value on Series H Issue           (243)           (243)
Repurchase of Series H Issue  (750)                    (750)
Issuance of common stock      38   461                   499 
Adjustment to initially apply FAS 158, net of tax                  (46)          (46)
Stock options exercised        1         9      10 
Decrease in notes receivable for the issuance of common stock                    1   1 
Other        3               3 
                         
                                 
Balance, December 31, 2006
 $  $683  $2,166  $6,486  $549  $(58) $(58) $9,768 
                         
The accompanying Notes are an integral part of these Consolidated Financial Statements.

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Notes to Consolidated Financial Statements

Note A. Summary of Significant Accounting Policies

Basis of Presentation

The Consolidated Financial Statements include the accounts of CNA Financial Corporation (CNAF) and its controlled subsidiaries. Collectively, CNAF and its subsidiaries are referred to as CNA or the Company. CNA’s property and casualty and the remaining life and group insurance operations are primarily conducted by Continental Casualty Company (CCC), The Continental Insurance Company (CIC) and Continental Assurance Company (CAC). Loews Corporation (Loews) owned approximately 91%89% of the outstanding common stock and 100% of the Series H preferred stock of CNAF as of December 31, 2004.

2006.

The Company’s individual life insurance business, including its previously wholly ownedwholly-owned subsidiary Valley Forge Life Insurance Company (VFL), was sold on April 30, 2004 to Swiss Re Life & Health America Inc. (Swiss Re). The results of the individual life insurance business sold through the date of sale are included in the Consolidated Statement of Operations for the yearsyear ended December 31, 2004, 2003 and 2002.2004. See Note P for further information.

CNA Group Life Assurance Company (CNAGLA) was sold to Hartford Financial Services Group, Inc. on December 31, 2003. The results of the group benefits business sold are included in the Consolidated Statement of Operations for the years ended December 31, 2003 and 2002. See Note P for further information.

The accompanying Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). All significant intercompany amounts have been eliminated. Certain amounts applicable to prior years have been conformed to the current year presentation.

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates.

The amounts presented on the December 31, 2005 Consolidated Balance Sheet related to Insurance receivables and Other liabilities have been corrected from $1,866 million and $2,283 million to $2,096 million and $2,513 million, to conform to the 2006 presentation. The correction of $230 million relates to balances payable to insureds that were previously reflected as a deduction from insurance receivables and are currently reflected as liabilities. The balances are principally related to amounts deposited with the Company by customers, such as amounts related to the funding of deductible obligations.

Business

As a result of the Company’s decisions to focus on core property and casualty operations and to exit certain businesses, the Company revised its reportable segment structure in the first quarter of 2004 to reflect the changes in its core operations and how management makes business decisions.

CNA’s core property and casualty insurance operations are now reported in two business segments: Standard Lines and Specialty Lines. CNA’s non-core operations are managed in two segments: Life and Group Non-Core and Corporate and Other Non-Core. Prior period segment disclosures have been conformed to the current year presentation.

CNA serves a wide variety of customers, including small, medium and large businesses; insurance companies; associations; professionals; and groups and individuals with a broad range of insurance and risk management products and services.

Core insurance products include property and casualty coverages. Non-core insurance products, which primarily have been sold or placed in run-off, as discussed above, include life and accident and health insurance; retirement products and annuities; and property and casualty reinsurance. CNA services include risk management, information services healthcare claims management, and claims administration. CNA’s products and services are marketed through independent agents, brokers, managing general agents and direct sales.

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Insurance Operations

Premiums:Insurance premiums on property and casualty and accident and health insurance contracts are recognized in proportion to the underlying risk insured which principally are earned ratably over the duration of the policies after deductions for ceded insurance premiums. The reserve for unearned premiums on these contracts represents the portion of premiums written relating to the unexpired terms of coverage.

An estimated allowance for doubtful accounts is recorded on the basis of periodic evaluations of balances due currently or in the future from insureds, including amounts due from insureds related to losses under high deductible policies, management’s experience and current economic conditions.

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Property and casualty contracts that are retrospectively rated contain provisions that result in an adjustment to the initial policy premium depending on the contract provisions and loss experience of the insured during the experience period. For such contracts, the Company estimates the amount of ultimate premiums that the Company may earn upon completion of the experience period and recognizes either an asset or a liability for the difference between the initial policy premium and the estimated ultimate premium. The Company adjusts such estimated ultimate premium amounts during the course of the experience period based on actual results to date. The resulting adjustment is recorded as either a reduction of or an increase to the earned premiums for the period.

Revenues on interest-sensitive life insurance contracts are composed of contract charges and fees, which are recognized over the coverage period.

Premiums for other life insurance products and annuities are recognized as revenue when due after deductions for ceded insurance premiums.

Claim and claim adjustment expense reserves:Claim and claim adjustment expense reserves, except reserves for structured settlements not associated with asbestos and environmental pollution and mass tort (APMT), workersworkers’ compensation lifetime claims, and accident and health claims and certain claims associated with discontinued operations, are not discounted and are based on 1) case basis estimates for losses reported on direct business, adjusted in the aggregate for ultimate loss expectations; 2) estimates of incurred but not reported losses; 3) estimates of losses on assumed reinsurance; 4) estimates of future expenses to be incurred in the settlement of claims; and 5) estimates of salvage and subrogation recoveries and 6) estimates of amounts due from insureds related to losses under high deductible policies. Management considers current conditions and trends as well as past Company and industry experience in establishing these estimates. The effects of inflation, which can be significant, are implicitly considered in the reserving process and are part of the recorded reserve balance. Ceded claim and claim adjustment expense reserves are reported as a component of reinsuranceReinsurance receivables in the Consolidated Balance Sheets.

See Note Q for further information on claim and claim adjustment expense reserves for discontinued operations.

Claim and claim adjustment expense reserves are presented net of anticipated amounts due from insureds related to losses under high deductible policies of $2.5 billion and $2.8 billion as of December 31, 2006 and 2005. A portion of these amounts is supported by collateral. The Company also has an allowance for uncollectible deductible amounts, which is presented as a component of the allowance for doubtful accounts included in the Insurance receivables on 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 4.6% to 7.5% at December 31, 20042006 and 2003.2005. At December 31, 20042006 and 2003,2005, the discounted reserves for unfunded structured settlements were $872$814 million and $898$843 million, net of discount of $1,367$1,250 million and $1,429$1,309 million.

Workers

Workers’ compensation lifetime claim reserves are calculated using mortality assumptions determined through statutory regulation and accidenteconomic factors. Accident and health claim reserves are calculated using mortality and morbidity assumptions based on Company and industry experience,experience. Workers’ compensation lifetime claim reserves and accident and health claim reserves are discounted at interest rates that range from 3.5% to 6.5% at December 31, 20042006 and 2003.2005. At December 31, 20042006 and 2003,2005, such discounted reserves totaled $1,893$1,284 million and $2,835$1,238 million, net of discount of $460$416 million and $851$430 million.

Future policy benefits reserves:Reserves for 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 6%6.0% to 8.6% at December 31, 20042006 and 2003,2005, 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. The net reserves for traditional life insurance products (whole and term life products)

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including interest-sensitive contracts were ceded on a 100% indemnity reinsurance basis to Swiss Re in connection with the sale of the individual life insurance business. See Note P for additionalfurther information.

Policyholders’ funds reserves:Policyholders’ funds reserves primarily include reserves for universal life insurance contracts and investment contracts without life contingencies. The liability for policy benefits for universal life-type contracts is equal to the balance that accrues to the benefit of policyholders, including credited interest, amounts that have been assessed to compensate the Company for services to be performed over future periods, and any amounts previously assessed against policyholders that are refundable on termination of the contract. For investmentthese contracts, policyholder liabilities are equal to the accumulated policy account values, which consist of an accumulation of deposit payments plus credited interest, less withdrawals and amounts assessed through the end of the period.

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Guaranty fund and other insurance-related assessments:Liabilities for guaranty fund and other insurance-related assessments are accrued when an assessment is probable, when it can be reasonably estimated, and when the event obligating the entity to pay an imposed or probable assessment has occurred. Liabilities for guaranty funds and other insurance-related assessments are not discounted and are included as part of otherOther liabilities in the Consolidated Balance Sheets. As of December 31, 20042006 and 2003,2005, the liability balance was $67balances were $189 million and $70$185 million. As of December 31, 20042006 and 2003,2005, included in other assets were $9$7 million and $7$10 million of related assets for premium tax offsets. The related asset is limited to the amount that is able to be assessed on future premium collections or policy surcharges from business written or committed to be written.

Reinsurance:Amounts recoverable from reinsurers are estimated in a manner consistent with claim and claim adjustment expense reserves or future policy benefits reserves and are reported as receivables in the Consolidated Balance Sheets. The cost of reinsurance is primarily accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies. The ceding of insurance does not discharge the primary liability of the Company. An estimated allowance for doubtful accounts is recorded on the basis of periodic evaluations of balances due from reinsurers, reinsurer solvency, management’s experience and current economic conditions.

The expenses incurred related to uncollectible reinsurance receivables are presented as a component of Insurance claims and policyholders’ benefits in the Consolidated Statements of Operations.

Reinsurance contracts that do not effectively transfer the underlying economic risk of loss on policies written by the Company are recorded using the deposit method of accounting, which requires that premium paid or received by the ceding company or assuming company be accounted for as a deposit asset or liability. The Company primarily records these deposits as either reinsurance receivables or other assets for ceded recoverables and reinsurance balances payable or other liabilities for assumed liabilities. At December 31, 20042006 and 2003,2005, the Company had approximately $117$104 million and $380$171 million recorded as deposit assets and $156$71 million and $369$111 million recorded as deposit liabilities.

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 estimate of 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. This adjustment is reflected in other revenue or other operating expense as appropriate.

In 2004, the expenses incurred related to uncollectible reinsurance receivables were reclassified from “Other operating expenses” to “Insurance claims and policyholders’ benefits” on the Consolidated Statements of Operations. Prior period amounts have been reclassified to conform to the current year presentation. This reclassification had no impact on net income (loss) in any period.

Participating insurance:Policyholder dividends are accrued using an estimate of the amount to be paid based on underlying contractual obligations under policies and applicable state laws. When limitations exist on the amount of net income from participating life insurance contracts that may be distributed to policyholders,shareholders, the policyholders’ share of net income on those contractspolicies that cannot be distributed to shareholders is excluded from stockholders’ equity by a charge to operations and the establishment of a corresponding liability.

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Deferred acquisition costs:Costs, includingAcquisition costs include commissions, premium taxes and certain underwriting and policy issuance costs which vary with and are related primarily to the acquisition of business. Such costs related to property and casualty insurance business are deferred and amortized ratably over the period the related premiums are earned. Anticipated investment income is considered in the determination of the recoverability of deferred acquisition costs.

The excess of first-year commissions over renewal commissions and other first-year costs of acquiring life insurance business, such as agency and policy issuance expenses, which vary with and are related primarily to the production of new and renewal business, have been deferred and are amortized with interest over the expected life of the related contracts. The excess of first-year ceded expense allowances over renewal ceded expense allowances reduces applicable unamortized deferred acquisition costs.

Deferred acquisition costs related to non-participating traditional life insurance and 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 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 results of operations when they occur. For these contracts, the amortization period is typically the estimated life of the policy.

For universal life and cash value annuity contracts,

Anticipated investment income is considered in the amortizationdetermination of the recoverability of deferred acquisition costs is recorded in proportion to the present value of estimated gross margins or profits. The gross margins or profits result from actual earned interest minus actual credited interest, actual costs of insurance (mortality charges) minus expected mortality, actual expense charges minus expected maintenance expenses and surrender charges. Amortization interest rates are based on rates in effect at the inception or acquisition of the contracts or the latest revised rate applied to the remaining benefit period, according to product line. Actual gross margins or profits can vary from the Company’s estimates resulting in increases or decreases in the rate of amortization. When appropriate, the Company revises its assumptions of the estimated gross margins or profits of these contracts, and the cumulative amortization is re-estimated and adjusted through current results of operations. To the extent that unrealized gains or losses on available-for-sale securities would result in an adjustment of deferred acquisition costs had they actually been realized, an adjustment is recorded to deferred acquisition costs and to unrealized investment gains or losses within stockholders�� equity.

costs. Deferred acquisition costs are recorded net of ceding commissions and other ceded acquisition costs. The Company evaluates deferred acquisition costs for recoverability. Adjustments, if necessary, are recorded in current results of operations.

Investments in life settlement contracts and related revenue recognition:The Company has purchased investments in life settlement contracts. Under a life settlement contract, CNA obtains the rights of being the owner and beneficiary to an underlying life insurance policy. 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 in accordance with Financial Accounting Standards Board (FASB) Technical Bulletin 85-4Accounting for Purchases of Life Insurance (FTB 85-4).policy. Amounts paid to purchase these contracts that are in excess of the cash surrender value, at the date of purchase, were expensed immediately.

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Periodic maintenance costs, such as premiums, necessary to keep the underlying policy inforce are expensed as incurred and are included in other operating expenses. Revenue is recognized and included in otherOther revenue in the Consolidated Statements of Operations when the life insurance policy underlying the life settlement contract matures.

See the Accounting Pronouncements section of this note for further discussion of Financial Accounting Standards Board (FASB) Staff Position No. 85-4-1,Accounting for Life Settlement Contracts by Third-Party Investors.

Separate Account Business

Separate account assets and liabilities represent contract holder funds related to investment and annuity products, which are segregated into accounts with specific underlying investment objectives. In 2003 and 2002, separate account balances included funds with balances accruing directly to the contract holders and also funds with performance measures guaranteed by the Company. Net income accruing to the Company related to the separate accounts, consisting of fee revenue and investment results in excess of guaranteed returns, were primarily included within other revenue in the Consolidated Statements of Operations.

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In July of 2003, the Accounting Standards Executive Committee (AcSEC) of the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 03-01,Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts (SOP 03-01). SOP 03-01 provides guidance on accounting and reporting by insurance enterprises for certain nontraditional long-duration contracts and for separate accounts. SOP 03-01 was effective for financial statements for fiscal years beginning after December 15, 2003. SOP 03-01 did not allow retroactive application to prior years’ financial statements. CNA adopted SOP 03-01 at January 1, 2004. The initial adoption of SOP 03-01 did not have a significant impact on the results of operations or equity of the Company, but did affect the classification and presentation of certain balance sheet and income statement items.

Under SOP 03-01, the main criterion that needs to be satisfied for separate account presentation is that results of the investments made by the separate accounts must be directly passed through to the individual contract holders. Certain of CNA’s separate accounts have guaranteed returns not related to investment performance whereby the contract holders do not bear the losses or receive the gains from the investment performance; rather, amounts less than or in excess of the guaranteed amounts accrue to CNA. Upon adoption of SOP 03-01, these separate accounts did not meet the requirements of SOP 03-01 for separate account presentation. Therefore, the assets supporting these separate accounts are reflected within general account investments and the related liabilities within insurance reserves as of December 31, 2004. SOP 03-01 specifically precludes reclassifying balances for years prior to adoption.

The adoption of SOP 03-01 did not result in a net impact to total assets, total liabilities or shareholder’s equity. The difference between assets and liabilities as reflected within the table below, relates to the net equity of the above-referenced separate accounts which accrues to CNA, as discussed above. Prior to adoption of SOP 03-01, this equity amount was presented as Other Assets and equity within the consolidated financial statements. Following adoption of SOP 03-01, the Other Assets amount has been replaced with the actual underlying investments that are now included within the general account and are reported based on their investment classification, and the offsetting equity impact is unchanged.

From an income statement perspective, SOP 03-01 did not impact net income; however, it required a reclassification within the income statement. Prior to the adoption of SOP 03-01, the net results of the separate accounts were primarily included in Other Revenue. Upon adopting SOP 03-01, premiums, benefits, net investment income and realized gains are included within their natural line items. Specifically related to the indexed group annuity contracts, the underlying portfolio consists of limited partnership investments and a trading portfolio which are classified as held for trading purposes and are carried at fair value, with both the net realized and unrealized gains (losses) included within net investment income in the Consolidated Statement of Operations.

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The following table provides the balance sheet presentation of assets and liabilities for certain guaranteed investment contracts and indexed group annuity contracts upon adoption of SOP 03-01, including the classification of the indexed group annuity contract investments as trading securities.

         
(In millions) December 31, 2004
 January 1, 2004 (a)
Assets
        
Investments:        
Fixed maturity securities, available-for-sale $797  $1,220 
Fixed maturity securities, trading  350   304 
Equity securities available-for-sale  8   4 
Equity securities trading  39    
Limited partnerships  351   419 
Derivatives  2    
Short term investments, available-for-sale  17   55 
Short term investments, trading  459   414 
   
 
   
 
 
Total investments
  2,023   2,416 
Accrued investment income  9   13 
Receivables for securities sold  189   97 
Other assets  1   1 
   
 
   
 
 
Total assets
 $2,222  $2,527 
   
 
   
 
 
Liabilities
        
Liabilities:        
Insurance reserves:        
Claim and claim adjustment expense $1  $1 
Future policy benefits  522   617 
Policyholders’ funds  1,205   1,324 
Collateral on loaned securities and derivatives     17 
Payables for securities purchased  102   43 
Other liabilities  87   47 
   
 
   
 
 
Total liabilities
 $1,917  $2,049 
   
 
   
 
 

(a)  Includes assets and liabilities of the individual life business sold on April 30, 2004. See Note N for further information.

The Company continues to have variable annuity contracts issued by CAC that meet the criteria for separate account presentation. The assets and liabilities of these contracts are legally segregated and reported as assets and liabilities of the separate account business. Substantially all assets of the separate account business are carried at fair value. Separate account liabilities are carried at contract values.

Net income accruing to the Company related to separate accounts is primarily included within Other revenue on the Consolidated Statements of Operations.

Investments

Valuation of investments:CNA classifies its fixed maturity securities (bonds and redeemable preferred stocks) and its equity securities as either available-for-sale or trading, and as such, they are carried at fair value. During 2004, the Company has designated certain new purchases related to a specific investment strategy, that primarily includes convertible bond securities, as held for trading purposes. In addition, upon adoption of SOP 03-01, certain securities were designated as held for trading purposes within the General Account. Changes in fair value of trading securities are reported within net investment income. The amortized cost of fixed maturity securities classified as available-for-sale is adjusted for amortization of premiums and accretion of discounts to maturity, which are included in net investment income. Changes in fair value related to available-for-sale securities are reported as a component of other comprehensive income. Investments are written down to fair value and losses are recognized in incomeRealized investment gains (losses) on the Consolidated Statements of Operations when a decline in value is determined to be other-than-temporary.

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

105


prepayments change, the effective yield is recalculated to reflect actual payments to date and anticipated future payments. The net investment in the securities is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the securities. Such adjustments are reflected in net investment income.

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. Changes in fair value, which represents changes in partnership’s net assets, are recorded within net investment income. The majority of the limited partnerships invest in a substantial number of securities that are readily marketable. The Company is primarily a passive investor in such partnerships and does not have influence over the partnerships’ management, who are committed to operate them according to established guidelines and strategies. These strategies may include the use of leverage and hedging techniques that potentially introduce more volatility and risk to the partnerships. In accordance with FASB Interpretation No. 46,46(R),Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (FIN 46R), during 2004, the Company has consolidated twothree limited partnerships, which were previously accounted for using the equity method. The net assets of the two limited partnerships of $113 million are reflected under their respective asset categories on the Company’s Consolidated Balance Sheets.

Cash equivalents are short-term, highly liquid investments that are both readily convertible into known amounts of cash and so near to maturity that they present insignificant risk of changes in value due to changing interest rates.

Other invested assets include certain derivative securities mortgage loans,and real estate and policy loans.investments. Investments in derivative securities are carried at fair value with changes in fair value reported as a component of realized gains or losses or other comprehensive income, depending on their hedge designation. Changes in the fair value of derivative securities which are not designated as hedges, are reported as a component of realized gains or losses. Mortgage loansReal estate investments are carried at unpaid principal balances, including unamortized premiumthe lower of cost or discount. Real estate is carried at depreciated cost. Policy loans are carried at unpaid balances.market value. Short term investments are generally carried at fair value,cost, which approximates amortized cost. Accumulated depreciation for mortgage loans and real estate was $12 million and $10 million at December 31, 2004 and 2003.

fair value.

Realized investment gains and losses:All securities sold resulting in investment gains and losses are recorded on the trade date.date, except for bank loan participations which are recorded on the date that the legal agreements are finalized. Realized investment gains and losses are determined on the basis of the cost or amortized cost of the specific securities sold.

Equity in unconsolidated affiliates:CNA uses the equity method of accounting for investments in companies in which its ownership interest of the voting shares of an investee company enables CNA to influence the operating or

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financial decisions of the investee company, but CNA’s interest in the investee does not require consolidation under Accounting Research Bulletin No. 51Consolidated Financial Statements (ARB 51) or FIN 46R. FIN 46R has changed the basis of consolidation from voting control to a broader consolidation model based on risks and rewards.consolidation. CNA’s proportionate share of equity in net income of these unconsolidated affiliates is reported in other revenues.

Securities lending activities:CNA lends securities to unrelated parties, primarily major brokerage firms. Borrowers of these securities must deposit collateral with CNA of at least 102% of the fair value of the securities loaned if the collateral is cash or securities. CNA maintains effective control over all loaned securities and, therefore, continues to report such securities as fixedFixed maturity securities in the Consolidated Balance Sheets.

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 $918$2,851 million and $430$767 million at December 31, 20042006 and 2003.2005. The fair value of non-cash collateral was $3,783$385 million and $505$138 million at December 31, 20042006 and 2003.

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2005.


Derivative Financial Instruments

All investments in derivatives are recorded at fair value. 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, credit default swaps and combinations of the foregoing. Derivatives embedded within non-derivative instruments (such as call options embedded in convertible bonds) must be splitseparated from the host instrument when the embedded derivative is not clearly and closely related to the host instrument. Collateralized debt obligations (CDO) 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 Statement of Financial Accounting Standard No. 133,Accounting for Derivative Instruments and Hedging Activities (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 net impact from CDOs was a realized gain of $5 million for the year ended December 31, 2004. The net impact of CDOs were realized losses of $1 million and $6 million for the years ended December 31, 2003 and 2002. The Company no longer issues this product.

Synthetic guaranteed investment contracts (GIC) are guaranteed investment contracts that simulate the performance of a traditional GIC through the use of financial instruments. These contracts are accounted for as derivative financial instruments. A key difference between a synthetic GIC and a traditional GIC is that the contract owner owns the financial instruments underlying the synthetic GIC; whereas, the contract owner owns only the contract itself with a traditional GIC. The Company mitigates its exposure under these contracts by maintaining the ability to reset the crediting rate on a monthly/quarterly basis. This rate reset effectively passes any cash flow volatility and asset underperformance back to the contract owner. The Company no longer issues this product.

The Company’s derivatives are reported as other invested assets with the exception of CDOs and synthetic GICs, which are reported as other assets and/or other liabilities. Embedded derivative instruments subject to bifurcation are reported together with the host contract, at fair value. If certain criteria are met, a derivative may be specifically designated as a hedge of exposures to changes in fair value, cash flows or foreign currency exchange rates. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative, and the nature of any hedge designation thereon.

thereon and whether the derivative was transacted in a designated trading portfolio.

The Company’s accounting for changes in the fair value of general account derivatives is as follows:
   
Nature of Hedge Designation
 Derivative'sDerivative’s Change in Fair Value Reflected In:
No hedge designation Realized investment gains or losses
Fair value designation Realized investment gains or losses, along with the change in fair value of the hedged asset or liability that is attributable to the hedged risk
Cash flow designation Other comprehensive income, with subsequent reclassification to earnings when the hedged transaction, asset or liability impacts earnings
Foreign currency designation Consistent with fair value or cash flow above, depending on the nature of the hedging relationship

Changes

The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedging transactions. The Company also formally assesses (both at the hedge’s inception and on an ongoing basis) whether the derivatives that are used in thehedging transactions have been highly effective in offsetting changes in fair value or cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods. When it is determined that a derivative for which hedge accounting has been designated is not (or ceases to be) highly effective, the Company discontinues hedge accounting prospectively.
Separate account investments held in the separate accountsdesignated trading portfolios are reflected in separate account earnings. Because separate account investments are generally carried at fair value with changes therein reflected in investment income. Hedge accounting on derivatives in these separate account earnings, hedge accountingaccounts is generally not applicable to separate account derivatives.applicable.

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The Company uses investment derivatives in the normal course of business, primarily toin an attempt to reduce its exposure to market risk (principally interest rate risk, equity stock price risk and foreign currency risk) stemming from various assets and liabilities and credit risk (the ability of an obligor to make timely payment of principal and/or interest). The Company’s principal objective under such risk strategies is to achieve the desired reduction in economic risk, even if the position will not receive hedge accounting treatment.

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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 prohibitsDerivatives entered into for hedging, regardless of the use of derivatives withchoice to designate hedge accounting, shall have a maturity greater than 18 months, unlessthat effectively correlates to the derivative is matched with assetsunderlying hedged asset or liabilities having a longer maturity.liability. The policy prohibits the use of derivatives containing greater than one-to-one leverage with respect to changes in the underlying price, rate or index. The policy also prohibits the use of borrowed funds, including funds obtained through repurchase transactions,securities lending, to engage in derivative transactions.

Credit exposure associated with non-performance by the counterparties to derivative instruments is generally limited to the uncollateralized fair value of the asset related to the instruments recognized in the Consolidated Balance Sheets. The Company attempts to mitigate the risk of non-performance by monitoring the creditworthiness of counterparties and diversifying derivatives to multiple counterparties. The Company generally requires that all over-the-counter derivative contracts be governed by an International Swaps and Derivatives Association (ISDA) Master Agreement, and exchanges collateral fromunder the terms of these agreements with its derivative investment counterparties depending on the amount of the exposure and the credit rating of the counterparty.

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,market values, 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 and variable rate debt and life insurance liabilities.debt. The Company has used these types of instruments as designated hedges against specific assets or liabilities on an infrequent basis.

The Company is exposed to equity price risk as a result of its investment in equity securities and equity derivatives. Equity price risk results from changes in the level or volatility of equity prices, which affect the value of equity securities, or instruments that derive their value from such securities. CNA attempts to mitigate its exposure to such risks by limiting its investment in any one security or index. The Company may also manage this risk by utilizing instruments such as options, swaps, futures and collars to protect appreciation in securities held. CNA uses derivatives in one of its separate accounts to mitigate equity price risk associated with its indexed group annuity contracts by purchasing Standard & Poor’s 500®500® (S&P 500®500®) index futures contracts in a notional amount equal to the contract holder liability, which is calculated using the S&P 500® rate of return.

liability.

The Company has exposure to credit risk arising from the uncertainty associated with a financial instrument obligor’s ability to make timely principal and/or interest payments. The Company attempts to mitigate this risk by limiting credit concentrations, practicing diversification, and frequently monitoring the credit quality of issuers and counterparties. In addition the Company may utilize credit derivatives such as credit default swaps to modify the credit risk inherent in certain investments. Credit default swaps involve a transfer of credit risk from one party to another in exchange for periodic payments. The Company infrequently designates these types of instruments as hedges against specific assets.

Foreign exchange rate risk arises from the possibility that changes in foreign currency exchange rates will impact the fair value of financial instruments denominated in a foreign currency. The Company’s foreign transactions are primarily denominated in Canadian dollars, British pounds, Euros and euros.Canadian dollars. The Company typically manages this risk via asset/liability currency matching and through the use of foreign currency futures and/or forwards. The Company has infrequently designated these types of instruments as hedges against specific assets or liabilities.

The contractual or notional amounts for derivatives are used to calculate the exchange of contractual payments under the agreements and are not representative of the potential for gain or loss on these instruments. Interest rates, equity prices and foreign currency exchange rates affect the fair value of derivatives. The fair values generally

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represent the estimated amounts that CNA would expect to receive or pay upon termination of the contracts at the reporting date. Dealer quotes are available for substantially all of CNA’s derivatives. For derivative instruments not actively traded, fair values are estimated using values obtained from independent pricing services, costs to settle or quoted market prices of comparable instruments.

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The Company is required to provide collateral for all exchange-traded futures and options contracts. These margin requirements are determined by the individual exchanges based on the fair value of the open positions and are in the custody of the exchange. Collateral may also be required for over-the-counter contracts such as interest rate swaps, credit default swaps and currency forwards per the ISDA agreements in place. The fair value of collateral provided was $58 million at December 31, 2006 and consisted primarily of cash. The fair value of the collateral at December 31, 2005 was $66 million and consisted primarily of U.S. Treasury Bills, which the Company had access to subject to replacement and therefore remained recorded as a component of Short term investments on the Consolidated Balance Sheets.

Income Taxes

The Company and its eligible subsidiaries (CNA Tax Group) are included in the consolidated Federalfederal income tax return of Loews and its eligible subsidiaries. The Company accounts for income taxes under the asset and liability method. Under the asset and liability method, deferred income taxes are recognized for temporary differences between the financial statement and tax return bases of assets and liabilities. Future tax benefits are recognized to the extent that realization of such benefits is more likely than not.

Property and EquipmentEquipmen

t

Property and equipment are carried at cost less accumulated depreciation. Depreciation is based on the estimated useful lives of the various classes of property and equipment and is determined principally on the straight-line method.

Furniture and fixtures are depreciated over seven years. Office equipment is depreciated over five years. The estimated lives for data processing equipment and software range from three to five years. Leasehold improvements are depreciated over the corresponding lease terms.

Goodwill and Other Intangible Assets

Goodwill and other indefinite-lived intangible assets of $142 million and $146 million as of December 31, 20042006 and 20032005 primarily represents the excess of purchase price over the fair value of the net assets of acquired entities. Otherentities and businesses. The balance at December 31, 2006 and 2005 primarily related to Specialty Lines. During 2006, the Company determined that goodwill and other intangible assets were $16of approximately $4 million as of December 31, 2004 and 2003. CNA adopted Statement of Financial Accounting Standards No. 142,Goodwill and Other Intangible Assets (SFAS 142) on January 1, 2002. SFAS 142 changedwas impaired related to the accounting for goodwill and indefinite-lived intangible assets from an amortization method to an impairment-only approach.Standard Lines segment. Goodwill and indefinite-lived intangible assets are tested for impairment annually or when certain triggering events require such tests.

During 2003, the Company sold certain businesses. Accordingly, the goodwill associated with these sold businesses decreased CNA’s goodwill by $2 million in Standard Lines and $1 million in Life and Group Non-Core and a reduction in CNA’s indefinite-lived intangible assets of $4 million in Life and Group Non-Core. Additionally, a $5 million pretax impairment charge was recorded in Specialty Lines.

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 $43 million after-tax ($43 million pretax) charge in Standard Lines, a $5 million after-tax ($8 million pretax) charge in Specialty Lines, an $8 million after-tax ($12 million pretax) charge in Life and Group Non-Core, and a $1 million after-tax ($1 million pretax) charge in Corporate and Other Non-Core, 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.

Earnings (Loss) per Share Data

Earnings (loss) per share available to common stockholders is based on weighted-averageweighted average outstanding shares. Basic and diluted earnings per share excludes dilution and is computed by dividing net income availableattributable to common stockholders by the weighted-averageweighted average number of common shares outstanding for the period of common stock or common stock equivalents assuming conversion. The weighted average number of shares outstanding for computing basic and dilutedperiod. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.
The Series H Cumulative Preferred Stock Issue (Series H Issue) was 256.0held by Loews and accrued cumulative dividends at an initial rate of 8% per year, compounded annually. In August 2006, the Company repurchased the Series H Issue from Loews for approximately $993 million, 227.0 million and 223.6 milliona price equal to the liquidation preference. The Series H Issue dividend amounts through the repurchase date for the years ended December 31, 2006, 2005 and 2004 2003 and 2002. Included in the weighted-average outstanding shares in 2004 and 2003 is the effect of 32.3 million shares of CNAFhave been subtracted from Income from Continuing Operations to determine income from continuing operations available to common stock issued on April 20, 2004 in conjunction with the conversion of the $750 million Series I convertible preferred stock issued in 2003. The effect of the preferred shares has been included in the weighted average shares since issuance.

stockholders.

Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. For the years ended December 31, 2004, 20032006, 2005 and 2002,2004, approximately one million shares attributable to the exercise of outstanding optionsexercises under stock-based employee compensation plans were excluded from the calculation of diluted earnings per share because the exercise price of these options was greater than the average market price of CNA common stock.

they were antidilutive.

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The computation of earnings (loss) per share is as follows:

Earnings (Loss) perPer Share
             
Years ended December 31
(In millions, except per share amounts)
 2004
 2003
 2002
Income (loss) from continuing operations $441  $(1,433) $247 
Less: undeclared preferred stock dividend  (65)  (60)  (2)
   
 
   
 
   
 
 
Income (loss) from continuing operations available to common stockholders  376   (1,493)  245 
Loss from discontinued operations, net of tax        (35)
Cumulative effect of change in accounting principles, net of tax        (57)
   
 
   
 
   
 
 
Net income (loss) available to common stockholders $376  $(1,493) $153 
   
 
   
 
   
 
 
Weighted-average outstanding common stock and common stock equivalents  256.0   227.0   223.6 
Effect of dilutive securities, employee stock options         
   
 
   
 
   
 
 
Adjusted weighted-average outstanding common stock and common stock equivalents assuming conversions  256.0   227.0   223.6 
   
 
   
 
   
 
 
Basic and diluted earnings (loss) per share available to common stockholders
 $1.47  $(6.58) $0.68 
   
 
   
 
   
 
 
             
Years ended December 31 2006  2005  2004 
(In millions, except per share amounts)            
Income from continuing operations $1,137  $243  $446 
Less: undeclared preferred stock dividend through repurchase date  (46)  (70)  (65)
          
             
Income from continuing operations available to common stockholders $1,091  $173  $381 
          
             
Weighted average outstanding common stock and common stock equivalents  262.1   256.0   256.0 
Effect of dilutive securities, employee stock options  0.2       
          
Adjusted weighted average outstanding common stock and common stock equivalents assuming conversions  262.3   256.0   256.0 
          
             
Basic earnings per share from continuing operations available to common stockholders
 $4.17  $0.68  $1.49 
          
Diluted earnings per share from continuing operations available to common stockholders
 $4.16  $0.68  $1.49 
          

The Company has stock-based compensation plans which are detailed in Note J. The Company applies the intrinsic value method by following Accounting Policy Board Opinion No. 25,Accounting for Stock Issued to Employees (APB 25), and related interpretations, in accounting for its stock-based compensation plan. Under the recognition and measurement principles of APB 25, no stock-based compensation cost has been recognized as the exercise price of the granted options equaled the market price of the underlying stock at the grant date.

The following table illustrates the effect on net income (loss) and earnings (loss) per share data if the Company had applied the fair value recognition provisions of SFASStatement of Financial Accounting Standards (SFAS) No. 123,Accounting for Stock-Based Compensation (SFAS 123) to stock-based employee compensation under the Company’s stock-based compensation plans.

plans for the years ended 2005 and 2004.

Pro Forma Effect of SFAS 123 on Results
             
Years ended December 31
(In millions, except per share amounts)
 2004
 2003
 2002
Net income (loss) available to common stockholders $376  $(1,493) $153 
Less: Total stock-based compensation cost determined under the fair value method, net of tax  (2)  (2)  (1)
   
 
   
 
   
 
 
Pro forma net income (loss) available to common stockholders $374  $(1,495) $152 
   
 
   
 
   
 
 
Basic and diluted earnings (loss) per share, as reported $1.47  $(6.58) $0.68 
   
 
   
 
   
 
 
Basic and diluted earnings (loss) per share, pro forma $1.46  $(6.59) $0.67 
   
 
   
 
   
 
 
         
Years ended December 31 2005  2004 
(In millions, except per share amounts)        
Income from continuing operations $243  $446 
Less: undeclared preferred stock dividend  (70)  (65)
       
 
Income from continuing operations available to common stockholders  173   381 
 
Income (loss) from discontinued operations, net of tax  21   (21)
       
 
Net income available to common stockholders  194   360 
 
Less: Total stock-based compensation cost determined under the fair value method, net of tax  (2)  (2)
       
 
Pro forma net income available to common stockholders $192  $358 
       
 
Basic and diluted earnings per share, as reported $0.76  $1.40 
       
 
Basic and diluted earnings per share, pro forma $0.75  $1.39 
       

Supplementary Cash Flow Information
Cash payments made for interest were $109 million, $139 million and $123 million for the years ended December 31, 2006, 2005 and 2004. Cash payments made for federal income taxes were $173 million and $164 million for the years ended December 31, 2006 and 2005. Cash refunds received for federal income taxes amounted to $627 million for the year ended December 31, 2004.
Accounting Pronouncements

In DecemberMay of 2003,2005, the FASB issued FIN 46R. As per ARB 51,SFAS No. 154,Accounting Changes and Error Correction (SFAS 154). This standard is a general rule for preparationreplacement of consolidated financial statements ofAccounting Policy Board Opinion No. 20,Accounting Changes, and FASB Standard No. 3,Reporting Accounting Changes in Interim Financial Statements. Under the new standard, any voluntary changes in accounting principles should be adopted via a parent and its subsidiary is ownership by the parent, either directly or indirectly, of over fifty percent of the outstanding voting shares of a subsidiary. However,retrospective application of the majority voting interest requirement of ARB 51accounting principle in the financial statements presented in addition to certain types of entities may not identifyobtaining an opinion from the party with a controlling financial interest becauseauditors that the controlling financial interest may be achieved through arrangements that do not involve voting interest. FIN 46R clarifies applicability of ARB 51 to entities in which the equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. FIN 46R requires an entity to consolidate a variable interest entity (VIE) even though the entity does not, either directly or indirectly, own over fifty percent of the outstanding voting shares.

new principle is

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FIN 46R

preferred. In addition, adoption of a change in accounting principle required by the issuance of a new accounting standard would also require retroactive restatement, unless the new standard includes explicit transition guidelines. SFAS 154 was applicableeffective for financial statements issued for reporting periods endedfiscal years beginning after MarchDecember 15, 2004. In accordance with FIN 46R, during the fourth quarter of 2004,2005 and was adopted by the Company has consolidated two limited partnerships. Previously, the limited partnerships were accounted for under the equity method. Therefore, this changeas of January 1, 2006. Adoption of SFAS 154 did not have anyan impact on the results of operations or equity of the Company.

In DecemberNovember of 2003,2005, the FASB revised SFAS No.132,Employers’ Disclosures about Pensions and Other Postretirement Benefits(SFAS 132) to require additional disclosures related to pensions and post retirement benefits. While retaining the existing disclosure requirements for pensions and postretirement benefits, additional disclosures were required related to pension plan assets, obligations, contributions and net benefit costs, beginning with fiscal years ending after December 15, 2003. Additional disclosures pertaining to benefit payments were required for fiscal years ending after June 30, 2004. The SFAS 132 revisions also include additional disclosure requirements for interim financial reports beginning after December 15, 2003. CNA has implemented the revised disclosures in its 2004 fiscal year and interim financial statements.

In May of 2004, the FASB revisedissued FASB Staff Position (FSP) 106-1,AccountingNo. 115-1 and Disclosure Requirements RelatedFAS 124-1,The Meaning of Other-Than-Temporary Impairment and its Application to the Medicare Prescription Drug, Improvement and Modernization Act of 2003 and issued FSP 106-2,Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003Certain Investments (FSP 106-2)115-1), as applicable to debt and equity securities that are within the scope of SFAS No. 115,Accounting for Certain Investments in Debt and Equity Securities (SFAS 115) and equity securities that are accounted for using the cost method specified in Accounting Principles Board Opinion No. 18,The Equity Method of Accounting for Investments in Common Stock. The FSP provides accounting guidance to employers who sponsor postretirement health care plans that provide prescription drug benefits and the prescription drug benefit provided by the employer is “actuarially equivalent” to Medicare Part D and qualifies for the subsidy under the Medicare amendment act. This FSP was effective for the Company as115-1 nullified certain requirements of July 1, 2004, and its adoption did not have a material impact on the Company’s results of operations or equity.

In March of 2004, theThe Emerging Issues Task Force (EITF) reached consensus on the disclosure guidance provided in EITF Issue No. 03-1,The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (EITF 03-1). Under, which provided guidance on determining whether an impairment is other-than-temporary. FSP 115-1 replaced guidance set forth in EITF 03-1 with references to existing other-than-temporary impairment guidance and clarified that an investmentinvestor should recognize an impairment loss no later than when the impairment is impaireddeemed other-than-temporary, even if a decision to sell has not been made. FSP 115-1 carried forward the fair valuerequirements in EITF 03-1 regarding required disclosures in the financial statements and requires additional disclosure related to factors considered in reaching the conclusion that the impairment is not other-than-temporary. In addition, in periods subsequent to the recognition of an other-than-temporary impairment loss for debt securities, the discount or reduced premium would be amortized over the remaining life of the investment is less than its cost including adjustments for amortization, accretion, foreign exchange, and hedging. An impairment would be considered other-than-temporary unless a) the investor has the ability and intent to hold an investment for a reasonable period of time sufficient for the recovery of the fair value up to (or beyond) the cost of the investment and b) evidence indicating that the cost of the investment is recoverable within a reasonable period of time outweighs evidence to the contrary. This new guidance for determining whether the decline in the fair value of the investment is other-than-temporarysecurity based on future estimated cash flows. FSP 115-1 was to be effective for reporting periods beginning after JuneDecember 15, 2004. 2005 and was adopted by the Company as of January 1, 2006. Adoption of this standard increased income by approximately $3 million for the year ended December 31, 2006 related to the amortization of discount or reduced premium resulting from previously impaired securities. The Company has included the required additional disclosures in Note B.

In SeptemberDecember of 2004, the FASB issued FSP EITF Issue 03-1-1,SFAS No. 123 (revised 2004),Share-Based Payment (SFAS 123R), that amends SFAS 123, as originally issued in May of 1995. SFAS 123R addresses the accounting for share-based payment transactions in which suspendedan enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. SFAS 123R supercedes Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees (APB 25). After the effective date of this standard, entities are not permitted to use the intrinsic value method specified in APB 25 to measure compensation expense and generally are required to measure compensation expense using a fair-value based method. The Company applied the modified prospective transition method. The modified prospective method requires a company to (a) record compensation expense for all awards it grants, modifies, repurchases or cancels after the date it adopts the standard and (b) record compensation expense for the unvested portion of previously granted awards that remain outstanding at the date of adoption. SFAS 123R was effective for the Company as of January 1, 2006. The Company applied the alternative transition method in calculating its pool of excess tax benefits available to absorb future tax deficiencies as provided by FSP FAS 123(R)-3,Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards. Adoption of SFAS 123R decreased net income by $2 million for the year ended December 31, 2006. Prior to 2006, the Company applied the intrinsic value method under APB 25, and related interpretations, in accounting for its stock-based compensation plan. Under the recognition and measurement and recognition guidance included in EITF Issue 03-1 related to other-than-temporary impairment pending additional implementation guidance. Pending adoptionprinciples of APB 25, no stock-based compensation cost was recognized, as the exercise price of the final rule,granted options equaled the Company continues to apply existing accounting literature for determining when a decline in fair value is other-than-temporary.

market price of the underlying stock at the grant date.

In December of 2004,September 2006, the FASB issued SFAS 153,No. 158,Exchanges of Non-Monetary Assets anEmployers’ Accounting for Defined Benefit Pension and Other Postretirement Plans (an amendment of APB OpinionFASB Statements No. 2987, 88, 106 and 132(R)) (SFAS 158). SFAS 153 amends158 requires a company who sponsors one or more single-employer defined benefit plans to recognize the definitionoverfunded or underfunded status of “exchange”a defined benefit postretirement plan as an asset or “exchange transaction”liability in its statement of financial position and expandsto recognize changes in that funded status in the listyear in which the changes occur through comprehensive income. SFAS 158 requires a company to measure benefit plan assets and obligations as of transactionsthe date of the company’s fiscal year-end statement of financial position. SFAS 158 also requires a company to disclose in the notes to financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that wouldarise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation. The requirement to recognize the funded status of a benefit plan and the disclosure requirements were adopted by the Company as of December 31, 2006. The requirement to measure plan assets and benefit

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obligations as of the date of the fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. Adoption of SFAS 158 decreased equity by $46 million at December 31, 2006. The Company has included the required additional disclosures in Note J.
In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 108,Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108). SAB 108 requires registrants to use a dual approach to include both a balance sheet approach and an income statement approach when quantifying and evaluating the materiality of a misstatement in a company’s financial statements and the related financial statement disclosures. If either approach results in quantifying a misstatement that is material, then a registrant shall adjust the financial statements. SAB 108 provides transition guidance for correcting errors existing in prior years. SAB 108 does not meetchange the definitionrequirements for the correction of non-monetary transfer.an error discovered in prior year financial statements. Errors discovered in prior year financial statements shall continue to be accounted for in accordance with SFAS 153 isNo. 154,Accounting Changes and Error Correction. SAB 108 was adopted by the Company as of December 31, 2006. Adoption of SAB 108 did not expected to have a significantan impact on the results of operations or equityfinancial condition of the Company.

In October of 2004,March 2006, the FASB issued FSP 109-2,No. 85-4-1,Accounting for Life Settlement Contracts by Third-Party Investors (FSP 85-4-1). A life settlement contract for purposes of FSP 85-4-1 is a contract between the owner of a life insurance policy (the policy owner) and Disclosure Guidancea third-party investor (investor). The previous accounting guidance, FASB Technical Bulletin No. 85-4,Accounting for Purchases of Life Insurance (FTB 85-4), required the purchaser of life insurance contracts to account for the Foreign Exchange Repatriation Provision withinlife insurance contract at its cash surrender value. Because life insurance contracts are purchased in the American Jobs Creation Actsecondary market at amounts in excess of 2004 (AJCA). AJCA introducesthe policies’ cash surrender values, the application of guidance in FTB 85-4 created a special one-time dividends received deductionloss upon acquisition of 85%the policy. FSP 85-4-1 provides initial and subsequent measurement guidance and financial statement presentation and disclosure guidance for investments by third-party investors in life settlement contracts. FSP 85-4-1 allows an investor to elect to account for its investments in life settlement contracts using either the repatriation of certain foreign earnings. A number of companies are requesting that Congressinvestment method or the Treasury Department provide additional clarifying languagefair value method. The election shall be made on key elementsan instrument-by-instrument basis and is irrevocable. FSP 85-4-1 is effective for fiscal years beginning after June 15, 2006. The Company has elected to account for its investment in life settlement contracts using the fair value method and the initial expected impact upon adoption under the fair value method will be an increase to retained earnings as of the repatriation provision. Should Loews, upon considerationJanuary 1, 2007 of any such potential clarifying language, ultimately elect to apply the repatriation provisionapproximately $38 million.
In July 2006, FASB issued FIN No. 48,Accounting for Uncertainty in Income Taxes an interpretation of the AJCA, the CNA Tax Group does not expectFASB Statement No. 109 (FIN 48). FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. FIN 48 states that a tax benefit from an uncertain position may be recognized only if it is “more likely than not” that the position is sustainable, based on its technical merits. The tax benefit of a qualifying position is the largest amount of tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with a taxing authority having full knowledge of all relevant information. FIN 48 is effective for fiscal years beginning after December 15, 2006. The impact on retained earnings as of such an election wouldJanuary 1, 2007 from the adoption of FIN 48 is expected to be material to its results of operations or equity.

approximately $5 million.

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Note B. Investments

The significant components of net investment income are presented in the following table.

Net Investment Income
                        
Years ended December 31
(In millions)
 2004
 2003
 2002
Years ended December 31 2006 2005 2004 
(In millions) 
Fixed maturity securities $1,571 $1,651 $1,854  $1,842 $1,608 $1,571 
Short term investments 56 63 62  248 147 56 
Limited partnerships 212 221  (34) 288 254 212 
Equity securities 14 19 66  23 25 14 
Income from trading portfolio (a) 110    103 47 110 
Interest on funds withheld and other deposits  (267)  (344)  (239)  (68)  (166)  (261)
Other 18 85 81  18 20 18 
 
 
 
 
 
 
        
 
Gross investment income 1,714 1,695 1,790  2,454 1,935 1,720 
Investment expenses  (40)  (48)  (60)  (42)  (43)  (40)
 
 
 
 
 
 
        
 
Net investment income
 $1,674 $1,647 $1,730  $2,412 $1,892 $1,680 
 
 
 
 
 
 
        

(a)
(a)There was no change in net unrealized gains (losses) on trading securities included in net investment income for the year ended December 31, 2006. The change in net unrealized gains (losses) on trading securities included in net investment income was $(7) million and $2 million for the yearyears ended December 31, 2005 and 2004.

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Net realized investment gains (losses) and net change in unrealized appreciation (depreciation) in investments were as follows:

Net Investment Appreciation
                        
Years ended December 31
(In millions)
 2004
 2003
 2002
Years ended December 31 2006 2005 2004 
(In millions) 
Net realized investment gains (losses):  
Fixed maturity securities:  
Gross realized gains $704 $1,244 $1,009  $382 $361 $704 
Gross realized losses  (457)  (807)  (1,118)  (377)  (451)  (457)
 
 
 
 
 
 
        
 
Net realized gains (losses) on fixed maturity securities 247 437  (109) 5  (90) 247 
       
 
 
 
 
 
 
  
Equity securities:  
Gross realized gains 225 143 251  24 73 225 
Gross realized losses  (23)  (29)  (409)  (8)  (35)  (23)
 
 
 
 
 
 
        
Net realized gains (losses) on equity securities 202 114  (158)
 
 
 
 
 
 
  
Other, including disposition of businesses, net of participating policyholders’ interest  (688)  (87) 13 
Net realized gains on equity securities 16 38 202 
       
 
Other, including disposition of businesses net of participating policyholders’ interest 66 39  (688)
       
 
 
 
 
 
 
  
Net realized investment gains (losses) before allocation to participating policyholders’ and minority interests  (239) 464  (254) 87  (13)  (239)
Allocation to participating policyholders’ and minority interests  (9)  (4) 2   (1) 3  (9)
 
 
 
 
 
 
        
 
Net realized investment gains (losses)  (248) 460  (252) 86  (10)  (248)
       
 
 
 
 
 
 
  
Net change in unrealized appreciation (depreciation) in general account investments:  
Fixed maturity securities  (53) 372 548  98  (443)  (53)
Equity securities  (98) 87  (23) 78 34  (98)
Other  2 17  2  (1)  
 
 
 
 
 
 
        
 
Total net change in unrealized appreciation (depreciation) in general account investments  (151) 461 542  178  (410)  (151)
Net change in unrealized appreciation (depreciation) on separate accounts and other  (70) 6 53 
Net change in unrealized depreciation on other  (10)  (12)  (70)
Allocation to participating policyholders’ and minority interests 19  (7)  (19) 4 18 19 
Deferred income tax (expense) benefit 55  (159)  (182)  (58) 158 55 
 
 
 
 
 
 
        
 
Net change in unrealized appreciation (depreciation) in investments  (147) 301 394  114  (246)  (147)
       
 
 
 
 
 
 
  
Net realized gains (losses) and change in unrealized appreciation (depreciation) in investments
 $(395) $761 $142  $200 $(256) $(395)
 
 
 
 
 
 
        

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Investment securities are exposed to various risks, such as interest rate, market and credit. Due to the level of risk associated with certain investment securities and the level of uncertainty related to changes in the value of investment securities, it is possible that changes in these risk factors in the near term could have an adverse material impact on the Company’s results of operations or equity.

A primary objective in the management of the fixed maturity and equity portfolios is to maximize total return relative to underlying liabilities and respective liquidity needs. The Company’s views on the current interest rate environment, tax regulations, asset class valuations, specific security issuer and broader industry segment conditions, and the domestic and global economic conditions, are some of the factors that may enter into a decision to move between asset classes. Based on the Company’s consideration of these factors, in the course of normal investment activity the Company may, in pursuit of the total return objective, be willing to sell securities that, in its analysis, are overvalued on a risk adjusted basis relative to other opportunities that are available at the time in the market; in turn the Company may purchase other securities that, according to its analysis, are undervalued in relation to other securities in the market. In making these value decisions securities may be bought and sold that shift the investment portfolio between asset classes. The Company also continually monitors exposure to issuers of securities held and broader industry sector exposures and may from time to time reduce such exposures based on its views of a specific issuer or industry sector. These activities could produce realized gains or losses.

The Company’s investment policies emphasize high credit quality and diversification by industry, issuer and issue. Assets supporting interest rate sensitive liabilities are segmented within the general account to facilitate asset/liability duration management.
Realized investment losses included $173 million, $107 million and $93 million of other-than-temporary impairment (OTTI) losses for the years ended December 31, 2006, 2005 and 2004. The 2006, 2005 and 2004 OTTI losses were recorded across various sectors. The increase in OTTI losses for 2006 was primarily driven by an increase in interest rate related OTTI losses on securities for which the Company did not assert an intent to hold until an anticipated recovery in value. The 2005 and 2004 OTTI losses included $34 million and $56 million related to loans made under a credit facility to a national contractor, that are classified as fixed maturity securities. See Note S for additional information on loans to the national contractor.

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The following tables provide a summary of fixed maturity and equity securities investments.
Summary of Fixed Maturity and Equity Securities
                     
  Cost or  Gross  Gross Unrealized Losses  Estimated 
  Amortized  Unrealized  Less than  Greater than  Fair 
December 31, 2006 Cost  Gains  12 Months  12 Months  Value 
(In millions)                    
Fixed maturity securities available-for-sale:                    
U.S. Treasury securities and obligations of government agencies $5,056  $86  $3  $1  $5,138 
Asset-backed securities  13,821   28   20   152   13,677 
States, municipalities and political subdivisions – tax-exempt  4,915   237   1   5   5,146 
Corporate securities  6,811   338   8   9   7,132 
Other debt securities  3,443   207   7   1   3,642 
Redeemable preferred stock  885   28   1      912 
                
                     
Total fixed maturity securities available-for-sale  34,931   924   40   168   35,647 
                
                     
Total fixed maturity securities trading  204            204 
                
                     
Equity securities available-for-sale:                    
Common stock  214   239   1      452 
Preferred stock  134   11         145 
                
                     
Total equity securities available-for-sale  348   250   1      597 
                
                     
Total equity securities trading  60            60 
                
                     
Total
 $35,543  $1,174  $41  $168  $36,508 
                

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Summary of Fixed Maturity and Equity Securities
                     
  Cost or  Gross  Gross Unrealized Losses  Estimated 
  Amortized  Unrealized  Less than  Greater than  Fair 
December 31, 2005 Cost  Gains  12 Months  12 Months  Value 
(In millions)                    
Fixed maturity securities available-for-sale:                    
U.S. Treasury securities and obligations of government agencies $1,355  $119  $4  $1  $1,469 
Asset-backed securities  12,986   43   137   33   12,859 
States, municipalities and political subdivisions – tax-exempt  9,054   193   31   7   9,209 
Corporate securities  5,906   322   52   11   6,165 
Other debt securities  2,830   234   18   2   3,044 
Redeemable preferred stock  213   4      1   216 
Options embedded in convertible debt securities  1            1 
                
                     
Total fixed maturity securities available-for-sale  32,345   915   242   55   32,963 
                
                     
Total fixed maturity securities trading  271            271 
                
                     
Equity securities available-for-sale:                    
Common stock  140   150   1      289 
Preferred stock  322   22   1      343 
                
                     
Total equity securities available-for-sale  462   172   2      632 
                
                     
Total equity securities trading  49            49 
                
                     
Total
 $33,127  $1,087  $244  $55  $33,915 
                

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The following table summarizes fixed maturity and equity securities in an unrealized loss position at December 31, 2006 and 2005, the aggregate fair value and gross unrealized loss by length of time those securities have been continuously in an unrealized loss position.
Unrealized Loss Aging
                 
  December 31, 2006  December 31, 2005 
      Gross      Gross 
  Estimated  Unrealized  Estimated  Unrealized 
  Fair Value  Loss  Fair Value  Loss 
(In millions)                
Fixed maturity securities:                
Investment grade:                
0-6 months $9,829  $24  $9,976  $142 
7-12 months  1,267   12   2,739   61 
13-24 months  5,248   127   1,400   45 
Greater than 24 months  1,022   41   219   7 
             
                 
Total investment grade  17,366   204   14,334   255 
             
                 
Non-investment grade:                
0-6 months  509   2   632   29 
7-12 months  87   2   118   10 
13-24 months  24      122   3 
Greater than 24 months  2      2    
             
                 
Total non-investment grade  622   4   874   42 
             
                 
Total fixed maturity securities  17,988   208   15,208   297 
             
                 
Equity securities:                
0-6 months  10   1   49   2 
7-12 months  1      1    
13-24 months            
Greater than 24 months  3      3    
             
                 
Total equity securities  14   1   53   2 
             
                 
Total fixed maturity and equity securities
 $18,002  $209  $15,261  $299 
             
An investment is impaired if the fair value of the investment is less than its cost adjusted for accretion, amortization, previous OTTI and hedging, otherwise defined as an unrealized loss. When an investment is impaired, the impairment is evaluated to determine whether it is temporary or other-than-temporary.
A significant judgment in the valuation of investments is the determination of when an other-than-temporary decline in valueOTTI has occurred. The Company follows a consistent and systematic process for impairing securities that sustain other-than-temporary declines in value.determining and recording an OTTI. The Company has established a committee responsible for the impairmentOTTI 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 impairmentOTTI indicators including, but not limited to, a significant adverse change in the financial condition and near term prospects of the investmentissuer or a significant adverse change in legal factors, the business climate or credit ratings.

When a security is placed on the watch list, it is monitored for further market value changes and additional newsinformation related to the issuer’s financial condition. The focus is on objective evidence that may influence the evaluation of impairmentOTTI factors.

The decision to impair a securityrecord an OTTI incorporates both quantitative criteria and qualitative information. The Impairment Committee considers a number of factors including, but not limited to: (a) the length of time and the extent to which the fair value has been less than book value, (b) the financial condition and near term prospects of the issuer, (c) the intent and ability of the Company to retain its investment for a period of time sufficient to allow for anyan anticipated

84


recovery in value, (d) whether the debtor is current on interest and principal payments and (e) general market conditions and industry or sector specific factors.

The Impairment Committee’s decision to impair a securityrecord an OTTI loss is primarily based on whether the security’s fair value is likely to remain significantly belowrecover to its book value in light of all of the factors considered. For securities that are impaired,considered to be OTTI, the security is adjusted to fair value and the resulting losses are recognized in realized gains/losses inRealized investment gains (losses) on the Consolidated Statements of Operations.

Realized

At December 31, 2006, the carrying value of the general account fixed maturities was $35,851 million, representing 81% of the total investment portfolio. The net unrealized position associated with the fixed maturity portfolio included $208 million in gross unrealized losses, consisting of asset-backed securities which represented 83%, corporate bonds which represented 8%, municipal securities which represented 3%, and all other fixed maturity securities which represented 6%. The gross unrealized loss for any single issuer was no greater than 0.1% of the carrying value of the total general account fixed maturity portfolio. The total fixed maturity portfolio gross unrealized losses included $931,491 securities which were, in aggregate, approximately 1% below amortized cost.
The gross unrealized losses on equity securities are $1 million, $321 millionincluding 105 securities which, in aggregate, were below cost by approximately 3%.
Given the current facts and $890 million of pretax impairment losses forcircumstances, the three years endedImpairment Committee has determined that the securities presented in the above unrealized gain/loss tables were temporarily impaired when evaluated at December 31, 2004, 20032006 or December 31, 2005, and 2002. The 2003 and 2002 impairmentstherefore no related realized losses were primarily the resultrecorded. A discussion of some of the continued credit deterioration on specific issuersfactors reviewed 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, 2004, the impairment losses recorded related largely to a $56 million pretax impairmentmaking that determination is presented below by major security type. The unrealized loss related to loans made underany single issuer is not considered to be significant.
Asset-Backed Securities
The unrealized losses on the Company’s investments in asset-backed securities were caused primarily by a credit facility to a national contractor, that are classifiedchange in interest rates. This category includes mortgage-backed securities guaranteed by an agency of the U.S. government. There were 476 agency mortgage-backed pass-through securities and 3 agency collateralized mortgage obligations (CMOs) in an unrealized loss position as fixed maturity securities.

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Other realized investment gains (losses) for the years endedof December 31, 2004, 20032006. The aggregate severity of the unrealized loss on these securities was approximately 3% of amortized cost. These securities do not tend to be influenced by the credit of the issuer but rather the characteristics and 2002projected principal payments of the underlying collateral.

The remainder of the holdings in this category are corporate mortgage-backed pass-through, CMOs and corporate asset-backed structured securities. The holdings in these sectors include gains and losses related to sales of certain operations or affiliates. See Note P for further details.

The following table provides a summary of fixed maturity and equity securities investments.

Summary of Fixed Maturity and Equity Securities

                     
  Cost or Gross Gross Unrealized Losses
 Estimated
 Amortized Unrealized Less than Greater than Fair
December 31, 2004
(In millions)
 Cost
 Gains
 12 Months
 12 Months
 Value
Fixed maturity securities available-for-sale:                    
U.S. Treasury securities and obligations of government agencies $4,233  $126  $13  $  $4,346 
Asset-backed securities  7,706   105   19   4   7,788 
States, municipalities and political subdivisions – tax-exempt  8,699   189   28   3   8,857 
Corporate securities  6,093   477   52   5   6,513 
Other debt securities  2,769   295   11      3,053 
Redeemable preferred stock  142   6      2   146 
Options embedded in convertible debt securities  234            234 
   
 
   
 
   
 
   
 
   
 
 
Total fixed maturity securities available-for-sale  29,876   1,198   123   14   30,937 
   
 
   
 
   
 
   
 
   
 
 
Total fixed maturity securities trading  390            390 
   
 
   
 
   
 
   
 
   
 
 
Equity securities available-for-sale:                    
Common stock  148   112         260 
Non-redeemable preferred stock  126   24         150 
   
 
   
 
   
 
   
 
   
 
 
Total equity securities available-for-sale  274   136         410 
   
 
   
 
   
 
   
 
   
 
 
Total equity securities trading  46            46 
   
 
   
 
   
 
   
 
   
 
 
Total
 $30,586  $1,334  $123  $14  $31,783 
   
 
   
 
   
 
   
 
   
 
 

114


                     
  Cost or Gross Gross Unrealized Losses
 Estimated
 Amortized Unrealized Less than Greater than Fair
December 31, 2003
(In millions)
 Cost
 Gains
 12 Months
 12 Months
 Value
Fixed maturity securities:                    
U.S. Treasury securities and obligations of government agencies $1,823  $91  $10  $4  $1,900 
Asset-backed securities  8,634   146   22   1   8,757 
States, municipalities and political subdivisions – tax-exempt  7,787   207   22   2   7,970 
Corporate securities  6,061   475   40   14   6,482 
Other debt securities  2,961   311   4   4   3,264 
Redeemable preferred stock  97   7         104 
Options embedded in convertible debt securities  201            201 
   
 
   
 
   
 
   
 
   
 
 
Total fixed maturity securities  27,564   1,237   98   25   28,678 
   
 
   
 
   
 
   
 
   
 
 
Equity securities:                    
Common stock  163   222   2      383 
Non-redeemable preferred stock  130   16   2      144 
   
 
   
 
   
 
   
 
   
 
 
Total equity securities  293   238   4      527 
   
 
   
 
   
 
   
 
   
 
 
Total
 $27,857  $1,475  $102  $25  $29,205 
   
 
   
 
   
 
   
 
   
 
 

The following tables summarize fixed maturity and equity493 securities in an unrealized loss position with over 92% of these unrealized losses related to securities rated AAA. The aggregate severity of the unrealized loss was approximately 2% of amortized cost. The contractual cash flows on the asset-backed structured securities are pass-through but may be structured into classes of preference. The structured securities held are generally secured by over collateralization or default protection provided by subordinated tranches. Within this category, securities subject to EITF Issue No. 99-20,Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets (EITF 99-20), are monitored for adverse changes in cash flow projections. If there are adverse changes in cash flows the amount of accretable yield is prospectively adjusted and an OTTI loss is recognized. As of December 31, 2006, there was no adverse change in estimated cash flows noted for the EITF 99-20 securities, which have an aggregate unrealized loss of $9 million and an aggregate severity of the unrealized loss of approximately 1% of amortized cost.

Because the decline in fair value was primarily attributable to changes in interest rates and not credit quality and because the Company has the ability and intent to hold those investments until an anticipated recovery of fair value, which may be maturity, the Company considers these investments to be temporarily impaired at December 31, 20042006.
Corporate Securities
The Company’s portfolio management objective for corporate bonds focuses on sector and 2003,issuer exposures and value analysis within sectors. In order to maximize investment objectives, corporate bonds are analyzed on a risk adjusted basis compared to other opportunities that are available in the aggregate fair valuemarket. Trading decisions may be made based on an issuer that may be overvalued in the Company’s portfolio compared to a like issuer that may be undervalued in the market. The Company also monitors issuer exposure and gross unrealized loss by lengthbroader industry sector exposures and may reduce exposures based on its current view of time those securities have been continuously in an unrealized loss position.

a specific issuer or sector.

Unrealized Loss Aging

                 
  December 31, 2004
 December 31, 2003
      Gross     Gross
  Estimated Unrealized Estimated Unrealized
(In millions) Fair Value
 Loss
 Fair Value
 Loss
Fixed maturity securities:                
Investment grade:                
0-6 months $7,742  $53  $4,138  $50 
7-12 months  2,448   59   834   36 
13-24 months  368   12   76   11 
Greater than 24 months  2      51   3 
   
 
   
 
   
 
   
 
 
Total investment grade  10,560   124   5,099   100 
   
 
   
 
   
 
   
 
 
Non-investment grade:                
0-6 months  188   7   134   5 
7-12 months  69   4   60   7 
13-24 months  20   2   16   1 
Greater than 24 months        105   10 
   
 
   
 
   
 
   
 
 
Total non-investment grade  277   13   315   23 
   
 
   
 
   
 
   
 
 
Total fixed maturity securities  10,837   137   5,414   123 
   
 
   
 
   
 
   
 
 
Equity securities:                
0-6 months  4      23   2 
7-12 months  1      10   2 
13-24 months  1      3    
Greater than 24 months  3      6    
   
 
   
 
   
 
   
 
 
Total equity securities  9      42   4 
   
 
   
 
   
 
   
 
 
Total fixed maturity and equity securities
 $10,846  $137  $5,456  $127 
   
 
   
 
   
 
   
 
 

11585


Of the unrealized losses in this category, approximately 81% relate to securities rated as investment grade (rated BBB or higher). The total holdings in this category are diversified across 10 industry sectors and 220 securities. The aggregate severity of the unrealized loss was approximately 1% of amortized cost. Within corporate bonds, the largest industry sectors were financial and consumer cyclical, which as a percentage of total gross unrealized losses were approximately 64% and 12% at December 31, 2006. The decline in fair value is primarily attributable to changes in interest rates and macro conditions in certain sectors that the market views as temporarily out of favor. Because the decline is not related to specific credit quality issues, and because the Company has the ability and intent to hold those investments until an anticipated recovery of fair value, which may be maturity, the Company considers these investments to be temporarily impaired at December 31, 2006.
The following tables summarize available-for-sale fixed maturity securities by contractcontractual maturity at December 31, 20042006 and 2003.2005. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid with or without call or prepayment penalties.

Securities not due at a single date are allocated based on weighted average life.

Contractual Maturity
                
                 December 31, 2006 December 31, 2005 
 December 31, 2004
 December 31, 2003
 Cost or Estimated Cost or Estimated 
 Cost or Estimated Cost or Estimated Amortized Fair Amortized Fair 
 Amortized Fair Amortized Fair Cost Value Cost Value 
(In millions) Cost
 Value
 Cost
 Value
 
Due in one year or less $1,048 $1,054 $275 $275  $1,599 $1,602 $953 $955 
Due after one year through five years 4,433 4,480 2,544 2,605  13,024 13,039 11,375 11,320 
Due after five years through ten years 9,238 9,577 3,596 3,886  9,555 9,619 6,176 6,280 
Due after ten years 7,451 8,038 12,515 13,155  10,753 11,387 13,841 14,408 
Asset-backed securities 7,706 7,788 8,634 8,757 
         
 
 
 
 
 
 
 
 
  
Total
 $29,876 $30,937 $27,564 $28,678  $34,931 $35,647 $32,345 $32,963 
 
 
 
 
 
 
 
 
          

The carrying value of fixed maturity investments that did not produce income during 2004 and 20032006 was $3 million and $41$10 million. The carrying value of fixed maturity investments that did not produce income during 2005 was less than $1 million. At December 31, 20042006 and 2003,2005, no investments, other than investments in U.S. government treasury and U.S. government agency securities, respectively, exceeded 10% of stockholders’ equity.

Investment Commitments
As of December 31, 20042006 and 2003,2005, the Company had committed approximately $104$109 million and $154$191 million to future capital calls from various third-party limited partnership investments in exchange for an ownership interest in the related partnerships.

In the normal course of investing activities, CCC had committed approximately $51 million as of December 31, 2004 and 2003 to future capital calls from certain of its unconsolidated affiliates in exchange for an ownership interest in such affiliates.

Restricted Investments

The Company may from time to time invest in securities that may be restricted in whole or in part. As of December 31, 2004 and 2003, the Company did not hold any significant positions in investments whose sale was restricted.

Cash and securities with carrying values of approximately $2.6 billion and $2.0 billion were deposited by the Company’s insurance subsidiaries under requirements of regulatory authorities as of December 31, 2004 and 2003.

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 Sheets, is $1,549 million and $1,117 million at December 31, 2004 and 2003.

The Company invests in multiple bank loan participations as part of its overall investment strategy and has committed to additional future purchases and sales. The purchase and sale of these investments are recorded on the date that the legal agreements are finalized and cash settlement is made. As of December 31, 2004,2006 and December 31, 2005, the Company had commitments to purchase $41$60 million and commitments to$82 million and sell $2$21 million and $12 million of various bank loan participations.

When loan participation purchases are settled and recorded they may contain both funded and unfunded amounts. An unfunded loan represents an obligation by the Company to provide additional amounts under the terms of the loan participation. The funded portions are reflected on the Consolidated Balance Sheets, while any unfunded amounts are not recorded until a draw is made under the loan facility. As of December 31, 2006 and December 31, 2005, the Company had obligations on unfunded bank loan participations in the amount of $29 million and $21 million.

Investments on Deposit
The Company may from time to time invest in securities that may be restricted in whole or in part. As of December 31, 2006 and 2005, the Company did not hold any significant positions in investments whose sale was restricted.
Cash and securities with carrying values of approximately $18$2.5 billion and $2.4 billion were deposited by the Company’s insurance subsidiaries under requirements of regulatory authorities as of December 31, 2006 and 2005.

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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 Sheets, is $1,852 million and $23$1,509 million as of December 31, 2006 and 2005.
Cash and securities with carrying values of approximately $11 million and $13 million were deposited with financial institutions as collateral for letters of credit as of December 31, 20042006 and 2003.2005. In addition, cash and securities were deposited in trusts with financial institutions to secure reinsurance obligations with various third parties. The carrying values of these deposits were approximately $329$327 million and $254$356 million as of December 31, 20042006 and 2003.

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2005.


During July of 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 VFL separate accounts. Related securities with carrying values of approximately $492 million were held by the Company and reported in separate account assets in the Consolidated Balance Sheet at December 31, 2003. VFL was sold in 2004. See Note P for further details.

Note C. Derivative Financial Instruments

A summary of the aggregate contractual or notional amounts, estimated fair values and recognized gains (losses) related to derivative financial instruments follows.

The contractual or notional amounts for derivatives are used to calculate the exchange of contractual payments under the agreements and are not representative of the potential for gain or loss on these instruments.

Derivative Financial Instruments
                                
 Contractual/ Estimated Estimated Recognized Contractual/ Estimated Estimated Net 
 Notional Fair Value Fair Value Gains Notional Fair Value Fair Value Recognized 
As of and for the year ended December 31, 2004
(In millions)
 Amount
 Asset
 (Liability)
 (Losses)
As of and for the year ended December 31, 2006 Amount Asset (Liability) Gains 
(In millions) 
General account
  
Without hedge designation
 
Swaps $489 $ $(8) $23  $4,795 $ $(30) $14 
Futures sold, not yet purchased    4 
Currency forwards 8    
Equity warrants 6 2   
Options embedded in convertible debt securities 9    
 
Trading activities
 
Futures purchased 1,230   (1) 96  722   (3) 65 
Futures sold, not yet purchased 124    (113) 79    
Forwards purchased 139 1  5 
Forwards sold, not yet purchased 9   5 
Commitments to purchase government and municipal securities 25    (12)
Equity warrants 11 1   
Options purchased 103 1   (1)
Options written 102   4 
Collateralized debt obligation liabilities    5 
Options embedded in convertible debt securities 701 234  24 
Currency forwards 25    
 
 
 
 
 
 
 
 
          
Total
 $2,933 $237 $(9) $36 
Total general account
 $5,644 $2 $(33) $83 
         
 
 
 
 
 
 
 
 
  
Separate accounts
  
Options written $9 $ $ $1  $1 $ $ $ 
 
 
 
 
 
 
 
 
          
Total
 $9 $ $ $1 
Total separate accounts
 $1 $ $ $ 
 
 
 
 
 
 
 
 
          

11787


                 
  Contractual/ Estimated Estimated Recognized
 Notional Fair Value Fair Value Gains
As of and for the year ended December 31, 2003
(In millions)
 Amount
 Asset
 (Liability)
 (Losses)
General account
                
Swaps $856  $  $(5) $87 
Interest rate caps  225          
Futures sold, not yet purchased  18         (9)
Forwards  16      (1)  2 
Commitments to purchase government and municipal securities  3,318   12      (1)
Equity warrants  11          
Options purchased  4          
Options written  515      (2)   
Collateralized debt obligation liabilities  110      (14)  (1)
Synthetic guaranteed investment contracts  280          
Options embedded in convertible debt securities  681   201      36 
   
 
   
 
   
 
   
 
 
Total
 $6,034  $213  $(22) $114 
   
 
   
 
   
 
   
 
 
Separate accounts
                
Futures purchased $1,106  $3  $  $208 
Futures sold, not yet purchased  12          
Options purchased           (1)
Options written  12         2 
   
 
   
 
   
 
   
 
 
Total
 $1,130  $3  $  $209 
   
 
   
 
   
 
   
 
 
Derivative Financial Instruments

                 
              Net 
  Contractual/  Estimated  Estimated  Recognized 
  Notional  Fair Value  Fair Value  Gains 
As of and for the year ended December 31, 2005 Amount  Asset  (Liability)  (Losses) 
(In millions)                
General account
                
With hedge designation
                
Swaps $265  $  $(1) $(1)
Without hedge designation
                
Swaps  756      (8)  46 
Futures sold, not yet purchased           2 
Currency forwards  15         2 
Equity warrants  6   2       
Options embedded in convertible debt securities  12   1      (33)
                 
Trading activities
                
Futures purchased  1,058      (4)  18 
Futures sold, not yet purchased  166         2 
Currency forwards  59      (1)  (1)
Commitments to purchase mortgage-backed securities  21          
Options purchased  20         (2)
Options written  21         2 
             
                 
Total general account
 $2,399  $3  $(14) $35 
             
                 
Separate accounts
                
Options written $7  $  $  $ 
             
Total separate accounts
 $7  $  $  $ 
             
Options embedded in convertible debt securities are classified as Fixed maturity securities on the Consolidated Balance Sheets, consistent with the host instruments.
Fair Value Hedges

The Company’s hedging activities that are designated as a fair value hedge for accounting purposes primarily involve hedging interest rate and foreign currency risks on various assets and liabilities. The Company periodically enters into interest rate swaps to modify the interest rate exposures of designated invested assets. Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a fair-value hedge, along with the changes in the fair value of the hedged asset that are attributable to the hedged risk, are recorded as Realized gains (losses) in the Consolidated Statements of Operations. For the year ended December 31, 2005, the Company recognized a net gain of $0.3 million, which represents the ineffective portion of all fair-value hedges. All components of each derivative’s gain or loss were included in the assessment of hedge effectiveness. There was no gain or loss on the ineffective portion of the fair value hedges for the years ended December 31, 20042006 and 2003,2004, because the Company did not designate any derivatives as fair value hedges in those years. The ineffective portion of the fair value hedges resulted in a realized loss of approximately $4 million for the year ended December 31, 2002.

Cash Flow Hedges

The Company entered into one transaction that was designated as a cash flow hedge for accounting purposes, hedging interest rate risk on the forecasted payment of interest resulting from the issuance of fixed rate debt obligations during 2004. Ineffectiveness resulting from this hedge was recorded in realized gains or losses and was immaterial for the year ended December 31, 2004.insignificant. For cash flow hedges of this type, gains and losses on derivative contracts that are reclassified from accumulatedAccumulated other comprehensive income to current period earnings are included as part of the interest cost over the forecasted life of the debt. The cash flow hedge resulted in a loss of $4 million which iswas recorded in Accumulated other comprehensive income at December 31, 2004. The Company reclassified $0.3 million and $0.3 million of the deferred net loss recorded in Accumulated other comprehensive income into earnings during 2006 and 2005. The Company did not enter into any transaction that was designated as a cash flow hedge during 2006 or 2005. The

88


Company expects that $0.3 million of the deferred net loss recorded in Accumulated other comprehensive income will be reclassified into earnings during 2007.
Derivative Activity Without Hedge Designations
The Company’s derivative activities that are not designated as a hedge for accounting purposes primarily involve hedging interest rate, foreign currency and credit rate risks on various assets as part of its overall portfolio management strategy. This activity may include entering into interest rate swaps, credit default swaps, currency forwards and commitments to purchase securities. It may also include buying or selling interest rate futures and options and purchasing warrants. These products are entered into as part of a macro hedging strategy and while they may be linked to specific assets or a pool of assets, the next twelve months.Company does not seek hedge accounting treatment on them.
Trading Activities
The Company’s derivative trading activities are associated with one of its consolidated separate accounts in which all investments are held for trading purposes. The derivatives segregated in this separate account are carried at fair value with the gains and losses included within net investment income. The Company did not designate anyis exposed to equity price risk in this separate account associated with its indexed group annuity contracts. The Company purchases Standard and Poor’s 500® (S&P500®) index futures contracts in a notional amount equal to the contract holders liability. Other derivatives held in the separate account may include currency forwards, interest rate futures, options written and purchased and forward purchase commitments, among others.
Separate Accounts
The results of the Company’s Separate Account derivative instruments as cash flow hedges during 2003 or 2002.

trading activity is included within Other revenues in the Consolidated Statements of Operations. The Company utilizes written options to enhance income in separate accounts.

Note D. Financial Instruments

In the normal course of business, the Company invests in various financial assets, incurs various financial liabilities and enters into agreements involving derivative securities.

Fair values are disclosed for all financial instruments for which it is practicable to estimate fair value, whether or not such values are recognized in the Consolidated Balance Sheets. Management attempts to obtain quoted market prices for these disclosures. Where quoted market prices are not available, fair values are estimated using present

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value or other valuation techniques. These techniques are significantly affected by management’s assumptions, including discount rates and estimates of future cash flows. Potential taxes and other transaction costs have not been considered in estimating fair values. The estimates presented herein are not necessarily indicative of the amounts that CNA would realize in a current market exchange.

Non-financial instruments such as real estate, deferred acquisition costs, property and equipment, deferred income taxes and intangibles, and certain financial instruments such as insurance reserves and leases are excluded from the fair value disclosures. Therefore, the fair value amounts cannot be aggregated to determine the underlying economic value of the Company.

The carrying amounts reported inon the Consolidated Balance Sheets for cash, shortCash, Short term investments, accruedAccrued investment income, receivablesReceivables for securities sold, federalFederal income taxes recoverable/payable, collateralCollateral on loaned securities, and derivatives, payablesPayables for securities purchased, and certain other assets and other liabilities approximate fair value because of the short term nature of these items. These assets and liabilities are not listed in the following tables.

The following methods and assumptions were used by CNA in estimating the fair value of financial assets and liabilities.

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.

The fair values for mortgage loans and policy loans were estimated using discounted cash flows utilizing interest rates currently offered for similar loans to borrowers of comparable credit quality. Loans with similar characteristics were aggregated for purposes of these calculations.

The fair value of limited partnership investments represents CNA’s equity in the partnership’s net assets as determined by the general partner.General Partner. Valuation techniques to determine fair value of other invested assets and other

89


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.

The fair values of notes receivable for the issuance of common stock were estimated using discounted cash flows utilizing interest rates currently offered for obligations securitized with similar collateral.

Premium deposits and annuity contracts were valued based on cash surrender values, and the outstanding fund balances.

estimated fair values or policyholder liabilities, net of amounts ceded related to sold business.

CNAF’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.

The fair values of CDOs were determined largely based on management’s estimates using default probabilities of the debt securities underlying the contract, which were obtained from a rating agency, the term of each contract, and actual default losses recorded on the contract.

The fair values of financial guarantee contracts were estimated using discounted cash flows utilizing interest rates currently offered for similar contracts.

The fair values of guaranteed investment contracts of the separate account business were estimated using discounted cash flow calculations based on interest rates currently offered for similar contracts with similar maturities. The fair values of the liabilities for variable separate account business were based on the quoted market values of the underlying assets of each variable separate account. The fair values of other separate account liabilities approximate their carrying value because of their short term nature.

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The carrying amount and estimated fair value of the Company’s financial instrument assets and liabilities are listed in the table below. Additional detail related to derivative financial instruments is also provided in Note C.

Financial Assets and Liabilities
                                
 2004
 2003
 2006 2005
 Estimated Estimated Estimated Estimated
 Carrying Fair Carrying Fair Carrying Fair Carrying Fair
December 31
(In millions)
 Amount
 Value
 Amount
 Value
December 31 Amount Value Amount Value
(In millions) 
Financial assets
  
Investments:  
Fixed maturity securities $31,327 $31,327 $28,678 $28,678  $35,851 $35,851 $33,234 $33,234 
Equity securities 456 456 527 527  657 657 681 681 
Mortgage loans  1 15 16 
Policy loans 1 1 175 176 
Limited partnership investments 1,549 1,549 1,117 1,117  1,852 1,852 1,509 1,509 
Other invested assets  (4)  (4) 40 40  12 12 3 3 
Separate account business:  
Fixed maturity securities 486 486 2,114 2,114  434 434 466 466 
Equity securities 55 55 117 117  41 41 44 44 
Limited partnership investments   419 419 
Other   415 415 
Notes receivable for the issuance of common stock 71 73 76 87  58 56 59 59 
 
Financial liabilities
  
Premium deposits and annuity contracts $422 $428 $1,282 $1,261  $898 $899 $1,363 $1,359 
Long term debt 1,726 1,820 1,641 1,712  2,156 2,240 1,438 1,507 
Short-term debt 531 531 263 263 
Collateralized debt obligation liabilities   14 14 
Financial guarantee contracts 45 45 50 50 
Short term debt   252 252 
 
Separate account business:  
Guaranteed investment contracts   211 229 
Variable separate accounts 65 65 540 540  52 52 53 53 
Other 503 503 2,449 2,449  448 448 491 491 

Note E. Income Taxes

CNA and its eligible subsidiaries (CNA Tax Group) are included in the consolidated Federalfederal income tax return of Loews and its eligible subsidiaries. Loews and CNA have agreed that for each taxable year, CNA will 1) be paid by Loews the amount, if any, by which the Loews consolidated Federalfederal income tax liability is reduced by virtue of the inclusion of the CNA Tax Group in the Loews consolidated Federalfederal income tax return, or 2) pay to Loews an amount, if any, equal to the Federalfederal 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.
For the years ended December 31, 2006 and 2005, CNA paid Loews $120 million and $146 million related to federal income taxes. CNA’s consolidated federal income taxes payable at December 31, 2006 reflects a $38 million payable to Loews and a $2 million payable related to affiliates less than 80% owned. At December 31, 2005, CNA’s consolidated federal income taxes recoverable included a $68 million recoverable from Loews and a $6 million payable related to affiliates less than 80% owned which settle their income taxes directly with the Internal Revenue Service (IRS).

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The Loews consolidated federal income tax returns for 2002 through 2004 have been settled with the Internal Revenue Service (IRS) throughIRS, including related carryback claims for refund which were approved by the 1997Joint Committee on Taxation in 2006. As a result, the Company recorded a federal income tax year. Thebenefit of $10 million, including a $7 million tax benefit related to Discontinued Operations, resulting primarily from the release of federal income tax reserves, and net refund interest of $2 million, net of tax, in 2006.
In 2006, the Company received from Loews $63 million related to the net tax settlement for the 2002-2004 tax returns and $4 million related to net refund interest. In 2005, the Company paid Loews $37 million related to the net tax deficiency for the 1998-2001 tax returns and received from Loews $121 million related to net refund interest.
In 2005, the Loews consolidated federal income tax returns for 1998were settled with the IRS through 2001, as the tax returns for 1998-2001, including related carryback claims and prior claims for refund, have been examined and are currently under reviewwere approved by the Joint Committee on Taxation. AlthoughAs a result, the Company’s ultimateCompany recorded a federal income tax obligationbenefit of $36 million and net refund interest of $79 million, net of tax, in 2005. The tax benefit related primarily to the release of federal income tax reserves. The net refund interest was included in Other revenues on the Consolidated Statements of Operations for thesethe years is subject to reviewended December 31, 2006 and final determination,2005, and was reflected in the opinion of management,Corporate and Other Non-Core segment.
The federal income tax return for 2005 is currently under examination by the IRS. The Company believes the outcome of the review and final determination of the Company’s ultimate tax obligationthis examination will not have a material effect on the financial condition or results of operations of the CNA Tax Group. PendingCompany.
For 2007, the outcomeIRS has invited Loews and the Company to participate in the Compliance Assurance Process (CAP) which is a voluntary program for a limited number of large corporations. Under CAP, the IRS conducts a real-time audit and works contemporaneously with the Company to resolve any issues prior to the filing of the review2007 tax return. Loews and final determination of the Company’s tax obligations for these years, interest on any tax refunds net of any tax deficiencies is subject to computation, review and final determination. The amount of any net refund interest ultimately due to the Company may have a material impact on

120


the results of operations in the period in which the review is finalized. The federal income tax returns for 2002 and 2003 are currently under examination by the IRS.agreed to participate. The Company believes the outcome of the 2002 and 2003 examinations will not have a material effect on the financial condition or results of operations of the CNA Tax Group.

that this approach should reduce tax-related uncertainties, if any.

A reconciliation between CNA’s Federalfederal income tax (expense) benefit at statutory rates and the recorded income tax (expense) benefit, after giving effect to minority interest, but before giving effect to discontinued operations, and the cumulative effects of changes in accounting principles, is as follows:

Tax Reconciliation
             
      
Years ended December 31
(In millions)
 2004
 2003
 2002
Income tax (expense) benefit at statutory rates $(174) $823  $(110)
Tax benefit from tax exempt income  111   101   53 
Other (expense) benefit, including state income taxes  34   (11)  (11)
   
 
   
 
   
 
 
Income tax (expense) benefit
 $(29) $913  $(68)
   
 
   
 
   
 
 
             
Years ended December 31 2006  2005  2004 
(In millions)            
Income tax expense at statutory rates $(577) $(57) $(176)
Tax benefit from tax exempt income  75   116   111 
Other tax benefits, including IRS settlements  33   46   34 
          
             
Effective income tax (expense) benefit
 $(469) $105  $(31)
          

Provision has been made for the expected U.S. Federalfederal 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.

On October 22, 2004, At December 31, 2006, the American Jobs Creation Act (AJCA) was signed into law. The AJCA includesCompany has not provided deferred taxes of $104 million, if sold through a provision allowingtaxable sale, on $297 million of undistributed earnings related to a deductiondomestic affiliate. Additionally, at December 31, 2006, the Company has not provided deferred taxes of 85% for certain$32 million on $92 million of undistributed earnings related to a foreign earnings that are repatriated. The AJCA provides Loews the opportunity to elect to apply this provision to qualifying earnings repatriations in 2005. Based on the existing language in the AJCA and current guidance, the CNA Tax Group does not expect to repatriate undistributed earnings. To the extent Congress or the Treasury Department provides additional clarifying language on key elements of the provision, Loews will consider the effects, if any, of such information and will re-evaluate, as necessary, its intentions with respect to the repatriation of certain foreign earnings. Should Loews, upon consideration of any such potential clarifying language, ultimately elect to apply the repatriation provision of the AJCA, the CNA Tax Group does not expect that the impact of such an election would be material to its results of operations.

subsidiary.

The current and deferred components of CNA’s income tax (expense) benefit, excluding taxes on discontinued operations, and the cumulative effects of the changes in accounting principles, are as follows:

Current and Deferred Taxes
                        
Years ended December 31 2006 2005 2004 
(In millions) 
Current tax (expense) benefit $(296) $(115) $6 
Deferred tax (expense) benefit  (173) 220  (37)
             
Years ended December 31
(In millions)
 2004
 2003
 2002
Current tax (expense) benefit $6 $980 $(61)
Deferred tax expense  (35)  (67)  (7)
 
 
 
 
 
 
  
Total income tax (expense) benefit
 $(29) $913 $(68) $(469) $105 $(31)
 
 
 
 
 
 
        

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The deferred tax effects of the significant components of CNA’s deferred tax assets and liabilities are set forth in the table below:

Components of Net Deferred Tax Asset
                
    
December 31
(In millions)
 2004
 2003
December 31     
(In millions) 2006 2005 
Deferred Tax Assets:
  
Insurance reserves:  
Property and casualty claim and claim adjustment expense reserves $701 $669  $775 $807 
Unearned premium reserves 233 288  245 232 
Life reserves 192 183  132 187 
Other insurance reserves 28 30  26 24 
Receivables 309 288  248 292 
Employee benefits 218 175  187 214 
Life settlement contracts 100 109  102 102 
Investment valuation differences 149 56  93 130 
Net operating loss and tax credits carried forward 41 158 
Net operating loss carried forward 23 38 
Other assets 215 234  171 194 
 
 
 
 
      
Gross deferred tax assets
 2,186 2,190  2,002 2,220 
Valuation allowance  (33)     (30)
 
 
 
 
      
Deferred tax assets after valuation allowance
 2,153 2,190  2,002 2,190 
     
 
 
 
 
  
Deferred Tax Liabilities:
  
Deferred acquisition costs  (691)  (769) 648 651 
Net unrealized gains  (429)  (508) 340 274 
Foreign and other affiliate(s)  (207)  (204) 11 15 
Other liabilities  (134)  (109) 148 145 
 
 
 
 
      
Gross deferred tax liabilities
  (1,461)  (1,590) 1,147 1,085 
 
 
 
 
      
 
Net deferred tax asset
 $692 $600  $855 $1,105 
 
 
 
 
      

At December 31, 2005, a valuation allowance of $30 million related to certain foreign subsidiaries remained outstanding, due to uncertainty in the ability of the foreign subsidiaries to generate sufficient future income. During 2006, the Company reconsidered the need for this allowance in light of recent earnings levels and anticipated future earnings and determined the allowance was no longer required. Therefore, the allowance was released in 2006. Although realization of deferred tax assets is not assured, management believes it is more likely than not that the recognized net deferred tax asset will be realized through future earnings, including but not limited to future income from continuing operations, reversal of existing temporary differences, and available tax planning strategies. A valuation allowance of $33 million (associated with a $41 million gross deferred tax asset on net foreign losses incurred by certain of the Company’s foreign subsidiaries) was established at December 31, 2004 due to the uncertainty in the ability of the foreign subsidiaries to generate sufficient future income.

Note F. Claim and Claim Adjustment Expense Reserves

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.

Establishing claim and claim adjustment expense reserves, including claim and claim adjustment expense reserves for catastrophic events that have occurred, is an estimation process. Many factors can ultimately affect the final settlement of a claim and, therefore, the necessary reserve. Changes in the law, results of litigation, medical costs, the cost of repair materials and labor rates can all affect ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably estimable than long-tail claims, such as general liability and professional liability claims. Adjustments to prior year reserve estimates, if necessary, are reflected in the results of operations in the period that the need for such adjustments is determined.

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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 and/or equity. The level of catastrophe losses experienced in any period cannot be predicted and can be material to the results of operations and/or equity of the Company.

Catastrophe losses, net of reinsurance, were $59 million, $493 million and $278 million $143 million and $59 million pretax for the years ended December 31, 2004, 20032006, 2005 and 2002.2004. The catastrophe losses in 2005 related primarily to Hurricanes Katrina, Wilma, Rita, Dennis and Ophelia. The catastrophe losses in 2004 related primarily to Hurricanes Charley, Frances, Ivan and Jeanne. TheThere can be no assurance that CNA’s ultimate cost for these catastrophes will not exceed current estimates.

Commercial catastrophe losses, gross of reinsurance, were $59 million, $976 million and $308 million for the years ended December 31, 2006, 2005 and 2004. See the Reinsurance section of the MD&A included in 2003 related primarily to Hurricane Claudette, Hurricane Isabel, Texas tornadoes, and Midwest rain storms. TheItem 7 for further discussion of the Company’s catastrophe losses in 2002 related primarily to the European floods, Hurricane Lili and Tropical Storm Isidore.

reinsurance program.

The table below provides a reconciliation between beginning and ending claim and claim adjustment expense reserves, including claim and claim adjustment expense reserves of the life and group companies.

company(ies).

Reconciliation of Claim and Claim Adjustment Expense Reserves
                        
      
As of and for the years ended December 31
(In millions)
 2004
 2003
 2002
As of and for the years ended December 31       
(In millions) 2006 2005 2004 
Reserves, beginning of year:  
Gross $31,730 $27,370 $31,266  $30,938 $31,523 $31,732 
Ceded 14,216 10,727 12,105  10,605 13,879 14,066 
 
 
 
 
 
 
        
Net reserves, beginning of year 17,514 16,643 19,161  20,333 17,644 17,666 
 
 
 
 
 
 
        
Reduction of net reserves (a)    (1,316)
Reduction of net reserves (b)   (1,309)  
 
Reduction of net reserves (c)(a)  (42)       (42)
 
Net incurred claim and claim adjustment expenses:  
Provision for insured events of current year 6,062 6,745 8,248  4,840 5,516 6,062 
Increase in provision for insured events of prior years 241 2,409 35  361 1,100 240 
Amortization of discount 135 115 72  121 115 135 
 
 
 
 
 
 
        
Total net incurred (d) 6,438 9,269 8,355 
 
Total net incurred (b) 5,322 6,731 6,437 
       
 
 
 
 
 
 
  
Net payments attributable to:  
Current year events 1,936 2,192 3,137 
Current year events (c) 784 1,341 1,936 
Prior year events 4,479 4,936 6,553  3,439 2,711 4,522 
Reinsurance recoverable against net reserve transferred under retroactive reinsurance agreements (See Note P)  (41)  (39)  (133)
Reinsurance recoverable against net reserve transferred under retroactive reinsurance agreements  (13)  (10)  (41)
       
 
 
 
 
 
 
  
Total net payments 6,374 7,089 9,557  4,210 4,042 6,417 
       
 
 
 
 
 
 
  
Net reserves, end of year 17,536 17,514 16,643  21,445 20,333 17,644 
Ceded reserves, end of year 13,984 14,216 10,727  8,191 10,605 13,879 
 
 
 
 
 
 
        
 
Gross reserves, end of year
 $31,520 $31,730 $27,370  $29,636 $30,938 $31,523 
 
 
 
 
 
 
        

(a)  In 2002, the net reserves were reduced by $1,316 million as a result of the sale of CNA Reinsurance Company Limited (CNA Re U.K.). See Note P for further discussion of this sale.
(a)(b)  In 2003, the net reserves were reduced by $1,309 million as a result of the sale of CNAGLA. See Note P for further discussion of this sale.
(c) In 2004, the net reserves were reduced by $42 million as a result of the sale of the individual life insurance business. See Note P for further discussion of this sale.
 
(b)(d) Total net incurred above does not agree to insuranceInsurance claims and policyholders’ benefit as reflected in the Consolidated Statements of Operations due to expenses incurred related to uncollectible reinsurance receivables and benefit expenses related to future policy benefits and policyholders’ funds which are not reflected in the table above.
(c)In 2006, net payments were decreased by $935 million due to the impact of significant commutations. In 2005, net payments were decreased by $1,581 million due to the impact of significant commutations. See Note H for further discussion related to commutations.

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The changes in provision for insured events of prior years (net prior year claim and claim adjustment expense reserve development) were as follows:

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Reserve Development

                        
      
Years ended December 31
(In millions)
 2004
 2003
 2002
Years ended December 31       
(In millions) 2006 2005 2004 
Environmental pollution and mass tort $1 $153 $  $63 $53 $1 
Asbestos 54 642    10 54 
Other 186 1,614 35  269 1,044 179 
 
 
 
 
 
 
        
Property and casualty reserve development 332 1,107 234 
       
 
Life reserve development in life company 29  (7) 6 
       
 
Total
 $241 $2,409 $35  $361 $1,100 $240 
 
 
 
 
 
 
        

The following tables summarize the gross and net carried reserves as of December 31, 20042006 and 2003.

2005.

December 31, 2004

2006

Gross and Net Carried

Claim and Claim Adjustment Expense Reserves

                                        
 Life and Corporate   Life and Corporate   
 Standard Specialty Group and Other   Standard Specialty Group and Other   
(In millions) Lines
 Lines
 Non-Core
 Non-Core
 Total
 Lines Lines Non-Core Non-Core Total 
Gross Case Reserves $6,904 $1,659 $2,800 $3,803 $15,166  $6,746 $1,715 $2,366 $2,511 $13,338 
Gross IBNR Reserves 7,398 3,201 880 4,875 16,354  8,188 3,814 768 3,528 16,298 
 
 
 
 
 
 
 
 
 
 
            
 
Total Gross Carried Claim and Claim Adjustment Expense Reserves
 $14,302 $4,860 $3,680 $8,678 $31,520  $14,934 $5,529 $3,134 $6,039 $29,636 
           
 
 
 
 
 
 
 
 
 
 
  
Net Case Reserves $4,759 $1,191 $1,394 $1,485 $8,829  $5,234 $1,350 $1,496 $1,453 $9,533 
Net IBNR Reserves 4,544 2,042 430 1,691 8,707  6,632 2,921 360 1,999 11,912 
 
 
 
 
 
 
 
 
 
 
            
 
Total Net Carried Claim and Claim Adjustment Expense Reserves
 $9,303 $3,233 $1,824 $3,176 $17,536  $11,866 $4,271 $1,856 $3,452 $21,445 
 
 
 
 
 
 
 
 
 
 
            

December 31, 2003

2005

Gross and Net Carried
Claim and Claim Adjustment Expense Reserves
                                        
 Life and Corporate   Life and Corporate   
 Standard Specialty Group and Other   Standard Specialty Group and Other   
(In millions) Lines
 Lines
 Non-Core
 Non-Core
 Total
 Lines Lines Non-Core Non-Core Total 
Gross Case Reserves $6,416 $1,605 $2,539 $4,342 $14,902  $7,033 $1,907 $2,542 $3,297 $14,779 
Gross IBNR Reserves 7,866 2,595 1,037 5,330 16,828  8,051 3,298 735 4,075 16,159 
 
 
 
 
 
 
 
 
 
 
            
 
Total Gross Carried Claim and Claim Adjustment Expense Reserves
 $14,282 $4,200 $3,576 $9,672 $31,730  $15,084 $5,205 $3,277 $7,372 $30,938 
           
 
 
 
 
 
 
 
 
 
 
  
Net Case Reserves $4,585 $1,087 $1,477 $1,879 $9,028  $5,165 $1,442 $1,456 $1,554 $9,617 
Net IBNR Reserves 4,382 1,832 414 1,858 8,486  6,081 2,352 381 1,902 10,716 
 
 
 
 
 
 
 
 
 
 
            
 
Total Net Carried Claim and Claim Adjustment Expense Reserves
 $8,967 $2,919 $1,891 $3,737 $17,514  $11,246 $3,794 $1,837 $3,456 $20,333 
 
 
 
 
 
 
 
 
 
 
            

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The following provides discussion of the Company’s Asbestos, Environmental Pollution and Mass Tort (APMT) and core reserves.

APMT Reserves

CNA’s property and casualty insurance subsidiaries have actual and potential exposures related to APMT claims.

Establishing reserves for APMT claim and claim adjustment expenses is subject to uncertainties that are greater than those presented by other claims. Traditional actuarial methods and techniques employed to estimate the ultimate cost of claims for more traditional property and casualty exposures are less precise in estimating claim and claim adjustment expense reserves for APMT, particularly in an environment of emerging or potential claims and coverage issues that arise from industry practices and legal, judicial and social conditions. Therefore, these traditional actuarial methods and techniques are necessarily supplemented with additional estimating techniques and methodologies, many of which involve significant judgments that are required of management. Accordingly, a high degree of uncertainty remains for the Company’s ultimate liability for APMT claim and claim adjustment expenses.

In addition to the difficulties described above, estimating the ultimate cost of both reported and unreported APMT claims is subject to a higher degree of variability due to a number of additional factors, including among others: the number and outcome of direct actions against the Company; coverage issues, including whether certain costs are covered under the policies and whether policy limits apply; allocation of liability among numerous parties, some of whom may be in bankruptcy proceedings, and in particular the application of “joint and several” liability to specific insurers on a risk; inconsistent court decisions and developing legal theories; increasinglycontinuing aggressive tactics of plaintiffs’ lawyers; the risks and lack of predictability inherent in major litigation; increased filings of claims in certain states; enactment of nationalstate and federal legislation to address asbestos claims; a further increaseincreases and decreases in asbestos, and environmental pollution and mass tort claims which cannot now be anticipated; increaseincreases and decreases in number ofcosts to defend asbestos, pollution and mass tort claims relating to silicaclaims; changing liability theories against the Company’s policyholders in environmental and silica-containing products, and the outcomemass tort matters; possible exhaustion of ongoing disputes as to coverage in relation to these claims; a further increase of claims and claims payment that may exhaust underlying umbrella and excess coverage at accelerated rates;coverage; and future developments pertaining to the Company’s ability to recover reinsurance for asbestos, pollution and environmental pollutionmass tort claims.

CNA has regularlyannually performed ground up reviews of all open APMT claims to evaluate the adequacy of the Company’s APMT reserves. In performing its comprehensive ground up analysis, the Company considers input from its professionals with direct responsibility for the claims, inside and outside counsel with responsibility for representation of the Company and its actuarial staff. These professionals review, among many factors, the policyholder’s present and predicted future exposures, including such factors as claims volume, trial conditions, prior settlement history, settlement demands and defense costs; the impact of asbestos defendant bankruptcies on the policyholder; the policies issued by CNA, including such factors as aggregate or per occurrence limits, whether the policy is primary, umbrella or excess, and the existence of policyholder retentions and/or deductibles; the existence of other insurance; and reinsurance arrangements.

With respect to other court cases and how they might affect the Company’s reserves and reasonably possible losses, the following should be noted. State and federal courts issue numerous decisions each year, which potentially impact losses and reserves in both a favorable and unfavorable manner. Examples of favorable developments include decisions to allocate defense and indemnity payments in a manner so as to limit carriers’ obligations to damages taking place during the effective dates of their policies; decisions holding that injuries occurring after asbestos operations are completed are subject to the completed operations aggregate limits of the policies; and decisions ruling that carriers’ loss control inspections of their insured’s premises do not give rise to a duty to warn third parties to the dangers of asbestos.

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Examples of unfavorable developments include decisions limiting the application of the “absolute pollution” exclusion; and decisions holding carriers liable for defense and indemnity of asbestos and pollution claims on a joint and several basis.

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 pollution, court decisions that continue to restrict the scope and applicability of the absolute pollution exclusion contained in policies issued by the Company after 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 pollution, 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.

Due to the inherent uncertainties in estimating claim and claim adjustment expense reserves for APMT and due to the significant uncertainties previously described related to APMT claims, the ultimate liability for these cases, both individually and in aggregate, may exceed the recorded reserves. Any such potential additional liability, or any range of potential additional amounts, cannot be reasonably estimated currently, but could be material to the Company’s business, results of operations, equity, and insurer financial strength and debt ratings. Due to, among other things, the factors described above, it may be necessary for the Company to record material changes in its APMT claim and claim adjustment expense reserves in the future, should new information become available or other developments emerge.

The following table provides data related to CNA’s APMT claim and claim adjustment expense reserves.

APMT Reserves
                                
 December 31, 2004
 December 31, 2003
 December 31, 2006 December 31, 2005 
 Environmental Environmental Environmental Environmental 
 Pollution and Pollution and Pollution and Pollution and 
(In millions) Asbestos
 Mass Tort
 Asbestos
 Mass Tort
 Asbestos Mass Tort Asbestos Mass Tort 
Gross reserves $3,218 $755 $3,347 $839  $2,635 $647 $2,992 $680 
Ceded reserves  (1,532)  (258)  (1,580)  (262)  (1,183)  (231)  (1,438)  (257)
 
 
 
 
 
 
 
 
          
 
Net reserves
 $1,686 $497 $1,767 $577  $1,452 $416 $1,554 $423 
 
 
 
 
 
 
 
 
          

Asbestos

CNA’s property and casualty insurance subsidiaries have exposure to asbestos-related claims. Estimation of asbestos-related claim and claim adjustment expense reserves involves limitations such as inconsistency of court decisions, specific policy provisions, allocation of liability among insurers and insureds, and additional factors such as missing policies and proof of coverage. Furthermore, estimation of asbestos-related claims is difficult due to, among other reasons, the proliferation of bankruptcy proceedings and attendant uncertainties, the targeting of a

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broader range of businesses and entities as defendants, the uncertainty as to which other insureds may be targeted in the future and the uncertainties inherent in predicting the number of future claims.

As of December 31, 20042006 and 2003,2005, CNA carried approximately $1,686$1,452 million and $1,767$1,554 million of claim and claim adjustment expense reserves, net of reinsurance recoverables, for reported and unreported asbestos-related claims. The Company recorded $54 million and $642 million of unfavorableno asbestos-related net claim and claim adjustment expense reserve development for the years ended December 31, 2004 and 2003. The Company recorded no asbestos related net claim and claim adjustment expense reserve development for the year ended December 31, 2002.2006. For the years ended December 31, 2005 and 2004, the Company recorded $10 million and $54 million of unfavorable asbestos-related net claim and claim adjustment expense reserve development. The 2004 unfavorable net prior year development was primarily related to a loss from the commutation of reinsurance treaties with Trenwick.The Trenwick Group (Trenwick). The Company paid asbestos-related claims, net of reinsurance recoveries, of $135$102 million, $121$142 million and $21$135 million for the years ended December 31, 2004, 20032006, 2005 and 2002.

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2004.


The Company recorded $1,826 million and $642 million in unfavorable gross and net prior year development for the year ended December 31, 2003 for reported and unreported asbestos-related claims, principally due to potential losses from policies issued by the Company with high attachment points, which previous exposure analysis indicated would not be reached. The Company examined the claims filing trends to determine timeframes within which high excess policies issued by the Company could be reached. Elevated claims volumes and increased claims values, together with certain adverse court decisions affecting the ability of policyholders to access excess policies, supported the conclusion that excess policies with high attachment points previously thought not to be exposed may now potentially be exposed. The ceded reinsurance arrangements on these excess policies are different from the primary policies. In general, more extensive reinsurance arrangements apply to the excess policies. As a result, the prior year development shows a higher ratio of ceded to gross amounts than the reserves established in prior periods, resulting in a higher percentage of reserves ceded as of December 31, 2003 versus prior periods.

Some asbestos-related defendants have asserted that their insurance policies are not subject to aggregate limits on coverage. CNA has such claims from a number of insureds. Some of these claims involve insureds facing exhaustion of products liability aggregate limits in their policies, who have asserted that their asbestos-related claims fall within so-called “non-products” liability coverage contained within their policies rather than products liability coverage, and that the claimed “non-products” coverage is not subject to any aggregate limit. It is difficult to predict the ultimate size of any of the claims for coverage purportedly not subject to aggregate limits or predict to what extent, if any, the attempts to assert “non-products” claims outside the products liability aggregate will succeed. The Company’s policies also contain other limits applicable to these claims, and the Company has additional coverage defenses to certain claims. The Company has attempted to manage itsCertain asbestos exposure by aggressively seeking to settle claims on acceptable terms. There can be no assurance that any of these settlement efforts will be successful, or that any such claims can be settled on terms acceptable to CNA. Where CNA cannot settle a claim on acceptable terms, the Company aggressively litigates the claim. A recent court ruling by the United States Court of Appeals for the Fourth Circuit has supported certain of the Company’s positions with respect to coverage for “non-products” claims. However, adverse developments with respect to such matters could have a material adverse effect on CNA’s results of operations and/or equity.

Certain asbestos litigation in which CNA is currently engaged is described below:

The ultimate cost of reported claims, and in particular APMT claims, is subject to a great many uncertainties, including future developments of various kinds that CNA does not control and that are difficult or impossible to foresee accurately. With respect to the litigation identified below in particular, numerous factual and legal issues remain unresolved. Rulings on those issues by the courts are critical to the evaluation of the ultimate cost to the Company. The outcome of the litigation cannot be predicted with any reliability. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.
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 is required to pay $74 million, net of reinsurance recoveries, over a ten year period commencing after the final approval of a bankruptcy plan of reorganization. The settlement resolves CNA’s liabilities for all pending and future asbestos and silica claims involving A.P. Green Industries, Bigelow Liptak Corporation and related subsidiaries, including alleged “non-products” exposures. The settlement received initial bankruptcy court approval on August 18, 2003 and CNA expects to procure2003. The court has held a confirmation of ahearing on the bankruptcy plan containing an injunction to protect CNA from any future claims.

claims and the parties are awaiting a ruling on confirmation.

CNA is engaged in insurance coverage litigation in New York State Court, filed in 2003, with a defendant class of underlying plaintiffs who have asbestos bodily injury claims against the former Robert A. Keasbey Company (Keasbey) in New York state court (Continental Casualty Co. v. Employers Ins. of Wausau et al., No. 601037/03 (N.Y. County)). Keasbey, a currently dissolved corporation, was a seller and installer of asbestos-containing insulation products in New York and New Jersey. Thousands of plaintiffs have filed bodily injury claims against Keasbey; however, Keasbey’s involvement at a number of work sites is a highly contested issue. Therefore, the defense disputes the percentage of valid claims against Keasbey. CNA issued Keasbey primary policies for 1970-1987 and excess policies for 1972-1978. CNA has paid an amount substantially equal to the policies’ aggregate limits for products and completed operations claims.claims in the confirmed CNA policies. Claimants against Keasbey allege, among other things, that CNA owes coverage under sections of the policies not subject to the aggregate limits, an allegation CNA vigorously contests in the lawsuit. In the litigation, CNA and the claimants seek declaratory relief as to the interpretation of various policy provisions. The court dismissed a claim alleging bad faith and seeking unspecified damages on March 21, 2004; that ruling was affirmed on March 31, 2005 by Appellate Division, First Department. The trial in the Keasbey coverage action commenced on July 13, 2005; closing arguments concluded on October 28, 2005. The Court reopened the record in January 2006 for additional evidentiary submissions and briefing, and additional closing arguments were held March 27, 2006. It is now being appealed.unclear when the Company will have a decision from the trial court. With respect to this litigation in particular, numerous factual and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. These factors include, among others: (a) whether the Company has any further responsibility to compensate claimants against Keasbey under its policies and, if so, under which policies; (b) whether the Company’s responsibilities extend to a particular claimants’claimant’s entire claim or only to a limited percentage of the claim; (c) whether the Company’s responsibilities under its policies are limited by the occurrence limits or other provisions of the policies; (d) whether certain exclusions in some of the policies apply to exclude certain claims; (e) the extent to which claimants can establish exposures to asbestos materials as to which Keasbey has any responsibility; (f) the legal theories which must be pursued by such claimants to establish the liability of Keasbey and whether such theories can, in fact, be established; (g) the diseases and damages claimedalleged by such claimants; and (h) and the extent that such liability would be shared with

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other responsible parties. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.

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CNA has insurance coverage disputes related to asbestos bodily injury claims against a bankrupt insured, Burns & Roe Enterprises, Inc. (Burns & Roe). Originally raised in litigation, now stayed, theseThese disputes are currently part of coverage litigation (stayed in view of the bankruptcy) and an adversary proceeding in 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 engineering and related services in connection with construction projects. At the time of its bankruptcy filing, on December 4, 2000, Burns & Roe asserted that it faced approximately 11,000 claims alleging bodily injury resulting from exposure to asbestos as a result of construction projects in which Burns & Roe was involved. CNA allegedly provided primary liability coverage to Burns & Roe from 1956-1969 and 1971-1974, along with certain project-specific policies from 1964-1970. The partieslitigation involves disputes over the confirmation of the Plan of Reorganization in the litigation are seeking a declaration ofbankruptcy, the scope and extent of coverage, if any, afforded to Burns & Roe for its asbestos liabilities. The litigation has been stayed since May 14, 2003 pending resolutionOn December 5, 2005, Burns & Roe filed its Third Amended Plan of the bankruptcy proceedings.Reorganization (“Plan”). A confirmation hearing relating to that Plan is anticipated in 2007. Coverage issues will be determined in a later proceeding. With respect to both confirmation of the Burns & Roe litigationPlan and the pending bankruptcy proceeding, numerous unresolved factual and legalcoverage issues, will impact the ultimate exposure to the Company. With respect to this litigation, numerous factual and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. These factors include, among others: (a) whether the Company has any further responsibility to compensate claimants against Burns & Roe under its policies and, if so, under which; (b) whether the Company’s responsibilities under its policies extend to a particular claimants’claimant’s entire claim or only to a limited percentage of the claim; (c) whether the Company’s responsibilities under its policies are limited by the occurrence limits or other provisions of the policies; (d) whether certain exclusions, including professional liability exclusions, in some of the Company’s policies apply to exclude certain claims; (e) the extent to which claimants can establish exposuresexposure to asbestos materials as to which Burns & Roe has any responsibility; (f) the legal theories which must be pursued by such claimants to establish the liability of Burns & Roe and whether such theories can, in fact, be established; (g) the diseases and damages claimedalleged by such claimants; (h) the extent that any liability of Burns & Roe would be shared with other potentially responsible parties; and (i) and the impact of bankruptcy proceedings on claims and coverage issue resolution. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.

CIC issued certain primary and excess policies to Bendix Corporation (Bendix), now part of Honeywell International, Inc. (Honeywell). Honeywell faces approximately 75,403 pending asbestos bodily injury claims resulting from alleged exposure to Bendix friction products. CIC’s primary policies allegedly covered the period from at least 1939 (when Bendix began to use asbestos in its friction products) to 1983, although the parties disagree about whether CIC’s policies provided product liability coverage before 1940 and from 1945 to 1956. CIC asserts that it owes no further material obligations to Bendix under any primary policy. Honeywell alleges that two primary policies issued by CIC covering 1969-1975 contain occurrence limits but not product liability aggregate limits for asbestos bodily injury claims. CIC has asserted, among other things, even if Honeywell’s allegation is correct, which CNA denies, its liability is limited to a single occurrence limit per policy or per year, and in the alternative, a proper allocation of losses would substantially limit its exposure under the 1969-1975 policies to asbestos claims. These and other issues are being litigated inContinental Insurance Co., et al. v. Honeywell International Inc., No. MRS-L-1523-00 (Morris County, New Jersey) which was filed on May 15, 2000. In the litigation, the parties are seeking declaratory relief of the scope and extent of coverage, if any, afforded to Bendix under the policies issued by the Company. With respect to this litigation, numerous factual and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. These factors include, among others: (a) whether certain of the primary policies issued by the Company contain aggregate limits of liability; (b) whether the Company’s responsibilities under its policies extend to a particular claimants’ entire claim or only to a limited percentage of the claim; (c) whether the Company’s responsibilities under its policies are limited by the occurrence limits or other provisions of the policies; (d) whether some of the claims against Bendix arise out of events which took place after expiration of the Company’s policies; (e) the extent to which claimants can establish exposures to asbestos materials as to which Bendix has any responsibility; (f) the legal theories which must be pursued by such claimants to establish the liability of Bendix and whether such theories can, in fact, be established; (g) the diseases and damages claimed by such claimants; (h) the extent that any liability of Bendix would be shared with other responsible parties; and (i) whether Bendix is responsible for reimbursement of funds advanced by the Company for defense and indemnity in the past. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.

Suits have also been initiated directly against the CNA companies and numerous other insurers in fourthree jurisdictions: Ohio, Texas, West Virginia and Montana. Lawsuits were filed in Texas beginning in 2002, against two CNA companies and numerous other insurers and non-insurer corporate defendants asserting liability for failing to warn of the dangers of asbestos (E.g.Boson v. Union Carbide Corp., (Nueces County, Texas)). During 2003, many of the Texas suits were dismissed as time-barred by the applicable Statute of Limitations. In other suits, the two Ohio actions,carriers argued that they did not owe any duty to the plaintiffs allegeor the defendants negligently performed duties undertakengeneral public to protect workers andadvise the public fromworld generally or the plaintiffs particularly of the effects of asbestos (Varner v. Ford Motor Co., et al. (Cuyahogaand that Texas statutes precluded liability for such claims, and two Texas courts dismissed these suits. Certain of the Texas courts’ rulings were appealed, but plaintiffs later dismissed their appeals. A different Texas court denied similar motions seeking dismissal at the pleading stage, allowing limited discovery to proceed. After that court denied a related challenge to jurisdiction, the insurers transferred those cases, among others, to a state multi-district litigation court in Harris County Ohio, filedcharged with handling asbestos cases, and the cases remain in that court. The insurers have petitioned the appellate court in Houston for an order of mandamus, requiring the multi-district litigation court to dismiss the cases on June 12, 2003)jurisdictional andPeplowski v. ACE American Ins. Co., et al. (U.S. D. C. N.D. Ohio, filed on April 1, 2004)). The state trial court granted insurers, including CNA, summary judgment against a representative group of plaintiffs, ruling

128


that insurers had no duty to warn plaintiffs about the dangers of asbestos. The summary judgment ruling is on appeal. substantive grounds. With respect to this litigation in particular, numerous factual and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. These factors include: (a) the speculative nature and unclear scope of any alleged duties owed to individuals exposed to asbestos and the resulting uncertainty as to the potential pool of potential claimants; (b) the fact that imposing such duties on all insurer and non-insurer corporate defendants would be unprecedented and, therefore, the legal boundaries of recovery are difficult to estimate; (c) the fact that many of the claims brought to date are barred by various Statutes of Limitation and it is unclear whether future claims would also be barred; (d) the unclear nature of the required nexus between the acts of the defendants and the right of any particular claimant to recovery; and (e) the existence of hundreds of co-defendants in some of the suits and the applicability of the legal theories pled by the claimants to thousands of potential defendants. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.

Similar lawsuits have also been filed in Texas against CNA beginning in 2002, and other insurers and non-insurer corporate defendants asserting liability for failing to warn of the dangers of asbestos (Boson v. Union Carbide Corp., et al. (District Court of Nueces County, Texas)). During 2003, many of the Texas claims have been dismissed as time-barred by the applicable Statute of Limitations. In other claims, the Texas courts have ruled that the carriers did not owe any duty to the plaintiffs or the general public to advise on the effects of asbestos thereby dismissing these claims. Certain of the Texas courts’ rulings have been appealed. With respect to this litigation in particular, numerous factual and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. These factors include: (a) the speculative nature and unclear scope of any alleged duties owed to individuals exposed to asbestos and the resulting uncertainty as to the potential pool of potential claimants; (b) the fact that imposing such duties on all insurer and non-insurer corporate defendants would be unprecedented and, therefore, the legal boundaries of recovery are difficult to estimate; (c) the fact that many of the claims brought to date are barred by various Statutes of Limitation and it is unclear whether future claims would also be barred; (d) the unclear nature of the required nexus between the acts of the defendants and the right of any particular claimant to recovery; (e) the existence of hundreds of co-defendants in some of the suits and the applicability of the legal theories pled by the claimants to thousands of potential defendants. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.

CNA

CCC was named inAdams v. Aetna, Inc., et al. (Circuit Court of Kanawha County, West Virginia, Nos, 0-2C-1708 to -1719, filed June 23,28, 2002), a purported class action against CNACCC and other insurers, alleging that the defendants violated West Virginia’s Unfair Trade Practices Act (“UTPA”) in handling and resolving asbestos claims against

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their policyholders. The Adams litigation had been stayed pending dispositioninsureds. In September 2006, CCC entered into a settlement with plaintiffs and on November 15, 2006, the Circuit Court of two cases inKanawha County dismissed plaintiffs’ claims against CCC. While no party filed an opposition to the settlement, the time for seeking leave to appeal that dismissal order to the West Virginia Supreme Court of Appeals. Those cases were decided in June, 2004. The Adams case also involves proceedings and mediation inAppeals has not yet expired. In the Bankruptcy Court in New York with jurisdiction overevent the Manville Bankruptcy. In those proceedings issues have been raised concerning the preclusive effect of the Manville Bankruptcy settlements with insurers and resulting injunctions against claims. Those issues are now on appealdismissal order is appealed to the United States DistrictWest Virginia Supreme Court forand the Eastern District of New York. With respect to this litigation in particular,dismissal order is set aside, numerous factual and legal issues remain to be resolved that are critical towould determine the final result in Adams, the outcome of which cannot be predicted with any reliability. These factorsissues include: (a) the legal sufficiency and factual validity of the novel statutory and common law claims pled by the claimants; (b) the applicability of claimants’ legal theories to insurers who issued excess policies and/or neither defended nor controlled the defense of certain policyholders; (c) the possibility that certain of the claims are barred by various Statutes of Limitation; (d) the fact that the imposition of duties would interfere with the attorney clientattorney-client privilege and the contractual rights and responsibilities of the parties to the Company’s insurance policies; (e) whether plaintiffs’ claims are barred in whole or in part by injunctions that have been issued by bankruptcy courts that are overseeing, or that have overseen, the bankruptcies of various insureds; (f) whether some or all of the named plaintiffs or members of the plaintiff class have released CCC from the claims alleged in the Amended Complaint when they resolved their underlying asbestos claims; (g) the appropriateness of the case for class action treatment; and (h) the potential and relative magnitude of liabilities of co-defendants. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.

On March 22, 2002, a direct action was filed in Montana (Pennock, et al. v. Maryland Casualty, et al. First Judicial District Court of Lewis & Clark County, Montana) by eight individual filed plaintiffs (all employees of W.R. Grace & Co. (W.R. Grace)) and their spouses against CNA, Maryland Casualty and the State of Montana. This action alleges that the carriers failed to warn of or otherwise protect W.R. Grace employees from the dangers of asbestos at a W.R. Grace vermiculite mining facility in Libby, Montana. The Montana direct action is currently stayed because of W.R. Grace’s pending bankruptcy. With respect to this litigation in particular,such claims, numerous factual and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. These factors include: (a) the unclear nature and scope of any alleged duties owed to people exposed to asbestos and the resulting uncertainty as to the potential pool of potential claimants; (b) the potential application of

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Statutes of Limitation to many of the claims which may be made depending on the nature and scope of the alleged duties; (c) the unclear nature of the required nexus between the acts of the defendants and the right of any particular claimant to recovery; (d) the diseases and damages claimed by such claimants; (e) and the extent that such liability would be shared with other potentially responsible parties; and (f) the impact of bankruptcy proceedings on claims resolution. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.

CNA is vigorously defending these and other cases and believes that it has meritorious defenses to the claims asserted. However, there are numerous factual and legal issues to be resolved in connection with these claims, and it is extremely difficult to predict the outcome or ultimate financial exposure represented by these matters. Adverse developments with respect to any of these matters could have a material adverse effect on CNA’s business, insurer financial strength and debt ratings, and results of operations and/or equity.

As a result of the uncertainties and complexities involved, reserves for asbestos claims cannot be estimated with traditional actuarial techniques that rely on historical accident year loss development factors. In establishing asbestos reserves, CNA evaluates the exposure presented by each insured. As part of this evaluation, CNA considers the available insurance coverage; limits and deductibles; the potential role of other insurance, particularly underlying coverage below any CNA excess liability policies; and applicable coverage defenses, including asbestos exclusions. Estimation of asbestos-related claim and claim adjustment expense reserves involves a high degree of judgment on the part of management and consideration of many complex factors, including: inconsistency of court decisions, jury attitudes and future court decisions; specific policy provisions; allocation of liability among insurers and insureds; missing policies and proof of coverage; the proliferation of bankruptcy proceedings and attendant uncertainties; novel theories asserted by policyholders and their counsel; the targeting of a broader range of businesses and entities as defendants; the uncertainty as to which other insureds may be targeted in the future and the uncertainties inherent in predicting the number of future claims; volatility in claim numbers and settlement demands; increases in the number of non-impaired claimants and the extent to which they can be precluded from making claims; the efforts by insureds to obtain coverage not subject to aggregate limits; the long latency period between asbestos exposure and disease manifestation and the resulting potential for involvement of multiple policy periods for individual claims; medical inflation trends; the mix of asbestos-related diseases presented and the ability to recover reinsurance.

Environmental Pollution and Mass Tort

Environmental pollution cleanup is the subject of both federal and state regulation. By some estimates, there are thousands of potential waste sites subject to cleanup. The insurance industry is involved in extensive litigation regarding coverage issues. Judicial interpretations in many cases have expanded the scope of coverage and liability beyond the original intent of the policies. The Comprehensive Environmental Response Compensation and Liability Act of 1980 (Superfund) and comparable state statutes (mini-Superfunds) govern the cleanup and restoration of toxic waste sites and formalize the concept of legal liability for cleanup and restoration by “Potentially Responsible Parties” (PRPs). Superfund and the mini-Superfunds establish mechanisms to pay for cleanup of waste sites if PRPs fail to do so and assign liability to PRPs. The extent of liability to be allocated to a PRP is dependent upon a variety of factors. Further, the number of waste sites subject to cleanup is unknown. To date, approximately 1,500 cleanup sites have been identified by the Environmental Protection Agency (EPA) and included on its National Priorities List (NPL). State authorities have designated many cleanup sites as well.

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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 the industry as an absolute pollution exclusion. CNA and the insurance industry are disputing coverage for many such claims. Key coverage issues include whether cleanup costs are considered damages under the policies, trigger of coverage, allocation of liability among triggered policies, applicability of pollution exclusions and owned property exclusions, the potential for joint and several liability and the definition of an occurrence. To date, courts have been inconsistent in their rulings on these issues.

A number of proposals to modify Superfund have been made by various parties. However, no modifications were enacted by Congress during 2004 or 2003, and it is unclear what positions Congress or the Administration will take and what legislation, if any, will result in the future. 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, 20042006 and 2003,2005, CNA carried approximately $497$416 million and $577$423 million of claim and claim adjustment expense reserves, net of reinsurance recoverables, for reported and unreported environmental pollution and mass tort claims. There was $1$63 million, $53 million and $153$1 million of unfavorable environmental pollution and mass tort net claim and claim adjustment expense reserve development recorded for the years ended December 31, 20042006, 2005 and 2003. There was no environmental pollution and mass tort net claim and claim adjustment expense reserve development recorded for the year ended December 31, 2002. Additionally, the2004. The Company recorded $40 million, $20 million and $15 million of current accident year losses related to mass tort infor the years ended December 31, 2006, 2005 and 2004. The Company paid environmental pollution-related claims and mass tort-related claims, net of reinsurance recoveries, of $96$110 million, $93$147 million and $116$96 million for the years ended December 31, 2004, 20032006, 2005 and 2002.

CNA2004.

In addition to mass tort claims arising from exposure to asbestos as discussed above, the Company also has made resolutionexposure arising from other mass tort claims. Such claims typically involve allegations by multiple plaintiffs alleging injury resulting from exposure to or use of large environmental pollution exposuressimilar substances or products over multiple policy periods. Examples include, but are not limited to, lead paint claims, hardboard siding, polybutylene pipe, mold, silica, latex gloves, benzene products, welding rods, diet drugs, breast implants, medical devices, and various other toxic chemical exposures. During the Company’s 2006 ground up review, the Company noted adverse development in various mass tort accounts. The adverse development results primarily from increases related to defense costs in a management priority. The Company has resolved a number of its large environmental accounts by negotiating settlement agreements. In its settlements, CNA sought to resolve those exposures and obtain the broadest release language to avoid future claims from the same policyholders seeking coverage for sites or claims that had not emerged at the time CNA settled with its policyholder. While the terms of each settlement agreement vary, CNA sought to obtain broad environmental releases that include known and unknown sites, claims and policies. The broad scope of the release provisions contained in those settlement agreements should, in many cases, prevent future exposure from settled policyholders. It remains uncertain, however, whether a court interpreting the language of the settlement agreements will adhere to the intent of the parties and uphold the broad scope of language of the agreements.

In 2003, CNA observed a marked increase in silica claims frequency in Mississippi, where plaintiff attorneys appear to have filed claims to avoid the effect of tort reform. In 2004, silica claims frequency in Mississippi has moderated notably due to implementation of tort reform measures and favorable court decisions. To date, the most significant silica exposures identified included a relatively small number of

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accounts with significant numbersarising out of new claims reported in 2003various substances and that continued atproducts. As a far lesser rate in 2004. Establishing claim and claim adjustment expenseresult, the Company increased mass tort reserves for silica claims is subject to uncertainties becauseprior accident years by $63 million in 2006.
The Company noted adverse development in various pollution accounts in its 2005 ground up review. In the course of disputes concerning medical causation with respect to certain diseases, including lung cancer, geographical concentration ofits review, the lawsuits asserting the claims, and the large riseCompany did not observe a negative trend or deterioration in the total number ofunderlying pollution claims without underlying epidemiological developments suggesting an increaseenvironment. Rather, individual account estimates changed due to changes in disease rates liability and/or plaintiffs. Moreover, judicial interpretations regarding application of various tort defenses, including application of various theories of joint and several liabilities, impedecoverage circumstances particular to those accounts. As a result, the Company’s ability to estimate its ultimate liabilityCompany increased pollution reserves for such claims.

prior accident years by $50 million in 2005.

Net Prior Year Development

2004 Net Prior Year Development

Unfavorable net prior year development of $125$185 million, including $241$251 million of unfavorable claim and allocated claim adjustment expense reserve development and $66 million of favorable premium development, was recorded in 2006. Unfavorable net prior year development of $807 million, including $945 million of unfavorable claim and allocated claim adjustment expense reserve development and $138 million of favorable premium development, was recorded in 2005. Unfavorable net prior year development of $134 million, including $250 million of unfavorable claim and allocated claim adjustment expense reserve development and $116 million of favorable premium development, was recorded in

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2004.


2004. The development discussed below includes premium development due to its direct relationship to claim and claim adjustment expense reserve development. The development discussed below isexcludes the amount priorimpact of the provision for uncollectible reinsurance, but includes the impact of commutations. See Note H for further discussion of the provision for uncollectible reinsurance.

In 2005 and 2004, the Company recorded favorable or unfavorable premium and claim and claim adjustment expense reserve development related to considerationthe corporate aggregate reinsurance treaties as movements in the claim and allocated claim adjustment expense reserves for the accident years covered by the corporate aggregate reinsurance treaties indicated such development was required. While the available limit of any relatedthese treaties was fully utilized in 2003, the ceded premiums and losses for an individual segment changed in subsequent years because of the re-estimation of the subject losses or commutations of the underlying contracts. In 2005, the Company commuted a significant corporate aggregate reinsurance allowance impacts.

treaty and in 2006, the Company commuted its remaining corporate aggregate reinsurance treaty. See Note H for further discussion of the corporate aggregate reinsurance treaties.

The following table summarizestables and discussion include the pretax 2004 net prior year development recorded for the Standard Lines, Specialty Lines and Corporate and Other Non-Core segments.

2004 Net Prior Year Development

                 
          Corporate  
  Standard Specialty and Other  
(In millions) Lines
 Lines
 Non-Core
 Total
Pretax unfavorable net prior year claim and allocated claim adjustment expense development excluding the impact of corporate aggregate reinsurance treaties:                
Property and casualty, excluding APMT $105  $75  $23  $203 
APMT        55   55 
   
 
   
 
   
 
   
 
 
Total  105   75   78   258 
Ceded losses related to corporate aggregate reinsurance treaties  8   (17)  9    
   
 
   
 
   
 
   
 
 
Pretax unfavorable net prior year development before impact of premium development  113   58   87   258 
   
 
   
 
   
 
   
 
 
Unfavorable (favorable) premium development, excluding impact of corporate aggregate reinsurance treaties  (96)  (33)  12   (117)
Ceded premiums related to corporate aggregate reinsurance treaties  (1)  5   (3)  1 
   
 
   
 
   
 
   
 
 
Pretax unfavorable (favorable) premium development  (97)  (28)  9   (116)
   
 
   
 
   
 
   
 
 
Total 2004 unfavorable net prior year development (pretax)
 $16  $30  $96  $142 
   
 
   
 
   
 
   
 
 

Also included infor the 2004 net prior year development is Life and Group Non-Core and unallocated loss adjustment expense reserve development.

Standard Lines

The gross and net carried claim and claim adjustment expense reserves were $14,302 million and $9,303 million atyears ended December 31, 2004. The gross2006, 2005 and net carried claim and claim adjustment expense reserves for Standard Lines were $14,282 million and $8,967 million at December 31, 2003.2004. Unfavorable net prior year development of $16$13 million including $113was recorded in the Life and Group Non-Core segment for the year ended December 31, 2006. Favorable net prior year development of $5 million and $7 million was recorded in the Life and Group Non-Core segment for the years ended December 31, 2005 and 2004.

2006 Net Prior Year Development
                 
          Corporate    
  Standard  Specialty  and Other    
(In millions) Lines  Lines  Non-Core  Total 
Pretax unfavorable (favorable) net prior year claim and allocated claim adjustment expense reserve development:                
 
Core (Non-APMT) $157  $(10) $23  $170 
APMT        63   63 
             
                 
Pretax unfavorable (favorable) net prior year development before impact of premium development  157   (10)  86   233 
             
                 
Total unfavorable (favorable) premium development  (88)  25   2   (61)
             
                 
Total 2006 unfavorable net prior year development (pretax)
 $69  $15  $88  $172 
             

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2005 Net Prior Year Development
                 
          Corporate    
  Standard  Specialty  and Other    
(In millions) Lines  Lines  Non-Core  Total 
Pretax unfavorable net prior year claim and allocated claim adjustment expense reserve development, excluding the impact of corporate aggregate reinsurance treaties:                
 
Core (Non-APMT) $376  $42  $171  $589 
APMT        63   63 
             
                 
Total  376   42   234   652 
Ceded losses related to corporate aggregate reinsurance treaties  183   5   57   245 
             
                 
Pretax unfavorable net prior year development before impact of premium development  559   47   291   897 
             
                 
Unfavorable (favorable) premium development, excluding impact of corporate aggregate reinsurance treaties  (101)  (12)  11   (102)
Ceded premiums related to corporate aggregate reinsurance treaties  (6)  19   4   17 
             
                 
Total unfavorable (favorable) premium development  (107)  7   15   (85)
             
                 
Total 2005 unfavorable net prior year development (pretax)
 $452  $54  $306  $812 
             
2004 Net Prior Year Development
                 
          Corporate    
  Standard  Specialty  and Other    
(In millions) Lines  Lines  Non-Core  Total 
Pretax unfavorable net prior year claim and allocated claim adjustment expense reserve development, excluding the impact of corporate aggregate reinsurance treaties:                
 
Core (Non-APMT) $107  $75  $20  $202 
APMT        55   55 
             
                 
Total  107   75   75   257 
Ceded losses related to corporate aggregate reinsurance treaties  8   (17)  9    
             
                 
Pretax unfavorable net prior year development before impact of premium development  115   58   84   257 
             
                 
Unfavorable (favorable) premium development, excluding impact of corporate aggregate reinsurance treaties  (96)  (33)  12   (117)
Ceded premiums related to corporate aggregate reinsurance treaties  (1)  5   (3)  1 
             
                 
Total unfavorable (favorable) premium development  (97)  (28)  9   (116)
             
                 
Total 2004 unfavorable net prior year development (pretax)
 $18  $30  $93  $141 
             

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2006 Net Prior Year Development
Standard Lines
Approximately $119 million of unfavorable claim and allocated claim adjustment expense reserve development was due to reinsurance commutation activity that took place in the fourth quarter of 2006. Approximately $82 million of unfavorable claim and $97allocated claim adjustment expense reserve development was related to casualty lines of business, primarily workers’ compensation, due to continued claim cost inflation in older accident years, primarily 2002 and prior. The primary drivers of the continuing claim cost inflation are medical inflation and advances in medical care.
Favorable claim and allocated claim adjustment expense reserve development of approximately $88 million was recorded in relation to the short-tail coverages such as property and marine, primarily in accident years 2004 and 2005. The favorable results are primarily due to the underwriting actions taken by the Company that have significantly improved the results on this business and favorable outcomes on individual claims.
The majority of the favorable premium development was due to additional premium primarily resulting from audits and changes to premium on several ceded reinsurance agreements. Business impacted included various middle market liability coverages, workers’ compensation, property, and large accounts. This favorable premium development was partially offset by approximately $44 million of unfavorable claim and allocated claim adjustment expense reserve development recorded as a result of this favorable premium development.
Specialty Lines
Approximately $55 million of unfavorable claim and allocated claim adjustment expense reserve development was recorded due to increased claim adjustment expenses and increased severities in the architects and engineers book of business in accident years 2003 and prior. Previous reviews assumed that incurred severities had increased, at least in part, due to increases in the adequacy of case reserve estimates with relatively minor changes in underlying severity. Subsequent changes in paid and case incurred losses have shown that more of the change was due to underlying increases in verdict and settlement size for these accident years rather than increases in case reserve adequacy, resulting in higher ultimate losses. One of the primary drivers of these larger verdicts and settlements is the continuing general increase in commercial and private real estate values.
Approximately $60 million of favorable claim and allocated claim adjustment expense reserve development was due to improved claim severity and claim frequency in the healthcare professional liability business, primarily in dental, nursing home liability, physicians and other healthcare facilities. The improved severity and frequency are due to underwriting changes. The Company no longer writes large national nursing home chains and focuses on smaller insureds in selected areas of the country. These changes have resulted in business that experiences fewer large claims.
Approximately $15 million of unfavorable claim and allocated claim adjustment expense reserve development was primarily related to increased severity on individual large claims from large law firm errors and omissions (E&O), and directors and officers (D&O) coverages. These increases result in higher ultimate loss projections from the average loss methods used by the Company’s actuaries.
Approximately $17 million of favorable claim and allocated claim adjustment expense reserve development was recorded in the warranty line of business for accident years 2004 and 2005. The reserves for this business are initially estimated based on the loss ratio expected for the business. Subsequent estimates rely more heavily on the actual case incurred losses due to the short-tail nature of this business. The short-tail nature of the business is due to the short period of time that passes between the time the business is written and the time when all claims are known and settled. Case incurred loss for the most recent accident year has been lower than indicated by the initial loss ratio.
The majority of the unfavorable premium development was related to ceded reinsurance activity.
Corporate and Other Non-Core
The majority of the unfavorable claim and allocated claim adjustment expense reserve development was related to the Company’s exposure arising from other mass tort claims. Such claims typically involve allegations by multiple plaintiffs alleging injury resulting from exposure to or use of similar substances or products over multiple policy periods. Examples include, but are not limited to, lead paint claims, hardboard siding, polybutylene pipe, mold,

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silica, latex gloves, benzene products, welding rods, diet drugs, breast implants, medical devices, and various other toxic chemical exposures. During the Company’s 2006 ground up review, the Company noted adverse development in various mass tort accounts. The adverse development results primarily from increases related to defense costs in a small number of accounts arising out of various substances and products.
2005 Net Prior Year Development
Standard Lines
During the fourth quarter of 2005, the Company executed commutation agreements with certain reinsurers, including the commutation of a corporate aggregate reinsurance agreement. These agreements resulted in approximately $285 million of unfavorable claim and allocated claim adjustment expense reserve development. This unfavorable claim and allocated claim adjustment expense reserve development was partially offset by a release of a previously established allowance for uncollectible reinsurance.
Also, in the fourth quarter of 2005, reserve reviews of certain products were conducted and changes in reserve estimates were recorded. Approximately $102 million of unfavorable claim and allocated claim adjustment expense reserve development was due to higher frequency and severity on claims related to excess workers’ compensation, particularly in accident years 2003 and prior. The primary drivers of the higher frequency and severity were increasing medical inflation and advances in medical care. Medical inflation increases the cost of claims resulting in more claims reaching the excess layers covered by the Company. Medical inflation also increases the size of claims in the Company’s layers. Similarly, advances in medical care extend the life expectancies of claimants again resulting in additional costs to be covered by the Company as well as more claims reaching the excess layers covered by the Company.
In addition, approximately $4 million of unfavorable claim and allocated claim adjustment expense reserve development was recorded due to increased severity on known claims on package policies provided to small businesses in accident years 2002 and 2003. Approximately $10 million of favorable claim and allocated claim adjustment expense reserve development was due to lower severities in the excess and surplus lines runoff business in accident years 2001 and prior. These severity changes were driven primarily by judicial decisions and settlement activities on individual cases.
Approximately $23 million of favorable claim and allocated claim adjustment expense reserve development was related to favorable loss trends on accident years 2002 and subsequent in the Company’s international business, specifically Europe and Canada, primarily in property, cargo and marine coverages. Approximately $4 million of favorable net prior year claim and allocated claim adjustment expense reserve development was due to less than expected losses in involuntary business.
Approximately $140 million of favorable net prior year claim and allocated claim adjustment expense reserve development was recorded due to improvement in the severity and number of claims for property coverages and marine business, primarily in accident year 2004. The improvements in severity and frequency are substantially due to underwriting actions taken by the Company that have significantly improved the results on this business.
Approximately $126 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development resulted from increased severity trends for workers’ compensation, primarily in accident year 2002 and prior. The primary drivers of the higher severity trends were increasing medical inflation and advances in medical care. Medical inflation increases the cost of medical services, and advances in medical care extend the life expectancies of claimants resulting in additional costs to be covered by the Company.
Approximately $15 million of unfavorable premium development was recorded in relation to this unfavorable net prior year claim and allocated claim adjustment expense reserve development which resulted from additional ceded reinsurance premium on agreements where the ceded premium is impacted by the level of ceded losses.
Approximately $90 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development and $83 million of favorable net prior year premium development resulted from an unfavorable arbitration ruling on two reinsurance treaties.

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Approximately $76 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development was attributed to increased severity in liability coverages for large account policies. These increases are driven by increasing medical inflation and larger verdicts than anticipated, both of which increase the severity of these claims.
Approximately $53 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development was related to reviews of liquor liability, trucking and habitational business that indicated that the number of large claims was higher than previously expected in recent accident years. The remainder of the favorable net prior year claim and allocated claim adjustment expense reserve development was primarily a result of improved experience on several coverages on middle market business, mainly in accident year 2004.
Favorable net prior year premium development was recorded primarily as a result of additional premium resulting from audits on recent policies, primarily workers’ compensation.
Additionally, there was $19 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development and $6 million of favorable premium development related to the corporate aggregate reinsurance treaties, excluding the impact of a corporate aggregate reinsurance commutation as discussed above.
Specialty Lines
Approximately $60 million of unfavorable claim and allocated claim adjustment expense reserve development was recorded due to increased claim adjustment expenses and increased severities in the architects and engineers book of business, in accident years 2000 through 2003. Previous reviews assumed that severities had increased, at least in part, due to increases in the adequacy of case reserve estimates. Subsequent changes in paid and incurred loss have shown that more of the change was due to larger verdicts and settlements during these accident years. One of the primary drivers of these larger verdicts and settlements is the continuing general increase in real estate values. Favorable net prior year premium development of approximately $10 million was recorded in relation to this unfavorable claim and allocated claim adjustment expense reserve development.
Approximately $45 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development was related to large D&O claims assumed from a London syndicate, primarily in accident years 2001 and prior. Approximately $43 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development was recorded due to large claims under excess coverages provided to health care facilities.
Approximately $32 million of favorable claim and allocated claim adjustment expense reserve development related to surety business was due to a favorable outcome on several specific large claims and lower than expected emergence of additional large claims related to accident years 1999 through 2003.
Approximately $30 million of unfavorable claim and allocated claim adjustment expense reserve development was related to a commutation agreement executed in the fourth quarter of 2005 of a corporate aggregate reinsurance agreement. This unfavorable claim and allocated claim adjustment expense reserve development was partially offset by a release of a previously established allowance for uncollectible reinsurance.
Approximately $24 million of favorable net prior year claim and allocated claim adjustment expense reserve development was recorded as a result of improvements in the claim severity and claim frequency, mainly in recent accident years, from nursing home businesses. The improved severity and frequency are due to underwriting changes in this business. The Company no longer writes large national chains and focuses on smaller insureds in selected areas of the country. These changes have resulted in business that experiences fewer large claims.
Approximately $14 million of favorable net prior year claim and allocated claim adjustment expense reserve development was recorded due to lower severity in the dental program. The lower severity is driven by efforts to resolve a higher percentage of claims without a resulting indemnity payment.
The remainder of the favorable net prior year claim and allocated claim adjustment expense reserve development was primarily attributed to favorable experience in the warranty line of business, partially offset by unfavorable net prior year claim and allocated claim adjustment expense reserve development attributed to other large D&O claims.
Additionally, there was approximately $25 million of favorable net prior year claim and allocated claim adjustment expense reserve development and $19 million of unfavorable premium development related to the corporate aggregate reinsurance treaties in 2005, excluding the impact of a corporate aggregate reinsurance commutation as discussed above.

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Corporate and Other Non-Core
Approximately $157 million of unfavorable claim and allocated claim adjustment expense reserve development was attributable to the Company’s assumed reinsurance operations, driven by a significant increase in large claim activity during 2005 across multiple accident years. This development was concentrated in the proportional liability, excess of loss liability, and professional liability businesses, which impact underlying coverages that include general liability, umbrella, E&O and D&O. The Company’s assumed reinsurance operations were put in run-off in 2003.
During the fourth quarter of 2005, the Company executed significant commutation agreements with certain reinsurers, including the commutation of a corporate aggregate reinsurance agreement. These agreements resulted in approximately $62 million of unfavorable claim and allocated claim adjustment expense reserve development.
Approximately $56 million of unfavorable claim and allocated claim adjustment expense reserve development recorded in 2005 was a result of a second quarter commutation of a finite reinsurance contract put in place in 1992. CNA recaptured $400 million of losses and received $344 million of cash. The commutation was economically attractive because of the reinsurance agreement’s contractual interest rate and maintenance charges.
Approximately $6 million of unfavorable claim and allocated claim adjustment expense reserve development was related to the corporate aggregate reinsurance treaties, excluding the impact of a corporate aggregate reinsurance commutation as discussed above. The unfavorable premium development was driven by $10 million of additional ceded reinsurance premium on agreements where the ceded premium depends on the ceded loss and $4 million of additional premium ceded to the corporate aggregate reinsurance treaties.
The Company noted adverse development in various pollution accounts in its most recent ground up review. In the course of its review, the Company did not observe a negative trend or deterioration in the underlying pollution claims environment. Rather, individual account estimates changed due to changes in liability and/or coverage circumstances particular to those accounts. As a result, the Company increased pollution reserves by $50 million in 2005.
The overall unfavorable claim and allocated claim adjustment expense reserve development was partially decreased by favorable claim and allocated claim adjustment expense reserve development in various other programs in runoff, including Financial Guarantee, Guarantee and Credit, and Mortgage Guarantee. These programs have recently exhibited favorable trends due to offsetting recoveries and commutations, leading to reductions in the estimated liabilities.
2004 for Net Prior Year Development
Standard Lines.

Lines

Approximately $190 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development recorded during 2004 resulted from increased severity trends for workersworkers’ compensation on large account policies primarily in accident years 2002 and prior. The primary drivers of the higher severity trends were increasing medical inflation and advances in medical care. Medical inflation increases the cost of medical services, and advances in medical care extend the life expectancies of claimants resulting in additional costs to be covered by the Company. Favorable premium development on retrospectively rated large account policies of $50 million was recorded in relation to this unfavorable net prior year claim and allocated claims adjustment expense reserve development.

Approximately $60 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development was recorded in involuntary pools in which the Company’s participation is mandatory and primarily based on premium writings. Approximately $15 million of this unfavorable net prior year claim and allocated claim adjustment expense reserve development was related to the Company’s share of the National WorkersWorkers’ Compensation Reinsurance Pool (NWCRP). During 2004, the NWCRP reached an agreement with a former pool member to settle their pool liabilities at an amount less than their established share. The result of this settlement will beis a higher allocation to the remaining pool members, including the Company. The remainder of this unfavorable net prior year

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claim and allocated claim adjustment expense reserve development was primarily due to increased severity trends for workersworkers’ compensation exposures in older years.

Approximately $60 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development resulted from the change in estimates due to increased severity trends for excess and surplus business

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driven by excess liability, liquor liability and coverages provided to apartment and condominium complexes. These severity changes were driven primarily by judicial decisions and settlement activities on individual cases.
Approximately $105 million of favorable net prior year claim and allocated claim adjustment expense reserve development resulted from reserve studies of commercial auto liability policies and the liability portion of package policies. The change was due to improvement in the severity and number of claims for this business. This is primarily due to a lower than expected number of large claims. Approximately $85 million of favorable net prior year claim and allocated claim adjustment expense reserve development was due to improvement in the severity and number of claims for property coverages primarily in accident year 2003.

The improvements in severity and frequency are substantially due to underwriting actions taken by the Company that have significantly improved the results on this business. Other favorable net prior year premium development of approximately $50 million resulted primarily from higher audit and endorsement premiums on workersworkers’ compensation policies.

During 2004, the Company executed commutation agreements with several members of the Trenwick Group.Trenwick. These commutations resulted in unfavorable claim and claim adjustment expense reserve development which was more than offset by a release of a previously established allowance for uncollectible reinsurance.

Specialty Lines

The gross and net carried claim and claim adjustment expense reserves were $4,860 million and $3,233 million at December 31, 2004. The gross and net carried claim and claim adjustment expense reserves for Specialty Lines were $4,200 million and $2,919 million at December 31, 2003. Unfavorable net prior year development of $30 million, including $58 million of unfavorable net claim and allocated claim adjustment expense reserve development and $28 million of favorable premium development, was recorded in 2004 for Specialty Lines.

The Company executed commutation agreements with several members of the Trenwick Group during 2004. These commutations resulted in unfavorable claim and claim adjustment expense reserve development which was more than offset by a release of a previously established allowance for uncollectible reinsurance. Additionally, unfavorable net prior year claim and allocated claim adjustment expense reserve development resulted from the increased emergence of several large directors and officers (D&O)D&O claims, primarily in recent accident years.

Corporate and Other Non-Core

The gross and net carried claim and claim adjustment expense reserves were $8,678 million and $3,176 million at December 31, 2004. The gross and net carried claim and claim adjustment expense reserves for Corporate and Other Non-Core were $9,672 million and $3,737 million at December 31, 2003. Unfavorable net prior year development of $96 million, including $87 million of net unfavorable claim and allocated claim adjustment expense reserve development and $9 million of unfavorable premium development was recorded in 2004 for Corporate and Other Non-Core.

In 2004, the Company executed commutation agreements with several members of the Trenwick Group.Trenwick. These commutations resulted in unfavorable net prior claim and allocated claim adjustment expense reserve development partially offset by a release of a previously established allowance for uncollectible reinsurance. The remainder of the unfavorable net prior year claim and allocated claim adjustment expense reserve development resulted from several other small commutations and increases to net reserves due to reducing ceded losses, partially offset by a release of a previously established allowance for uncollectible reinsurance.

Note G. Legal Proceedings and Contingent Liabilities
2003 Net Prior Year DevelopmentInsurance Brokerage Antitrust Litigation

Unfavorable net prior year development

On August 1, 2005, CNAF and several of $2,952 million, including $2,409 millionits insurance subsidiaries were joined as defendants, along with other insurers and brokers, in multidistrict litigation pending in the United States District Court for the District of New Jersey,In re Insurance Brokerage Antitrust Litigation, Civil No. 04-5184 (FSH). The plaintiffs in this litigation allege improprieties in the payment of contingent commissions to brokers and bid rigging in connection with the sale of various lines of insurance. The plaintiffs further allege the existence of a conspiracy and assert claims for federal and state antitrust law violations, for violations of the federal Racketeer Influenced and Corrupt Organizations Act and for recovery under various state common law theories. By an order entered on October 3, 2006, the Court required the plaintiffs to supplement their pleadings with a statement setting forth the details of their claims. The Company believes it has meritorious defenses to this action and intends to defend the case vigorously.
The extent of losses beyond any amounts that may be accrued are not readily determinable at this time. However, based on facts and circumstances presently known, in the opinion of management, an unfavorable claimoutcome will not materially affect the equity of the Company, although results of operations may be adversely affected.
Global Crossing Limited Litigation
CCC has been named as a defendant in an action brought by the bankruptcy estate of Global Crossing Limited (Global Crossing) in the United States Bankruptcy Court for the Southern District of New York. In the Complaint, served on CCC on May 24, 2005, plaintiff seeks unspecified monetary damages from CCC and claim adjustment expense reserve developmentthe other defendants for alleged fraudulent transfers and $543 millionalleged breaches of unfavorable premium development,fiduciary duties arising from actions taken by Global Crossing while CCC was recordeda shareholder of Global Crossing. On August 3, 2006, the Court granted in

part and

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2003. The development discussed below includes premium development due

denied in part CCC’s motion to its direct relationshipdismiss the Estate Representative’s Amended Complaint. CCC believes it has meritorious defenses to claim and claim adjustment expense reserved development. The development discussed below is the amount prior to consideration of any related reinsurance allowance impacts.

The following table summarizes the pretax 2003 net prior year development for the Standard Lines, Specialty Lines and Corporate and Other Non-Core segments.

2003 Net Prior Year Development

                 
          Corporate  
  Standard Specialty and Other  
(In millions) Lines
 Lines
 Non-Core
 Total
Pretax unfavorable net prior year claim and allocated claim adjustment expense development excluding the impact of corporate aggregate reinsurance treaties:                
                 
Property and casualty, excluding APMT $1,424  $313  $355  $2,092 
APMT        795   795 
   
 
   
 
   
 
   
 
 
Total  1,424   313   1,150   2,887 
Ceded losses related to corporate aggregate reinsurance treaties  (485)  (56)  (102)  (643)
   
 
   
 
   
 
   
 
 
Pretax unfavorable net prior year development before impact of premium development  939   257   1,048   2,244 
   
 
   
 
   
 
   
 
 
Unfavorable (favorable) premium development, excluding impact of corporate aggregate reinsurance treaties  211   6   (32)  185 
Ceded premiums related to corporate aggregate reinsurance treaties  269   31   58   358 
   
 
   
 
   
 
   
 
 
Pretax unfavorable premium development  480   37   26   543 
   
 
   
 
   
 
   
 
 
Total 2003 unfavorable net prior year development (pretax)
 $1,419  $294  $1,074  $2,787 
   
 
   
 
   
 
   
 
 

Also included in the 2003 net prior year development is Life and Group Non-Core and unallocated loss adjustment expense reserve development.

Standard Lines

Unfavorable net prior year development of $1,419 million, including $939 million of unfavorable claim and allocated claim adjustment expense reserve development and $480 million of unfavorable premium development, was recorded in 2003 for Standard Lines.

Approximately $495 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development was recorded related to construction defectremaining claims in 2003. Based on analyses completed during 2003, it became apparent that the assumptions regarding the number of claims, which were used to estimate the expected losses, were no longer appropriate. The analyses indicated that the actual number of claims reported during 2003 was higher than expected primarily in states other than California. States where this activity is most evident include Texas, Arizona, Nevada, Washingtonaction and Colorado. The number of claims reported in states other than California during the first six months of 2003 was almost 35% higher than the last six months of 2002. The number of claims reported during the last six months of 2002 increased by less than 10% from the first six months of 2002. In California, claims resulting from additional insured endorsements increased throughout 2003. Additional insured endorsements are regularly included on policies provided to subcontractors. The additional insured endorsement names general contractors and developers as additional insureds covered by the policy. Current California case law (Presley Homes, Inc. v. American States Insurance Company,(June 11, 2001) 90 Cal App. 4th 571, 108 Cal. Rptr. 2d 686) specifies that an individual subcontractor with an additional insured obligation has a dutyintends to defend the additional insuredcase vigorously.

The extent of losses beyond any amounts that may be accrued are not readily determinable at this time. However, based on facts and circumstances presently known, in the entire action, subject to contribution or recovery later. In addition,opinion of management, an unfavorable outcome will not materially affect the additional insured is allowed to choose one specific carrier to defend the entire action. These additional insured claims can remain open

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for a longer period of time than other construction defect claims because the additional insured defense obligation can continue until the entire case is resolved. The adverse reserve development recorded related to construction defect claims was primarily related to accident years 1999 and prior.

Unfavorable net prior year development of approximately $595 million, including $518 million of unfavorable claim and allocated claim adjustment expense reserve development and $77 million of unfavorable premium development, was recorded for large account business including workers compensation coverages in 2003. Manyequity of the policies issued to these large accounts include provisions tailored specifically to the individual accounts. Such provisions effectively result in the insured being responsible for a portion of the loss. An example of such a provision is a deductible arrangement where the insured reimburses the Company, for all amounts less than a specified dollar amount. These arrangements often limit the aggregate amount the insured is required to reimburse the Company. Analyses indicated that the provisions that result in the insured being responsible for a portion would have less of an impact due to the larger size of claims as well as the increased number of claims. The unfavorable net prior year development recorded was primarily related to accident years 2000 and prior.

Approximately $98 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development recorded in 2003, resulted from a program covering facilities that provide services to developmentally disabled individuals. This net prior year development was due to an increase in the size of known claims and increases in policyholder defense costs. With regard to average claim size, updated data showed the average claim increasing at an annual rate of approximately 20%. Prior data had shown average claim size to be level. Similar to the average claim size, updated data showed the average policyholder defense cost increasing at an annual rate of approximately 20%. Prior data had shown average policyholder defense cost to be level. The net prior year development recorded was primarily for accident years 2001 and prior.

Approximately $40 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development recorded in 2003 was for excess workers compensation coverages due to increasing severity. The increase in severity means that a higher percentage of the total loss dollars will be the Company’s responsibility since more claims will exceed the point at which the Company’s coverage begins. The net prior year development recorded was primarily for accident year 2000.

Approximately $73 million of unfavorable development recorded in 2003 was the result of a commutation of all ceded reinsurance treaties with Gerling Global Group of companies (Gerling), related to accident years 1999 through 2001, including $41 million of unfavorable claim and allocated claim adjustment expense development and $32 million of unfavorable premium development. Unfavorable net prior year claim and allocated claim adjustment expense reserve development of approximately $40 million recorded in 2003 was related to a program covering tow truck and ambulance operators, primarily impacting the 2001 accident year. The Company had previously expected that loss ratios for this business would be similar to its middle market commercial automobile liability business. During 2002, the Company ceased writing business under this program.

Approximately $25 million of unfavorable net prior year premium development recorded in 2003 was related to 2003 reevaluation of losses ceded to a reinsurance contract covering middle market workers compensation exposures. The reevaluation of losses led to a new estimate of the number and dollar amount of claims that would be ceded under the reinsurance contract. As a result of the reevaluation of losses, the Company recorded approximately $36 million of unfavorable claim and allocated claim adjustment expense reserve development, which was ceded under the contract. The net prior year development was recorded for accident year 2000.

Approximately $11 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development recorded for the year ended December 31, 2003 was related to directors and officers exposures in Global Lines. The unfavorable net prior year reserve development was primarily due to securities class action cases related to certain known corporate malfeasance cases and investment banking firms. This net prior year development recorded was primarily for accident years 2000 through 2002.

The following premium and claim and allocated claim adjustment expense development was recorded in the third quarter of 2003 as a result of the elimination of deficiencies and redundancies in reserve positions within the segment. Unfavorable net prior year development of approximately $210 million related to small and middle market workers compensation exposures and approximately $110 million related to E&S lines was recorded in 2003. Offsetting these increases was $210 million of favorable net prior year development in the property line of business,

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including $79 million related to the September 11, 2001 World Trade Center Disaster and related events (WTC event).

Also, offsetting the unfavorable premium and claim and allocated claim adjustment expense 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.

Specialty Lines

Unfavorable net prior year development of $294 million, including $257 million of unfavorable net claim and allocated claim adjustment expense reserve development and $37 million of unfavorable premium development, was recorded in 2003 for Specialty Lines.

Approximately $50 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development recorded in 2003 was related to increased severity in excess coverages provided to facilities providing health care services. The increase in reserves is based on reviews of individual accounts where claims had been expected to be less than the point at which the Company’s coverage applies. The current claim trends indicated that the layers of coverage provided by the Company would be impacted. The net prior year development recorded was primarily for accident years 2001 and prior.

Approximately $68 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development recorded in 2003 was for surety coverages primarily related to workers compensation bond exposure from accident years 1990 and prior and large losses for accident years 1999 and 2002. Approximately $21 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development was recorded in the surety line of business in 2003 as the result of recent developments on one large claim.

Approximately $75 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development recorded in 2003 was related to directors and officers exposures in CNA Pro. The unfavorable net prior year reserve development was primarily due to securities class action cases related to certain known corporate malfeasance cases and investment banking firms. This net prior year development recorded was primarily for accident years 2000 through 2002.

Approximately $84 million of losses was recorded for during 2003 as the result of a commutation of ceded reinsurance treaties with Gerling covering CNA Health Pro, relating to accident years 1999 through 2002.

The following 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 net prior year 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. See Note H for further discussion of the Company’s aggregate reinsurance treaties.

Corporate and Other Non-Core

Unfavorable net prior year development of $1,074 million, including $1,048 million of net unfavorable claim and allocated claim adjustment expense reserve development and $26 million of unfavorable premium development was recorded in 2003 for Corporate and Other Non-Core.

This development was primarily driven by $795 million of unfavorable net prior year claim and allocated claim adjustment expense reserve development related to APMT.

In addition to APMT development, there was unfavorable net prior year development recorded in 2003 related to CNA Re of $149 million and $75 million related to voluntary pools.

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Unfavorable net prior year claim and allocated claim adjustment expense reserve development of approximately $25 million was recorded in CNA Re primarily for directors and officers exposures. The unfavorable net prior year development was a result of a claims review that was completed during the second quarter of 2003. The unfavorable net prior year development was primarily due to securities class action cases related to certain known corporate malfeasance cases and investment banking firms. The unfavorable net prior year development recorded was for accident years 2000 and 2001.

The CNA Re unfavorable net prior year development for 2003 was also due to a general change in the pattern of how losses emerged over time as reported by the companies that purchased reinsurance from 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 had 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 was related to professional liability exposures in accident years 2001 and prior.

Additionally, CNA Re recorded $15 million of unfavorable net prior year development for construction defect related exposures. Because of the unique nature of this exposure, losses have not followed expected development patterns. The continued reporting of claims in California, the increase in the number of claims from states other than California and a review of individual ceding companies’ exposure to this type of claim resulted in an increase in the estimated reserve.

The following premium and claim and allocated claim adjustment expense development, was recorded in 2003 as a result of the elimination of deficiencies and redundancies in the reserve positions of individual products within CNA Re. Unfavorable net prior year premium and claim and allocated claim adjustment expense development of approximately $42 million related to Surety exposures, $32 million related to excess of loss liability exposures and $12 million related to facultative liability exposures were recorded in the third quarter of 2003.

Offsetting this unfavorable net prior year development was approximately $55 million of favorable net prior year development related to the WTC event as well as a $45 million underwriting benefit from cessions to corporate aggregate reinsurance treaties recorded in 2003. The benefit from cessions to the corporate aggregate reinsurance treaties was comprised of $102 million of ceded losses and $57 million of ceded premiums for accident years 2000 and 2001.

Unfavorable net prior year claim and allocated claim adjustment expense reserve development of approximately $75 million was recorded during the third quarter of 2003 related to an adverse arbitration decision involving a single large property and business interruption loss on a voluntary insurance pool. The decision was rendered against a voluntary insurance pool in which the Company was a participant. The loss was caused by a fire which occurred in 1995. The Company no longer participates in this pool.

2002 Net Prior Year Development

Unfavorable net prior year development of $126 million, including $35 million of unfavorable claim and claim adjustment expense reserve development and $91 million of unfavorable premium development, was recorded in 2002. The development discussed below includes premium development due to its direct relationship to claim and claim adjustment expense reserve development. The development discussed below is the amount prior to consideration of any related reinsurance allowance impacts.

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The following table summarizes the pretax 2002 net prior year development for the Standard Lines, Specialty Lines and Corporate and Other Non-Core segments.

2002 Net Prior Year Development

                 
          Corporate  
  Standard Specialty and Other  
(In millions) Lines
 Lines
 Non-Core
 Total
Pretax unfavorable (favorable) net prior year claim and allocated claim adjustment expense development excluding the impact of corporate aggregate reinsurance treaties:                
Property and casualty, excluding APMT $(191) $55  $248  $112 
APMT            
   
 
   
 
   
 
   
 
 
Total  (191)  55   248   112 
Ceded losses related to corporate aggregate reinsurance treaties  (14)  (41)  (93)  (148)
   
 
   
 
   
 
   
 
 
Pretax unfavorable (favorable) net prior year development before impact of premium development  (205)  14   155   (36)
   
 
   
 
   
 
   
 
 
Unfavorable (favorable) premium development, excluding impact of corporate aggregate reinsurance treaties  76   17   (103)  (10)
Ceded premiums related to corporate aggregate reinsurance treaties  10   29   62   101 
   
 
   
 
   
 
   
 
 
Pretax unfavorable (favorable) premium development  86   46   (41)  91 
   
 
   
 
   
 
   
 
 
Total 2002 unfavorable (favorable) net prior year development (pretax)
 $(119) $60  $114  $55 
   
 
   
 
   
 
   
 
 

Also included in the 2002 net prior year development is Life and Group Non-Core and unallocated loss adjustment expense reserve development.

Standard Lines

Favorable net prior year development of $119 million, including $205 million of favorable claim and allocated claim adjustment expense reserve development and $86 million of unfavorable premium development, was recorded in 2002 for Standard Lines. Approximately $140 million of favorable net prior year development was attributable to participation in the Workers Compensation Reinsurance Bureau (WCRB), a reinsurance pool, and residual markets. The favorable net prior year development for WCRB was the result of information received from the WCRB that reported thealthough results of a recent actuarial review. This information indicated that the Company’s net required reserves for accident years 1970 through 1996 were $60 million less than the carried reserves. In addition, during 2002, the Company commuted accident years 1965 through 1969 for a payment of approximately $5 million to cover carried reserves of approximately $13 million, resulting in further favorable net prior year development of $8 million. The favorable residual market net prior year development was the result of lower than expected paid loss activity during recent periods for accident years dating back to 1984. The paid losses during 2002 on prior accident years were approximately 60% of the previously expected amount.

In addition, Standard Lines had favorable net prior year 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 2002. Approximately one-half of this favorable net prior year development was recorded in accident years prior to 1999, with the remainder of the favorable net prior year development recorded in accident years 1999 to 2001.

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Approximately $50 million of favorable net prior year development during 2002 was recorded in commercial automobile liability. Most of the favorable net prior year development was from accident year 2000. An actuarial review completed during 2002 showed that underwriting actions had resulted in reducing the number of commercial automobile liability claims for recent accident years, especially the number of large losses.

Approximately $45 million of favorable net prior year development was recorded in property lines during 2002. The favorable net prior year 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.

Offsetting these favorable net prior year reserve development was approximately $100 million of unfavorable premium development in middle market workers compensation, approximately $70 million of unfavorable net prior year development in programs written in CNA E&S, approximately $30 million of unfavorable net prior year development on a contractors account package policy program and approximately $20 million of unfavorable net prior year development on middle market general liability coverages. The unfavorable net prior year development on workers compensation was principally due to additional reinsurance premiums for accident years 1999 through 2001.

A CNA E&S program, covering facilities that provide services to developmentally disabled individuals, accounts for approximately $50 million of the unfavorable net prior year development. The unfavorable net prior year development was due to an increase in the size of known claims and increases in policyholder defense costs. These increases became apparent as the result of an actuarial review completed during 2002, with most of the development recorded in accident years 1999 and 2000. The other program which contributed to the CNA E&S unfavorable net prior year development covers tow truck and ambulance operators in the 2000 and 2001 accident years. This program was started in 1999. The Company expected that loss ratios for this business wouldoperations may 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 were 25 points higher than the middle market commercial automobile liability loss ratios.

The marine business recorded unfavorable net prior year development of approximately $15 million during 2002. The remaining unfavorable net prior year development for the Marine business was due principally to unfavorable net prior year development on hull and liability coverages from accident years 1999 and 2000 offset by favorable reserve development on cargo coverages recorded for accident year 2001. Reviews completed during 2002 showed additional reported losses on individual large accounts and other bluewater business that drove the unfavorable hull and liability reserve development.

The unfavorable net prior year 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 then recent quarterly periods, the change in reported losses was higher than prior quarters, resulting in the unfavorable net prior year development.

adversely affected.

Specialty Lines

Unfavorable net prior year development of $60 million, including $14 million of unfavorable claim and allocated claim adjustment expense reserve development and $46 million of unfavorable premium development, was recorded in 2002 for Specialty Lines. Unfavorable net prior year development of approximately $180 million was recorded for CNA HealthPro in 2002 and was driven principally by medical malpractice excess products provided to hospitals and physicians and coverages provided to long term care facilities, principally national for-profit nursing homes. Approximately $100 million of the unfavorable net prior year development was related to assumed excess products and loss portfolio transfers, and was primarily driven by unexpected increases in the number of excess claims in accident years 1999 and 2000. The percentage of total claims greater than $1 million has increased by 33%, from less than 3% of all claims to more than 4% of all claims. CNA HealthPro no longer writes assumed excess products and loss portfolio transfers.

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Approximately $50 million of the unfavorable net prior year unfavorable development was related to long term care facilities. The unfavorable net prior year development principally impacted 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 was responsible for the remaining development in CNA HealthPro. The unfavorable net prior year 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 net prior year 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 this unfavorable net prior year development was favorable net prior year development in CNA Pro and for Enron-related exposures. Programs providing professional liability coverage to accountants, lawyers and realtors primarily drove favorable net prior year development of approximately $110 million in CNA Pro. Reviews of this business completed during 2002 indicated 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 net prior year development of $20 million was associated with a settlement with Enron. 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 was settled for less than the attachment point of this excess layer.

A $12 million underwriting benefit was recorded for the corporate aggregate reinsurance treaties in 2002, comprised of $41 million of ceded losses and $29 million of ceded premiums for accident year 2001.

Corporate and Other Non-Core

Unfavorable net prior year development of $114 million, including $155 million of unfavorable claim and allocated claim adjustment expense reserve development and $41 million of favorable premium development, was recorded in 2002 for Corporate and Other Non-Core. The development recorded in 2002 consisted primarily of CNA Re development.

The unfavorable net prior year development recorded in 2002 related primarily to CNA Re and 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.

Additionally, during 2002, CNA Re revised its estimate of premiums and losses related to the WTC event. In estimating CNA Re’s WTC event losses, the Company performed a treaty-by-treaty analysis of exposure. The Company’s original loss estimate was based on a number of assumptions including the loss to the industry, the loss to individual lines of business and the market share of CNA Re’s cedants. Information that became available in the first quarter of 2002 resulted in CNA Re increasing its estimate of WTC event related premiums and losses on its property facultative and property catastrophe business. The impact of increasing the estimate of gross WTC event losses by $144 million was fully offset on a net of reinsurance basis (before the impact of the CCC Cover) by higher reinstatement premiums and a reduction of return premiums. Approximately $95 million of CNA Re’s net WTC loss estimate was attributable to CNA Re U.K., which was sold in 2002.

A $32 million underwriting benefit was recorded for CNA Re for the corporate aggregate reinsurance treaties in 2002. The benefit was comprised of $93 million of ceded losses and $62 million of ceded premiums for accident year 2001.

Concerns about reinsurance security, prompted in part by rating agency downgrades of several reinsurers’ financial strength ratings, have impacted the reinsurance marketplace. Many ceding companies have sought provisions for

140


the collateralization of assumed reserves in the event of a financial strength ratings downgrade or other triggers. Before exiting the reinsurance market, CNA Re had been impacted by this trend and had entered into several contracts with rating or other triggers. Additionally, personal insurance unfavorable net prior year development of $35 million was recorded in 2002 on accident years 1997 through 1999. The unfavorable net prior year development was principally due to the then continuing policyholder defense costs associated with remaining open personal insurance claims. The unfavorable net prior year development was partially offset by favorable reserve development on other run-off business driven principally by financial and mortgage guarantee coverages from accident years 1997 and prior. The favorable net prior year development on financial and mortgage guarantee coverages resulted from a review of the underlying exposures and the outstanding losses, which showed that salvage and subrogation continues to be collected on these types of claims, thereby reducing estimated future losses net of anticipated reinsurance recoveries.

Note G. Legal Proceedings and Related Contingent Liabilities

IGI Contingency

In 1997, CNA Reinsurance Company Limited (CNA Re Ltd.) 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 Operationsgroup operations business unit participated as a pool member in the AAHRU Facility in varying percentages between 1997 and 1999.

A portion of the premiums assumed under the IGI Program related to United States workersworkers’ compensation “carve-out” business. Some of these premiums were received from John Hancock Mutual Life Insurance Company (John Hancock) under four excess of loss reinsurance treaties (the Treaties) issued by CNA Re Ltd. While John Hancock has indicated that it is not able to accurately quantify its potential exposure to its cedents on business which is retroceded to CNA, John Hancock has reported $172$280 million of paid and unpaid losses under these Treaties. John Hancock is disputing portions of its assumed obligations resulting in these reported losses, and has advised CNA that it is, or has been, involved in multiple arbitrations with its own cedents, in which proceedings John Hancock is seeking to avoid and/or reduce risks that would otherwise arguably be ceded to CNA through the Treaties. John Hancock has further informed CNA that it has settled several of these disputes, but has not provided CNA with details of the settlements. To the extent that John Hancock is successful in reducing its liabilities in these disputes, that development may have an impact on the recoveries it is seeking under the Treaties from CNA.

As indicated, CNA arranged substantial reinsurance protection to manage its exposures under the IGI Program, including the United States workersworkers’ compensation carve-out“carve-out” business ceded from John Hancock and other reinsurers. While certain reinsurers of CNA, including participants in the AAHRU Facility, disputed their liabilities under the reinsurance contracts with respect to the IGI Program, those disputes have been resolved and substantial reinsurance coverage exists for those exposures.

In addition,

CNA has instituted arbitration proceedings against John Hancock in which CNA is seeking rescission of the Treaties as well as access to and the right to inspect the books and records relating to the Treaties. Discovery is ongoing in that arbitration proceeding and a hearing is currently scheduled for April 2007. Based on information known at this time, CNA believes it has strong grounds to successfully challenge its alleged exposure derived from John Hancock through the ongoing arbitration proceedings. CNA has also undertaken legal action seeking to avoid portions of the remaining exposure arising out of the IGI Program.

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CNA has established reserves for its estimated exposure under the IGI Program, other than that derived from John Hancock, and an estimate for recoverables from retrocessionaires. CNA has not established any reserve for any exposure derived from John Hancock because, as indicated, CNA believes the contract will be rescinded. Although the results of the Company’s various loss mitigation strategies with respect to the entire IGI Program to date support the recorded reserves, the estimate of ultimate losses is subject to considerable uncertainty due to the complexities described above.above, and the Company’s inability to guarantee any outcome in the arbitration proceedings. As a result of these uncertainties, the results of operations in future periods may be adversely affected by potentially significant reserve additions. However, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time. Management does not believe that any such reserve additions would be material to the equity of the Company, although results of operations may be adversely affected.Company. The Company’s position in relation to the IGI Program was unaffected by the sale of CNA Re Ltd. in 2002.

106


CaliforniaNew Jersey Wage and Hour Litigation

Ernestine Samora, et al.W. Curtis Himmelman, individually and on behalf of all others similarly situated v. CCCContinental Casualty Company, Case No. BC 242487, SuperiorCivil Action: 06-166, District Court of California, County of Los Angeles, California andBrian Wenzel v. Galway Insurance Company, Superior Court of California, County of Orange No. BC01CC08868 areNew Jersey (Trenton Division) is a purported class actionsaction and representative action brought on behalf of present and former CNA employeesenvironmental claims analysts and workers’ compensation claims analysts asserting they worked hours for which they should have been compensated at a rate of one and one-half times their base hourly wage. The Complaint was filed on January 12, 2006. The claims were originally brought under both federal and New Jersey state wage and hour laws on the basis that the relevant jobs are not exempt from overtime pay because the duties performed are not exempt duties. On August 11, 2006, the Court dismissed plaintiff’s New Jersey state law claims. Under federal law, plaintiff seeks to represent others similarly situated who opt in to the action and who also allege they are owed overtime pay for hours worked over a four-year period. Plaintiffs seekeight hours per day and/or forty hours per workweek for the period January 5, 2003 to the entry of judgment. Plaintiff seeks “overtime compensation,” “penalty wages,”“compensatory, punitive and “other statutory penalties”damages, interest, costs and disbursements and attorneys’ fees” without specifying any particular amounts.amounts (as well as an injunction). The Company has denieddenies the material allegations of the amended complaintComplaint and intends to vigorously contest the claims.

Numerous unresolved factualclaims on numerous substantive and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time. However, based on facts and circumstances presently known in the opinion of management, an unfavorable outcome would not materially adversely affect the equity of the Company, although results of operations may be adversely affected.

Voluntary Market Premium Litigation

CNA, along with dozens of other insurance companies, is currently a defendant in nine cases, including eight purported class actions, brought by large policyholders. procedural grounds.

The complaints differ in some respects, but generally allege that the defendants, as part of an industry-wide conspiracy, included improper charges in their retrospectively rated and other loss-sensitive insurance programs. Among the claims asserted are violations of state antitrust laws, breach of contract, fraud and unjust enrichment. In one federal court case,Sandwich Chef of Texas, Inc. v. Reliance National Indemnity Insurance Co., 202 F.R.D. 480 (S.D. Tex. 2001), rev’d, 319 F.3d 205 (5th Cir. 2003), cert. denied, 72 USLW 3235 (U.S. Oct 6, 2003), the United States Court of Appeals for the Fifth Circuit reversed a decision by the District Court for the Southern District of Texas certifying a multi-state class. The Company intends to vigorously contest these claims.

Numerous unresolved factual and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time. However, based on facts and circumstances presently known, in the opinion of management, an unfavorable outcome will not materially affect the equity of the Company, although results of operations may be adversely affected.

APMTCalifornia Long Term Care Litigation
Shaffer v. Continental Casualty Company, et al., U.S. District Court, Central District of California, CV06-2235 RGK, is a class action on behalf of certain California long term health care policyholders, alleging that CCC knowingly used unrealistic actuarial assumptions in pricing these policies, which according to plaintiff, would inevitably necessitate premium increases. The plaintiff asserts claims for intentional fraud, negligent misrepresentation, and violations of various California statutes. On January 26, 2007, the court certified the case to proceed as a class action, although CCC is currently seeking review of that decision in the Ninth Circuit Court of Appeals. CCC has denied the material allegations of the amended complaint and intends to vigorously contest the claims.
Numerous unresolved factual and legal issues remain that are critical to the final result, the outcome of which cannot be predicted with any reliability. Accordingly, the extent of losses are not readily determinable at this time. However, based on facts and circumstances presently known in the opinion of management, an unfavorable outcome would not materially adversely affect the equity of the Company, although results of operations may be adversely affected.
Asbestos, Environmental Pollution and Mass Tort (APMT) Reserves

CNA is also a party to litigation and claims related to APMT cases arising in the ordinary course of business. See Note F for further discussion.

142


Other Litigation

CNA is also a party to other litigation arising in the ordinary course of business. Based on the facts and circumstances currently known, such other litigation will not, in the opinion of management, materially affect the results of operations or equity of CNA.

Note H. Reinsurance

CNA assumes and cedes reinsuranceinsurance to other insurers, reinsurers and members of various reinsurance pools and associations. CNA utilizes reinsurance arrangements to limit its maximum loss, provide greater diversification of risk, minimize exposures on larger risks and to exit certain lines of business. The ceding of insurance does not discharge the primary liability of the Company. Therefore, a credit exposure exists with respect to property and casualty and life reinsurance ceded to the extent that any reinsurer is unable to meet theirits obligations or to the extent that the reinsurer disputes the liabilities assumed under reinsurance agreements.

Property and casualty reinsurance coverages are tailored to the specific risk characteristics of each product line and CNA’s retained amount varies by type of coverage. Treaty reinsurance isReinsurance contracts are purchased to protect specific lines of business such as property, workersworkers’ compensation and professional liability. Corporate catastrophe reinsurance is also purchased for property and workers

107


workers’ compensation exposure. Most treaty reinsurance iscontracts are purchased on an excess of loss basis. CNA also utilizes facultative reinsurance in certain lines.

The Company’s overall In addition, CNA assumes reinsurance program includes certain propertyas a member of various reinsurance pools and casualty contracts, such as the corporate aggregate reinsurance treaties discussed in more detail below, that are entered into and accounted for on a “funds withheld” basis. Under the funds withheld basis, the Company records the cash remitted to the reinsurer for the reinsurer’s margin, or cost of the reinsurance contract, as ceded premiums. The remainder of the premiums ceded under the reinsurance contract not remitted in cash is recorded as funds withheld liabilities. The Company is required to increase the funds withheld balance at stated interest crediting rates applied to the funds withheld balance or as otherwise specified under the terms of the contract. The funds withheld liability is reduced by any cumulative claim payments made by the Company in excess of the Company’s retention under the reinsurance contract. If the funds withheld liability is exhausted, interest crediting will cease and additional claim payments are recoverable from the reinsurer. The funds withheld liability is recorded in reinsurance balances payable in the Consolidated Balance Sheets.

Interest cost on funds withheld and other deposits is credited during all periods in which a funds withheld liability exists. Pretax interest cost, which is included in net investment income, was $267 million, $344 million and $239 million in 2004, 2003 and 2002. The amount subject to interest crediting rates on such contracts was $2,570 million and $2,789 million at December 31, 2004 and 2003. Certain funds withheld reinsurance contracts, including the corporate aggregate reinsurance treaties, require interest on additional premiums arising from ceded losses as if those premiums were payable at the inception of the contract. Additionally, on the corporate aggregate reinsurance treaties discussed below, if the Company exceeds certain aggregate loss ratio thresholds, the rate on which interest charges are accrued would increase and be retroactively applied to the inception of the contract or to a specified date. Any such retroactive interest is accrued in the period the additional premiums arise or the loss ratio thresholds are met. The amount of retroactive interest, included in the totals above, was $46 million, $147 million and $10 million in 2004, 2003 and 2002.

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.

143

associations.


The following table summarizes the amounts receivable from reinsurers at December 31, 20042006 and 2003.

Components2005.

         
Components of reinsurance receivables      
(In millions) December 31, 2006  December 31, 2005 
Reinsurance receivables related to insurance reserves:        
Ceded claim and claim adjustment expense $8,191  $10,605 
Ceded future policy benefits  1,050   1,193 
Ceded policyholders’ funds  48   56 
Reinsurance receivables related to paid losses  658   582 
       
Reinsurance receivables
  9,947   12,436 
Allowance for uncollectible reinsurance  (469)  (519)
       
         
Reinsurance receivables, net of allowance for uncollectible reinsurance
 $9,478  $11,917 
       
Ceded claim and claim adjustment expense related reinsurance receivables were reduced by $1,162 million and $2,007 million in 2006 and 2005 due to the impact of reinsurance receivablescommutations. The funds withheld liability, which is included in Reinsurance balances payable on the Consolidated Balance Sheets, had a corresponding reduction of $942 million and $1,126 million in 2006 and 2005. See further discussion related to commutations below.
         
(In millions) December 31, 2004
 December 31, 2003
Reinsurance receivables related to insurance reserves:        
Ceded claim and claim adjustment expense $13,984  $14,216 
Ceded future policy benefits  1,260   1,218 
Ceded policyholders’ funds  65   7 
Billed reinsurance receivables  685   813 
   
 
   
 
 
Reinsurance receivables
  15,994   16,254 
Allowance for uncollectible reinsurance  (531)  (573)
   
 
   
 
 
Reinsurance receivables, net of allowance for uncollectible reinsurance
 $15,463  $15,681 
   
 
   
 
 

The Company has established an allowance for uncollectible reinsurance receivables. The allowance for uncollectible reinsurance receivables was $531 million and $573 million at December 31, 2004 and 2003. The net decrease in the allowance was primarily due to a release of a previously established allowance relateddue to The Trenwick Group resulting from the execution of a significant commutation agreements, partially offset by a net increase in the allowance for other reinsurance receivables.agreement, as discussed further below. The provision for uncollectible reinsurance receivables is presented aswas $23 million, $35 million and $95 million in 2006, 2005 and 2004.

The Company attempts to mitigate its credit risk related to reinsurance by entering into reinsurance arrangements with reinsurers that have credit ratings above certain levels and by obtaining collateral. The primary methods of obtaining collateral are through reinsurance trusts, letters of credit and funds withheld balances. Such collateral was approximately $2.6 billion and $4.3 billion at December 31, 2006 and 2005. On a componentmore limited basis, CNA may enter into reinsurance agreements with reinsurers that are not rated.
In 2001, the Company entered into a one-year corporate aggregate reinsurance treaty related to the 2001 accident year covering substantially all property and casualty lines of “Insurance claimsbusiness in the Continental Casualty Company pool (the CCC Cover). The CCC Cover was fully utilized in 2003 and policyholders’ benefits”interest charges accrued on the related funds held balance at 8% per annum. In 2006, the Company commuted the CCC Cover. This commutation had no impact on the Consolidated Statements of Operations.Operations for the year ended December 31, 2006.
Also, in 2006, the Company commuted several reinsurance treaties, including several finite treaties, with a European reinsurance group. This commutation resulted in a pretax loss, net of allowance for uncollectible reinsurance, of $48 million. The Company received $35 million of cash in connection with this significant commutation.
In 2005, CNA entered into several significant commutation agreements, including the commutation of the Aggregate Cover, which was a corporate aggregate reinsurance treaty related to the 1999 through 2001 accident years and covered substantially all of the Company’s property and casualty lines of business. These commutations resulted in an unfavorable pretax impact of $399 million and CNA received $446 million of cash in connection with these significant commutations.
In 2004, the Company executed commutation agreements with several members of The Trenwick Group. These commutations resulted in unfavorable claim and claim adjustment expense reserve development which was more than offset by a release of previously established allowance of uncollectible reinsurance. These commutations resulted in a pretax favorable impact of $28 million and CNA received $69 million of cash.
CNA’s largest recoverables from a single reinsurer at December 31, 2006, including prepaid reinsurance premiums, were approximately $1,574 million from subsidiaries of Swiss Reinsurance Group, $1,013 million from subsidiaries of The Hartford Life Group Insurance Company, $911 million from subsidiaries of Muenchener

108


Rueckversicherungs, $574 million from The Allstate Corporation (Allstate), and $535 million from syndicates of Equitas.
Prior to the April of 2004 sale of its individual life and annuity business to Swiss Re, CNA had reinsured a portion of this business through coinsurance, yearly renewable term and facultative programs to various reinsurers. As a result of the sale of the individual life and annuity business, 100% of the net reserves were reinsured to Swiss Re. As of December 31, 2006 and 2005, CNA ceded $891 million and $968 million of future policy benefits to Swiss Re. Subject to certain exceptions, Swiss Re assumed the credit risk of the business that was previously reinsured to other carriers. As of December 31, 2004, CNA ceded $1,012 million2006 and 2005, the assumed credit risk was $28 million.
On December 31, 2003, the Company completed the sale of future policy benefitsthe majority of its Group Benefits business to Swiss Re.The Hartford Financial Services Group, Inc. (The Hartford). In connection with the sale, of the group benefits business, CNA ceded insurance reserves to The Hartford. As of December 31, 20042006 and 2003, these2005, ceded claim and claim adjustment expense reserves, ceded policyholder benefits and ceded policyholder funds were $1,726$1,029 million and $1,473$1,347 million.

Subject to certain exceptions, The Company attempts to mitigate itsHartford assumed 50% of the credit risk relatedof the business that was previously reinsured to reinsurance by entering into reinsurance arrangements only with reinsurers that haveother carriers. As of December 31, 2006 and 2005, the assumed 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 collateralrisk was approximately $4,561$21 million and $5,255 million at December 31, 2004 and 2003.

In 2003, the Company commuted all remaining ceded and assumed reinsurance contracts with four Gerling entities. The commutations resulted in a pretax loss of $109 million, which was net of a previously established allowance for doubtful accounts of $47$26 million. The Company has no further exposure to the Gerling companies that are in run-off.

CNA’s largest recoverables from a single reinsurer at December 31, 2004, including prepaid reinsurance premiums, were approximately $2,236 million from subsidiaries of The Allstate Corporation (Allstate), $2,163 million from subsidiaries of Swiss Reinsurance Group, $1,843 million from subsidiaries of Hannover Reinsurance (Ireland), Ltd., $1,726 million from Hartford Life Group Insurance Company, $944 million from American Reinsurance Company, and $603 million from subsidiaries of the Berkshire Hathaway Group.

Insurance claims and policyholders’ benefits reported in the Consolidated Statements of Operations are net of reinsurance recoveries of $5,789$1,314 million, $6,325$1,459 million and $4,164$4,626 million for 2004, 20032006, 2005 and 2002.

144

2004.


The effects of reinsurance on earned premiums and written premiums for the years ended December 31, 2004, 20032006, 2005 and 20022004 are shown in the following tables.

Components of Earned Premiums
                                        
 Assumed/ Assumed/ 
(In millions) Direct
 Assumed
 Ceded
 Net
 Net %
 Direct Assumed Ceded Net Net % 
2006 Earned Premiums
 
Property and casualty $9,125 $120 $2,283 $6,962  1.7%
Accident and health 718 59 138 639 9.2 
Life 100  98 2  
           
 
Total earned premiums
 $9,943 $179 $2,519 $7,603  2.4%
           
 
2005 Earned Premiums
 
Property and casualty $10,354 $186 $3,675 $6,865  2.7%
Accident and health 1,040 60 400 700 8.6 
Life 140  136 4  
           
 
Total earned premiums
 $11,534 $246 $4,211 $7,569  3.3%
           
 
2004 Earned Premiums
  
Property and casualty $10,739 $199 $3,634 $7,304  2.7% $10,739 $199 $3,634 $7,304  2.7%
Accident and health 1,228 63 507 784 8.0  1,228 63 507 784 8.0 
Life 419  298 121   419  298 121  
 
 
 
 
 
 
 
 
 
 
            
Total earned premiums
 $12,386 $262 $4,439 $8,209  3.2%
 
 
 
 
 
 
 
 
 
 
 
2003 Earned Premiums
 
Property and casualty $10,661 $726 $4,452 $6,935  10.5%
Accident and health 1,602 92 59 1,635 5.6 
Life 1,102 7 465 644 1.0 
 
 
 
 
 
 
 
 
 
 
  
Total earned premiums
 $13,365 $825 $4,976 $9,214  9.0% $12,386 $262 $4,439 $8,209  3.2%
 
 
 
 
 
 
 
 
 
 
            
2002 Earned Premiums
 
Property and casualty $9,694 $946 $3,812 $6,828  13.9%
Accident and health 2,612 153 15 2,750 5.6 
Life 1,089  (5) 449 635  (0.7)
 
 
 
 
 
 
 
 
 
 
 
Total earned premiums
 $13,395 $1,094 $4,276 $10,213  10.7%
 
 
 
 
 
 
 
 
 
 
 

Included in the direct and ceded earned premiums for the years ended December 31, 2006, 2005 and 2004 2003 and 2002 are $3,293$1,489 million, $2,652$3,306 million and $2,305$3,293 million related to business that is 100% reinsured as a result of business dispositions and a significant captive program.

Components of Written Premiums

                     
                  Assumed/
(In millions) Direct
 Assumed
 Ceded
 Net
 Net %
2004 Written Premiums
                    
Property and casualty $10,289  $48  $3,376  $6,961   0.7%
Accident and health  1,241   62   508   795   7.8 
Life  426      305   121    
   
 
   
 
   
 
   
 
   
 
 
Total written premiums
 $11,956  $110  $4,189  $7,877   1.4%
   
 
   
 
   
 
   
 
   
 
 
2003 Written Premiums
                    
Property and casualty $10,880  $649  $4,450  $7,079   9.2%
Accident and health  1,601   92   59   1,634   5.6 
Life  1,098   6   465   639   1.0 
   
 
   
 
   
 
   
 
   
 
 
Total written premiums
 $13,579  $747  $4,974  $9,352   8.0%
   
 
   
 
   
 
   
 
   
 
 
2002 Written Premiums  
                    
Property and casualty $9,978  $953  $3,936  $6,995   13.6%
Accident and health  2,618   187   13   2,792   6.7 
Life  1,091   (5)  449   637   (0.7)
   
 
   
 
   
 
   
 
   
 
 
Total written premiums
 $13,687  $1,135  $4,398  $10,424   10.9%
   
 
   
 
   
 
   
 
   
 
 

145109


Components of Written Premiums
                     
                  Assumed/ 
(In millions) Direct  Assumed  Ceded  Net  Net % 
2006 Written Premiums
                    
Property and casualty $9,193  $111  $2,282  $7,022   1.6%
Accident and health  719   59   139   639   9.2 
Life  86      84   2    
                
                     
Total written premiums
 $9,998  $170  $2,505  $7,663   2.2%
                
                     
2005 Written Premiums
                    
Property and casualty $9,546  $203  $2,934  $6,815   3.0%
Accident and health  1,037   58   395   700   8.3 
Life  136      132   4    
                
                     
Total written premiums
 $10,719  $261  $3,461  $7,519   3.5%
                
                     
2004 Written Premiums
                    
Property and casualty $10,289  $48  $3,375  $6,962   0.7%
Accident and health  1,241   62   508   795   7.8 
Life  427      305   122    
                
                     
Total written premiums
 $11,957  $110  $4,188  $7,879   1.4%
                
The impact of reinsurance on life insurance inforce at December 31, 2004, 20032006, 2005 and 20022004 is shown in the following table.

Components of Life Insurance Inforce
                 
(In millions) Direct
 Assumed
 Ceded
 Net
2004 (a) $56,610  $35  $54,486  $2,159 
2003  388,380   588   295,659   93,309 
2002  423,151   14,600   340,520   97,231 
                 
(In millions) Direct Assumed Ceded Net
2006 $15,652  $1  $15,633  $20 
2005  20,548   1   20,528   21 
2004  56,610   35   54,486   2,159 

(a)  The decline in gross inforce is attributable to the sales of the group benefits and the individual life businesses.

For 2002, the Company entered into a corporate aggregate reinsurance treaty covering substantially all of the Company’s

Life and accident and health premiums are primarily from long duration contracts; property and casualty linespremiums are primarily from short duration contracts.
Reinsurance accounting allows for contractual cash flows to be reflected as premiums and losses, as compared to deposit accounting, which requires cash flows to be reflected as assets and liabilities. To qualify for reinsurance accounting, reinsurance agreements must include risk transfer. To meet risk transfer requirements, a reinsurance contract must include both insurance risk, consisting of business (the 2002 Cover). Cededunderwriting and timing risk, and a reasonable possibility of a significant loss for the assuming entity. Reinsurance contracts that include both significant risk sharing provisions, such as adjustments to premiums or loss coverage based on loss experience, and relatively low policy limits as evidenced by a high proportion of maximum premium assessments to loss limits, may require considerable judgment to determine whether or not risk transfer requirements are met. For such contracts, often referred to as finite products, the Company assesses risk transfer for each contract generally by developing quantitative analyses at contract inception which measure the present value of reinsurer losses as compared to the present value of the related premium. In 2003, the Company discontinued purchases of finite contracts.
Funds Withheld Reinsurance Arrangements
The Company’s overall reinsurance program has included certain property and casualty contracts, such as the commuted CCC and Aggregate Covers, that were entered into and accounted for on a “funds withheld” basis and which are deemed to be finite reinsurance. Under the funds withheld basis, the Company recorded the cash remitted to the reinsurer for the reinsurer’s margin, of $10 million was recorded in 2002. No losses were ceded under this contract, and the 2002 Cover was commuted as of December 31, 2002.

The Company has an aggregate reinsurance treaty related to the 1999 through 2001 accident years that covers substantially allor cost of the Company’s property and casualty linesreinsurance contract, as ceded premiums. The remainder of business (the Aggregate Cover). The Aggregate Cover provides for two sections of coverage. These coverages attach at defined loss ratios for each accident year. Coverage under the first section of the Aggregate Cover, which is available for all accident years covered by the treaty, has a $500 million limit per accident year of ceded losses and an aggregate limit of $1 billion of ceded losses for the three accident years. The ceded premiums associated with the first section are a percentage of ceded losses and for each $500 million of limit the ceded premium is $230 million. The second section of the Aggregate Cover, which only relates to accident year 2001, provides additional coverage of up to $510 million of ceded losses for a maximum ceded premium of $310 million. Under the Aggregate Cover, interest charges on the funds withheld liability accrue at 8% per annum. The aggregate loss ratio for the three-year period has exceeded certain thresholds which requires additional premiums to be paid and an increase in the rate at which interest charges are accrued. This rate will increase to 8.25% per annum commencing in 2006. Also, if an additional aggregate loss ratio threshold is exceeded, additional premiums of 10% of amounts in excess of the aggregate loss ratio threshold are to be paid retroactively with interest.

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. 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. The aggregate limits for the Aggregate Cover have been fully utilized.

The impact of the Aggregate Cover was as follows:

Impact of Aggregate Cover

             
Year ended December 31
(In millions)
 2004
 2003
 2002
Ceded earned premium $(1) $(258) $ 
Ceded claim and claim adjustment expenses     500    
Interest charges  (82)  (147)  (51)
   
 
   
 
   
 
 
Pretax benefit (expense)
 $(83) $95  $(51)
   
 
   
 
   
 
 

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

146110


CCC Cover).

the premiums ceded under the reinsurance contract not remitted in cash was recorded as funds withheld liabilities. The loss protection providedCompany was required to increase the funds withheld balance at stated interest crediting rates applied to the funds withheld balance or as otherwise specified under the terms of the contract. The funds withheld liability was reduced by any cumulative claim payments made by the 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 coverageCompany in excess of the second section ofCompany’s retention under the Aggregate Cover discussed above. Under the CCC Cover, interest charges onreinsurance contract. If the funds withheld are accrued at 8% per annum.liability was exhausted, interest crediting would cease and additional claim payments would be recoverable from the reinsurer. The interest rate increases to 10% per annum if the aggregate loss ratio exceeds certain thresholds. The aggregate loss ratio exceeded that threshold in 2004 which required retroactive interest charges on funds withheld liability is recorded in Reinsurance balances payable on the Consolidated Balance Sheets.
Interest cost on reinsurance contracts accounted for on a funds withheld basis is incurred during all periods in which a funds withheld liability exists and is included in net investment income. There were no amounts subject to such interest crediting at December 31, 2006. The amount subject to interest crediting rates was $1,050 million at December 31, 2005.
As of $46 million. During 2003, as a result of unfavorable development relatedDecember 31, 2006 and 2005, there were one and thirteen ceded reinsurance treaties inforce, respectively, that the Company considers to be finite reinsurance. The remaining treaty at December 31, 2006 provides reinsurance protection for the 1999 accident year 2001, the CCC Cover was fully utilized.

Aton specified portions of the Company’s discretion, the contract can be commuted annually on the anniversary date of the contract.domestic property and casualty business. The CCC Cover requires mandatory commutation onremaining treaty is fully utilized and had no related funds withheld liability at December 31, 2010, if the agreement has not been commuted on or before such date. Upon mandatory commutation of the CCC Cover, the reinsurer is required to release to2006. In 2003, the Company the existing balancediscontinued purchases of the funds withheld account if the unpaid ultimate ceded losses at the time of commutation are less than or equal to the funds withheld account balance. If the unpaid ultimate ceded losses at the time of commutation are greater than the funds withheld account balance, the reinsurer will release the existing balance of the funds withheld account and pay CNA the present value of the projected amount the reinsurer would have had to pay from its own funds absent a commutation. The present value is calculated using 1-year LIBOR as of the date of the commutation.

such contracts.

The impact of the CCC Cover was as follows:

Impact of CCC Cover

             
Year ended December 31
(In millions)
 2004
 2003
 2002
Ceded earned premium $  $(100) $(101)
Ceded claim and claim adjustment expenses     143   148 
Interest charges  (91)  (59)  (37)
   
 
   
 
   
 
 
Pretax (expense) benefit
 $(91) $(16) $10 
   
 
   
 
   
 
 

147111


The following table summarizes the pretax impact of contracts accounted for on a funds withheld basis, including the commuted Aggregate and CCC Covers discussed above.
                 
Years ended December 31            
(In millions) Aggregate Cover  CCC Cover  All Other  Total 
2006
                
Ceded earned premium $  $  $(11) $(11)
Ceded claim and claim adjustment expense        (113)  (113)
Ceding commissions            
Interest charges     (40)  (19)  (59)
             
                 
Pretax expense
 $  $(40) $(143) $(183)
             
                 
2005
                
Ceded earned premium $(17) $  $48  $31 
Ceded claim and claim adjustment expense  (244)     (154)  (398)
Ceding commissions        (27)  (27)
Interest charges  (57)  (66)  (34)  (157)
             
                 
Pretax expense
 $(318) $(66) $(167) $(551)
             
                 
2004
                
Ceded earned premium $(1) $  $(19) $(20)
Ceded claim and claim adjustment expense        15   15 
Ceding commissions        2   2 
Interest charges  (82)  (91)  (72)  (245)
             
                 
Pretax expense
 $(83) $(91) $(74) $(248)
             
Included in “All Other” above for the year ended December 31, 2006 is $110 million of unfavorable development resulting from a commutation, which is included in the ceded claim and claim adjustment expenses above. This unfavorable development was partially offset by the release of previously established allowance for uncollectible reinsurance, resulting in an unfavorable impact of $48 million.
Included in “All Other” above for the year ended December 31, 2005 is approximately $24 million of pretax expense related to Standard Lines which resulted from an unfavorable arbitration ruling on two reinsurance treaties impacting ceded earned premiums, ceded claim and claim adjustment expenses, ceding commissions and interest charges. This unfavorable outcome was partially offset by a release of previously established reinsurance bad debt reserves resulting in a net impact from the arbitration ruling of $10 million pretax expense for the year ended December 31, 2005.
The pretax impact by operating segment of the Company’s funds withheld reinsurance arrangements was as follows:
             
Years ended December 31         
(In millions) 2006  2005  2004 
Standard Lines $(155) $(399) $(185)
Specialty Lines  (4)  (41)  (1)
Corporate and Other  (24)  (111)  (62)
          
             
Pretax benefit (expense)
 $(183) $(551) $(248)
          

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Note I. Debt

Debt is composed of the following obligations.

Debt
                
December 31
(In millions)
 2004
 2003
December 31     
(In millions) 2006 2005 
Variable rate debt:  
Credit facility – CNA Surety, due September 30, 2005 $25 $30 
Term loan – CNA Surety, due through September 30, 2005 10 20 
Credit facility – CNA Surety, due June 30, 2008 $ $20 
Debenture – CNA Surety, face amount of $31, due April 29, 2034 30   31 31 
Credit facility – CNAF, due April 30, 2004  250 
 
Senior notes:  
6.500%, face amount of $493, due April 15, 2005 493 492 
6.750%, face amount of $250, due November 15, 2006 249 249   250 
6.450%, face amount of $150, due January 15, 2008 149 149  150 149 
6.600%, face amount of $200, due December 15, 2008 199 199  200 199 
6.000%, face amount of $400, due August 15, 2011 398  
8.375%, face amount of $70, due August 15, 2012 69 69  69 69 
5.850%, face amount of $549, due December 15, 2014 546   546 546 
6.500%, face amount of $350, due August 15, 2016 348  
6.950%, face amount of $150, due January 15, 2018 149 149  149 149 
Debenture, 7.250%, face amount of $243, due November 15, 2023 241 241  241 241 
Capital leases, 10.400%-11.500%, due through December 31, 2011  33 
Other debt, 1.000%-11.500%, due through 2019 47 23 
Surplus notes: 
Encompass Insurance Company of America (EICA) surplus note, face amount of $50, due March 31, 2006 50  
Other debt, 1.000%-6.850%, due through 2019 24 36 
 
     
 
 
 
 
  
Total debt
 $2,257 $1,904  $2,156 $1,690 
     
 
 
 
 
  
Short term debt $531 $263  $ $252 
Long term debt 1,726 1,641  2,156 1,438 
 
 
 
 
      
 
Total debt
 $2,257 $1,904  $2,156 $1,690 
 
 
 
 
      

In DecemberJuly of 2004,2005, CNA acquired three buildings which previously were leasedSurety, a 63% owned and consolidated subsidiary of CNA, refinanced $30 million of outstanding borrowings under capital leases. As partits $50 million credit agreement with a new credit facility (the “2005 Credit Facility”). The 2005 Credit Facility provides a $50 million revolving credit facility that matures on June 30, 2008. In November of that transaction,2005, CNA directly assumedSurety repaid $10 million of outstanding borrowings. During 2006, the underlying debt obligation whichoutstanding 2005 Credit Facility balance of $20 million was repaid. Subsequently, CNA Surety reduced the lessoravailable aggregate revolving credit facility to $25 million in borrowings.
In November of 2006, CNAF retired its $250 million 6.75% senior notes. A portion of the three buildings owed.

proceeds from the public offering discussed below were used to repay these notes.

In FebruaryAugust of 2004, CCC issued $346 million in surplus notes related to the Life and Group sales. CNA received insurance regulatory approval for the repayment of a $300 million CCC Life surplus note, and repaid the note, including accrued interest, on June 16, 2004. CNA received insurance regulatory approval for the repayment of the $46 million CCC Group surplus note and repaid the note, including accrued interest, on December 15, 2004.

On December 15, 20042006, CNAF completed its sale of $549sold $400 million of 5.85%6.0% five-year senior notes and $350 million of 6.5% ten-year senior notes in a public offering. During 2004, Encompass Insurance Company of America (EICA), a wholly owned subsidiary of the Company, sold a $50 million surplus note to Allstate Insurance Company. The EICA note bears interest semi-annually at 2.5% per annum and is due on March 31, 2006. CNA plans to seek approval from the insurance regulatory authority for repayment of the surplus note at maturity.

In May of 2004, CNA Surety, a 64% owned and consolidated subsidiary of CNA, issued privately, through a wholly-owned trust, $30 million of preferred securities through two pooled transactions. These securities bear interest at a rate of LIBOR plus 337.5 basis points with a thirty-year term and are redeemable after five years. The securities were issued by CNA Surety Capital Trust I (Issuer Trust). The sole asset of the Issuer Trust consists of a $31 million junior subordinated debenture issued by CNA Surety to the Issuer Trust. The subordinated debenture bears interest at a rate of LIBOR plus 337.5 basis points and matures in April of 2034. As of December 31, 2004, the interest rate on the junior subordinated debenture was 5.7%.

148


On September 30, 2003, CNA Surety entered into a $50 million credit agreement, which consisted of a $30 million two-year revolving credit facility and a $20 million two-year term loan, with semi-annual principal payments of $5 million. The credit agreement is an amendment to a $65 million credit agreement, extending the revolving loan termination date from September 30, 2003 to September 30, 2005. The new revolving credit facility was fully utilized at inception. In June of 2004, CNA Surety reduced the outstanding borrowings under the credit facility by $10 million, and in September of 2004, CNA Surety increased the outstanding borrowings under the credit facility by $5 million to fund the semi-annual term loan payment.

Under the amended credit facility agreement, CNA Surety pays a facility fee of 35.0 basis points on the revolving credit portion of the facility, interest at LIBOR plus 90 basis points, and for utilization greater than 50% of the amount available to borrow an additional fee of 5.0 basis points. On the term loan, CNA Surety pays interest at LIBOR plus 62.5 basis points. At December 31, 2004, the weighted-average interest rate on the $35 million of outstanding borrowings under the credit agreement, including facility fees and utilization fees, was 3.3%. Effective January 30, 2003, CNA Surety entered into a swap agreement on the term loan portion of the agreement which uses the 3-month LIBOR to determine the swap increment. As a result, the effective interest rate on the $10 million in outstanding borrowings on the term loan was 2.77% at December 31, 2004. On the $25 million revolving credit agreement, the effective interest rate at December 31, 2004 was 3.49%.

The combined aggregate maturities for debt at December 31, 20042006 are presented in the following table.

Maturity of Debt
        
(In millions)  
2005 $531 
2006 304 
2007 12  $ 
2008 354  350 
2009 5   
2010  
2011 400 
Thereafter 1,061  1,418 
Less original issue discount  (10)  (12)
 
 
    
 
Total
 $2,257  $2,156 
 
 
    

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Note J. Benefit Plans

Pension and Postretirement Healthcare and Life Insurance Benefit Plans

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. Effective January 1,In 2000, the CNA Retirement Plan was closed to new participants; instead, retirement benefits are provided to these employees under the Company’s savings plans discussed below.plans. While the terms of the pension plans vary, benefits are generally based on years of credited service and the employee’s highest 60 consecutive months of compensation. CNA uses December 31 as the measurement date for the majority of its plans.

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 and mortgage-backed securities with the balance in short term investments, equity securities and limited partnerships.

CNA provides certain healthcare and life insurance benefits to eligible retired employees, their covered dependents and their beneficiaries. The funding for these plans is generally to pay covered expenses as they are incurred.

In September of 2004, the Company announced significant changes to the CNA Retiree Health and Group Benefits plan affecting current and future retirees. Benefit changes were effective January 1, 2005 and include: elimination of dental plan subsidy, elimination of Medicare Part B premium reimbursement, reduction of retiree life insurance to a maximum of $10,000 per retiree and elimination of various medical plan options. The effects of these changes are

149


reflected in the 2004 actuarial valuation beginning October 1, 2004, resulting in a reduction to the accumulated postretirement benefit obligation of $137 million at December 31, 2004 and a reduction in the net periodic benefit cost of $5 million for the year ended December 31, 2004.

In 2000, approximately 60% of CCC’s eligible employees elected to forego earning additional benefits in CNA’sthe CNA Retirement Plan, a defined benefit pension plan. These employees maintain an “accrued pension account” within the defined benefit pension plan that is credited with interest annually at the 30-year treasury rate. Instead, employees who elected to discontinue accruing benefits in the defined benefit pension plan receive certain enhanced employer contributions in the CNA Savings and Capital Accumulation Plan (discussed below).discussed below. Employees hired on or after January 1, 2000 are not eligible to participate in the CNA Retirement Plan.

CNA’s funding policy for defined benefit pension plan.plans is to make contributions in accordance with applicable governmental regulatory requirements with consideration of the funded status of the plans. The assets of the plans are invested primarily in mortgage-backed securities, short term investments, equity securities and limited partnerships.
CNA provides certain healthcare and life insurance benefits to eligible retired employees, their covered dependents and their beneficiaries. The funding for these plans is generally to pay covered expenses as they are incurred.
In September of 2004, the Company announced significant changes to the CNA Retiree Health and Group Benefits plan affecting current and future retirees. Benefit changes were effective January 1, 2005 and included elimination of dental plan subsidy and elimination of various medical plan options. These changes resulted in a substantial unrecognized prior service cost benefit.

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The following table provides a reconciliation of benefit obligations.

Benefit Obligations and Accrued Benefit Costs
                                
 Pension Benefits
 Postretirement Benefits
 Pension Benefits Postretirement Benefits 
(In millions) 2004
 2003
 2004
 2003
 2006 2005 2006 2005 
Benefit obligation at January 1 $2,403 $2,243 $345 $385  $2,636 $2,527 $210 $180 
 
Changes in benefit obligation:  
Service cost 31 33 4 7  26 27 2 3 
Interest cost 145 146 17 22  142 145 10 10 
Participants’ contributions   9 8    7 8 
Plan amendments  1  (138)  (30)  1   
Actuarial gain (loss) 104 150  (26)  (16)
Curtailment/settlement 2  (25)   
Actuarial loss (gain)  (60) 87  (34) 21 
Benefits paid  (164)  (151)  (31)  (31)  (152)  (146)  (19)  (12)
Foreign currency translation 6 6   
Special termination benefits 2    
Foreign currency translation and other 8  (5) 1  
         
 
 
 
 
 
 
 
 
  
Benefit obligations at December 31 2,527 2,403 180 345  2,602 2,636 177 210 
         
 
 
 
 
 
 
 
 
  
Fair value of plan assets at January 1 1,988 1,938    2,107 2,029   
Change in plan assets:  
Actual return on plan assets 164 200    226 161   
Company contributions 37 25 22 23  79 67 12 4 
Participants’ contributions   9 8    7 8 
Curtailment/settlement  (1)  (28)   
Benefits paid  (164)  (151)  (31)  (31)  (152)  (146)  (19)  (12)
Foreign currency translation 5 4   
Foreign currency translation and other  (2)  (4)   
         
 
 
 
 
 
 
 
 
  
Fair value of plan assets at December 31 2,029 1,988    2,258 2,107   
 
 
 
 
 
 
 
 
          
 
Funded status  (498)  (415)  (180)  (345)  (344)  (529)  (177)  (210)
Unrecognized net actuarial loss 468 390 77 108  528 94 
Unrecognized net transition asset  (1)  
Unrecognized prior service cost (benefit) 9 11  (202)  (85) 9  (174)
     
 
 
 
 
 
 
 
 
  
Prepaid (accrued) benefit cost $(21) $(14) $(305) $(322) $7 $(290)
 
 
 
 
 
 
 
 
      
Amounts recognized in the Consolidated Balance Sheets: 
 
Amounts recognized in the Consolidated Balance Sheet: 
Prepaid benefit cost $21 $10 $ $  20  
Accrued benefit liability  (352)  (235)  (305)  (322)  (372)  (290)
Intangible assets 11 13    9  
Accumulated other comprehensive income 299 198    350  
 
 
 
 
 
 
 
 
      
Prepaid (accrued) benefit cost $(21) $(14) $(305) $(322)
 
 
 
 
 
 
 
 
  
Net amount recognized $7 $(290)
     
 
Amounts recognized in the Consolidated Balance Sheet: 
Other liabilities  (344)  (177) 
     
 
Net benefit plan liability at December 31 $(344) $(177) 
     
 
Amounts recognized in Accumulated other comprehensive income, not yet recognized in net periodic benefit cost: 
Net transition asset  (1)  
Prior service cost (credit) 6  (146) 
Net actuarial loss 381 55 
     
 
Net amount recognized $386 $(91) 
     

115


The accumulated benefit obligation for all defined benefit pension plans was $2,318$2,453 million and $2,214$2,468 million at December 31, 20042006 and 2003.

150

2005. Included in these amounts were benefit obligations related to an overfunded plan that was less than $1 million at December 31, 2005. The fair value of plan assets related to the overfunded plan was $10 million at December 31, 2005.


The projected benefit obligation, accumulated benefit obligation, and fair value of plan assets for the pension plans with accumulated benefit obligations in excess of plan assets as of December 31, 2006 and 2005 are presented in the following table.

         
Pension Plans with Accumulated Benefit Obligation    
in Excess of Plan Assets    
(In millions) 2006 2005
Projected benefit obligation $2,485  $2,567 
Accumulated benefit obligation  2,351   2,408 
Fair value of plan assets  2,148   2,036 
The components of net periodic benefit costs are presented in the following table.
                        
Years ended December 31
(In millions)
 2004
 2003
 2002
Years ended December 31 2006 2005 2004 
(In millions) 
Pension benefits
  
Service cost $31 $33 $34  $26 $27 $31 
Interest cost on projected benefit obligation 145 146 141  142 145 145 
Expected return on plan assets  (152)  (146)  (141)  (162)  (156)  (152)
Prior service cost amortization 2 3 3  2 2 2 
Actuarial loss 13 8 4  25 21 13 
Curtailment gain    (8)
Settlement loss 5 8 11    5 
 
 
 
 
 
 
        
 
Net periodic pension cost
 $44 $52 $44  $33 $39 $44 
       
 
 
 
 
 
 
  
Postretirement benefits
  
Service cost $4 $6 $5  $2 $3 $4 
Interest cost on projected benefit obligation 17 22 25  10 10 17 
Prior service cost amortization  (20)  (16)  (16)  (28)  (28)  (20)
Actuarial loss 3 4 5  4 4 3 
 
 
 
 
 
 
        
Net periodic postretirement cost
 $4 $16 $19 
 
 
 
 
 
 
  
Pension benefits
 
Increase (decrease) in minimum liability included in other comprehensive income $101 $176 $(2)
Net periodic postretirement (benefit) cost
 $(12) $(11) $4 
       
 
Pension and postretirement benefits
 
Increase (decrease) in FAS 87 minimum liability included in other comprehensive income $(124) $51 $101 
Increase in FAS 158 liability included in accumulated other comprehensive income 71   
       
 
Total increase (decrease) $(53) $51 $101 
       

116

Weighted-average


As discussed in Note A, the Company adopted SFAS 158 as of December 31, 2006. The incremental effect of applying SFAS 158 on individual line items in the Consolidated Balance Sheet is presented in the following table.
Effect of Applying SFAS 158
             
December 31, 2006 Before Application of     After Application of
(In millions) SFAS 158 Adjustments SFAS 158
Deferred income taxes $830  $25  $855 
Other assets  614   (22)  592 
Total assets  60,280   3   60,283 
Other liabilities  2,691   49   2,740 
Total liabilities  50,131   49   50,180 
Minority interest  337   (2)  335 
Accumulated other comprehensive income, net of minority interest of $2 million  593   (44)  549 
Total stockholders’ equity  9,812   (44)  9,768 
Weighted average actuarial assumptions used at December 31, 2004, 2003,2006 and 20022005 to determine benefit obligations are set forth in the following table.

Weighted-AverageWeighted Average Actuarial Assumptions for Benefit Obligations
                    
December 31 2004
 2003
 2002
 2006 2005
Pension benefits
  
Discount rate  5.875%  6.25%  6.75%  5.750%  5.625%
Expected return on plan assets 8.00 8.00 8.00 
Expected long term rate of return 8.00 8.00 
Rate of compensation increases 5.83 5.83 5.83  5.83 5.83 
 
Postretirement benefits
  
Discount rate  5.875%  6.25%  6.75%  5.625%  5.500%

Weighted-average

Weighted average actuarial assumptions used to determine net cost for the years ended December 31, 2004, 20032006, 2005 and 20022004 are set forth in the following table.

Weighted-AverageWeighted Average Actuarial Assumptions for Net Cost
                        
December 31 2004
 2003
 2002
 2006 2005 2004
Pension benefits
  
Discount rate  6.22%  6.75%  7.25%  5.625%  5.875%  6.22%
Expected return on plan assets 8.00 8.00 8.00 
Expected long term rate of return 8.00 8.00 8.00 
Rate of compensation increases 5.83 5.83 5.83  5.83 5.83 5.83 
 
Postretirement benefits
  
Discount rate  6.19%  6.75%  7.25%  5.500%  5.875%  6.190%

The table below presents the estimated amounts to be recognized from accumulated other comprehensive income into net periodic benefit cost during 2007.
         
(In millions) Pension Benefits  Postretirement Benefits 
Amortization of net actuarial loss $13  $2 
Amortization of prior service cost (benefit)  1   (18)
       
 
Total estimated amounts to be recognized
 $14  $(16)
       

151117


The long term rate of return for plan assets is determined using a building block approach based on widely-accepted capital market principles, long term return analysis for global fixed income and equity markets as well as the active total return oriented portfolio management style. Long term trends are evaluated relative to current market factors such as inflation, interest rates and fiscal and monetary policies, in order to assess the capital market assumptions as applied to the plan. Consideration of diversification needs and rebalancing is maintained.

The Company has limited its share of the health care trend rate to a cost-of-living adjustment notestimated to exceedbe 4% per year. The assumed healthcare cost trend rate used in measuring the accumulated postretirement benefit obligation was 4% per year in 2004, 20032006, 2005 and 2002.2004. The healthcare cost trend rate assumption has a significant effect on the amount of the benefit obligation and periodic cost reported. An increase in the assumed healthcare cost trend rate of 1% in each year would have no impact on the accumulated postretirement benefit obligation or the aggregate net periodic postretirement benefit cost for 20042006 as the cost-of-living adjustment is estimated to be 4% which is the maximum contractual benefit. A decrease in the assumed healthcare cost trend rate of 1% in each year would decrease the accumulated postretirement benefit obligation as of December 31, 20042006 by $9$10 million and theimpact aggregate net periodic postretirement benefit costbenefits for 20042006 by $1 million.

The Company’s pension plan weighted-averageplans weighted average asset allocation at December 31, 20042006 and 2003,2005, by asset category, is as follows:

Pension Plan Assets
                
 Percentage of Plan Assets Percentage of Plan Assets 
 December 31, December 31, 
 2004
 2003
 2006 2005 
Asset Category
  
Fixed maturity securities  47%  56%  48%  24%
Equity securities 17 13  26 25 
Limited Partnerships 15 11 
Limited partnerships 22 15 
Short term investments 21 20  2 33 
Other 2 3 
     
 
 
 
 
  
Total  100%  100%  100%  100%
 
 
 
 
      

CNA employs a total return approach whereby a mix of equity and fixed maturity securities are used to maximize the long term return of plan assets for a prudent level of risk. The intent of this strategy is to minimize plan expenses by outperforming plan liabilities over the long run. Risk tolerance is established through careful consideration of the plan liabilities, plan funded status and corporate financial conditions. The investment portfolio contains a diversified blend of fixed maturity, equity and short-termshort term securities. Alternative investments, including hedge funds, are used judiciously to enhance risk adjusted long term returns while improving portfolio diversification. Derivatives may be used to gain market exposure in an efficient and timely manner. Investment risk is measured and monitored on an ongoing basis through annual liability measurements, periodic asset/liability studies and quarterly investment portfolio reviews.

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The table below presents the estimated future minimum benefit payments to participants at December 31, 2004.

2006.

Estimated Future Minimum Benefit Payments to Participants
        
         Pension Postretirement
 Pension Postretirement Benefits Benefits
(In millions) Benefits
 Benefits
 
2005 $137 $15 
2006 138 14 
2007 139 14  150 12 
2008 141 13  148 12 
2009 144 13  149 13 
Thereafter 777 71 
 
 
 
 
 
Total
 $1,476 $140 
 
 
 
 
 
2010 150 13 
2011 153 14 
2012-2016 826 71 

152


In 2005,2007, CNA expects to contribute $7$58 million to its pension planplans and $14$12 million to its postretirement healthcare and life insurance benefit plans.

Savings Plans

CNA sponsors savings plans, which are generally contributory plans that allow most employees 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.

As noted above, during 2000, CCC employees were required to make a choice regarding their continued participation in CCC’sCNAF’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.

In addition, these employees are eligible to receive additional discretionary contributions of up to 2% of eligible compensation and an additional Company match of up to 80% of the first 6% of eligible compensation contributed by the employee. These contributions are made at the discretion of management and are contributed to participant accounts in the first quarter of the year following management’s determination of the discretionary amounts. EmployeesAs of December 31, 2006, employees do not vest in these contributions until reaching five years of service.

Effective January 1, 2007, employees vest in these contributions ratably over five years, retroactively applied.

Benefit expense for the Company’s savings plans was $55 million, $24 million and $49 million $57 millionin 2006, 2005 and $51 million in 2004, 2003 and 2002.

2004.

Stock OptionsStock-Based Compensation

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 and stock appreciation rights (SARs) to certain management personnel for up to 2.04 million shares of the Company’s common stock. All options and SARs 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 and SARs under the LTI Plan as of December 31, 2004,2006 was approximately 0.52 million.

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The following table presents activity under the LTI Plan during 2004, 20032006, 2005 and 2002.

2004.

OptionOptions and SARs Plan Activity
                         
  2004
 2003
 2002
      Weighted-     Weighted-     Weighted-
      Average     Average     Average
      Option     Option     Option
  Number Price per Number Price per Number Price per
  Of Shares
 Share
 Of Shares
 Share
 Of Shares
 Share
Balance at January 1  1,434,800  $29.97   1,146,850  $31.80   892,100  $33.43 
Options granted  350,400   26.30   384,000   24.61   440,200   28.93 
Options exercised  (2,900)  26.28             
Options forfeited  (308,300)  29.63   (96,050)  30.51   (185,450)  32.79 
   
 
   
 
   
 
   
 
   
 
   
 
 
Balance at December 31
  1,474,000  $29.17   1,434,800  $29.97   1,146,850  $31.80 
   
 
   
 
   
 
   
 
   
 
   
 
 
Options exercisable at December 31
  827,450  $31.16   551,575  $32.73   306,975  $33.63 
   
 
   
 
   
 
   
 
   
 
   
 
 
Weighted-average fair value per share of options granted
     $7.74      $5.43      $6.45 
       
 
       
 
       
 
 
                         
  2006  2005  2004 
      Weighted-      Weighted-      Weighted- 
      Average      Average      Average 
      Option      Option      Option 
  Number  Price per  Number  Price per  Number  Price per 
  of Awards  Award  of Awards  Award  of Awards  Award 
Balance at January 1  1,628,600  $28.71   1,474,000  $29.17   1,434,800  $29.97 
Awards granted  327,000   30.98   328,800   27.27   350,400   26.30 
Awards exercised  (236,500)  30.71   (42,050)  28.60   (2,900)  26.28 
Awards forfeited  (24,200)  29.05   (132,150)  30.38   (308,300)  29.63 
                   
                         
Balance at December 31
  1,694,900  $28.86   1,628,600  $28.71   1,474,000  $29.17 
                   
Awards exercisable at December 31
  965,400  $29.13   963,650  $30.17   827,450  $31.16 
                   
                         
Weighted average fair value per share of awards granted
     $10.73      $7.48      $7.74 
                      

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During 2006, the Company awarded SARs totaling 327,000 shares. The weighted-averageSARs balance at December 31, 2006 was 319,000 shares with 8,000 shares forfeited.

The weighted average grant-date fair value of awards granted during the year ended December 31, 2006 was $10.73 per award. The weighted average remaining contractual lifeterm of optionsawards outstanding and exercisable as of December 31, 2004, was seven2006, were 6.65 years and 5.42 years. The aggregate intrinsic values of awards outstanding and exercisable at December 31, 2006 were $19 million and $11 million. The total intrinsic value of awards exercised for the range of exercise prices on those optionsyear ended December 31, 2006 was $21.77 to $37.45.

$2 million.

The fair value of granted options and SARs was estimated at the grant date using the Black-Scholes option-pricing model. The weighted-average fair valueBlack-Scholes model incorporates a risk free rate of options granted during eachreturn and various assumptions regarding the underlying common stock and the expected life of the three years ended December 31, 2004, 2003securities granted. Different interest rates and 2002 was $3 million, $2 million and $3 million. The following weighted-average assumptions were used for the years ended December 31, 2004, 2003 and 2002:each grant, as appropriate at that date. The risk free interest raterates used ranged from 2.7% to 4.6%. The estimates of 3.7%, 2.7%the underlying common stock’s volatility ranged from 22.3% to 25.2%, and 4.0%;the expected dividend yield ofwas 0%; and for all valuations. The expected option life of fivethe securities granted ranged from 5.0 to 6.3 years. The weighted-average assumption for the expected stock price volatility was 24.8%, 25.0% and 25.2% for the years ended December 31, 2004, 2003 and 2002.

CNA Surety has reserved shares of its common stock for issuance to directors, officers and employees of CNA Surety through incentive stock options, non-qualified stock options and stock appreciation rightsSARs under separate plans (CNA Surety Plans). The CNA Surety Plans have anin the aggregate number of 0.73 million shares available for which options may be granted. At December 31, 2004,2006, approximately 1.71 million options were outstanding under these plans. The data provided in the preceding paragraphs and table does not include CNA Surety’s stock-based compensation plans.
The Company recorded stock-based compensation expense of $3.2 million and $336 thousand for the years ended December 31, 2006 and 2005. The related income tax benefit recognized was $1.1 million and $118 thousand. These amounts also include compensation in the form of restricted stock grants awarded by the Company and expense recorded by CNA Surety for these periods. At December 31, 2006, the compensation cost related to nonvested awards not yet recognized was $4.2 million and the weighted average period over which it is expected to be recognized is 1.27 years.
At December 31, 2006, the Company’s non-vested portion of a restricted stock grant totaled 28,329 shares with a grant-date fair value of $842 thousand.
Equity based compensation that is not fully vested prior to termination is generally forfeited upon termination, except as otherwise provided by contractual obligations. In addition, any such compensation that vested prior to termination is generally cancelled immediately, except in cases of retirement, death or disability, and as otherwise provided by contractual obligations.

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NoteK. Operating Leases, Other Commitments and Contingencies, and Guarantees

Operating Leases

CNA occupies office facilities under lease agreements that expire at various dates. In addition, data processing, office and transportation equipment is leased under agreements that expire at various dates through 2009.dates. Most leases contain renewal options that provide for rent increases based on prevailing market conditions. Lease expense for the years ended December 31, 2006, 2005 and 2004 2003 and 2002 was $70$53 million, $66$71 million and $78$70 million. Lease and sublease revenues for the years ended December 31, 2004, 20032006, 2005 and 20022004 were $7 million, $6$5 million and $9$7 million. CCC and CAC remain contingently liable under two ground leases covering a portion of an office building property sold in 2003. Although the two leases expire in 2058, CCC and CAC have certain collateral, as well as certain contractual rights and remedies, in place to minimize any exposure that may arise from the new owner’s failure to comply with its obligations under the ground leases.

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, 2004.

2006.

Future Minimum Lease Payments and Sublease Receipts
        
         Future Future 
 Future Future Minimum Minimum 
 Minimum Minimum Lease Sublease 
 Lease Sublease Payments Receipts 
(In millions) Payments
 Receipts
 
2005 $64 $4 
2006 55 3 
2007 46 1  $49 $7 
2008 33 1  43 6 
2009 23 1  35 5 
2010 31 5 
2011 25 4 
Thereafter 72 4  51 5 
     
 
 
 
 
  
Total
 $293 $14  $234 $32 
 
 
 
 
      

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 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, 2004.

The Company holds an investment in a real estate joint venture that is accounted for onventure. In the equity basisnormal course of accounting.business, CNA, on a joint and several basis with other unrelated insurance company shareholders, havehas committed to continue funding the operating deficits of this joint venture. Additionally, CNA and the other unrelated

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shareholders, on a joint and several basis, have guaranteed an operating lease for an office building, which expires in 2016.

The guarantee of the operating lease is a parallel guarantee to the commitment to fund operating deficits; consequently, the separate guarantee to the lessor is not expected to be triggered as long as the joint venture continues to be funded by its shareholders and continues to make its annual lease payments.

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, 20042006 that the Company could be required to pay under this guarantee isare approximately $312$239 million. If CNA waswere 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.

Other Commitments and Contingencies

In the normal course of business, CNA has obtainedprovided letters of credit in favor of various unaffiliated insurance companies, regulatory authorities and other entities. At December 31, 20042006 and 2003,2005, there were approximately $47$27 million and $58$30 million of outstanding letters of credit.

The Company has entered into a limited number of guaranteed payment contracts, primarily relating to telecommunication and software services, amounting to approximately $36 million.$15 million at December 31, 2006. Estimated future minimum payments under these contracts are as follows: $19$12 million in 2005, $112007 and $3 million in 2006 and $6 million in 2007.

2008.

The Company currently has an agreement in place for services to be rendered in relation to employee benefits, administration and consulting. If the Company terminates this agreement without cause, or the agreement is

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terminated due to the Company’s default, prior to the end of any renewal term, the Company shall pay the greater of fifteen percent of the average monthly fees related to such services for the remainder of the term, or the specified minimum termination fee for the year. The minimum termination fee for the year ended December 31, 20052007 is $9$7 million.

During 2002, CNAF sold $750 million of a new issue of preferred stock, designated Series H Cumulative Preferred Issue (Series H Issue), to Loews. The Series H Issue accrues cumulative dividends at an initial rate of 8% per year, compounded annually. As of December 31, 2004, the Company had $127 million of undeclared (and therefore unrecorded) but accumulated dividends.

Guarantees

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 make 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 is approximately $30 million at December 31, 2004.

CNA has provided guarantees of the indebtedness of certain of its independent insurance producers, whichproducers. These guarantees expire in 2008. The Company would be required to remit prompt and complete payment when due, should the primary obligor default. In the event of default on the part of the primary obligor, the Company holds an interest in andhas a right to any and all shares of common stock of the primary obligor. The maximum potential amount of future payments that CNA could be required to pay under these guarantees iswas approximately $7$6 million at December 31, 2004.

2006.

In the course of selling business entities and assets to third parties, the Company has agreed to indemnify purchasers for losses arising out of breaches of representation and warranties with respect to the business entities or assets being sold, including, in certain cases, losses arising from undisclosed liabilities or certain named litigation. Such indemnification provisions generally survive for periods ranging from nine months following the applicable closing

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date to the expiration of the relevant statutes of limitation. As of December 31, 2004,2006, the aggregate amount of quantifiable indemnification agreements in effect for sales of business entities, assets and assetsthird party loans was $950$933 million.

In addition, the Company has agreed to provide indemnification to third party purchasers for certain losses associated with sold business entities or assets that are not limited by a contractual monetary amount. As of December 31, 2004,2006, the Company had outstanding unlimited indemnifications in connection with the sales of certain of its business entities or assets forthat included tax liabilities arising prior to a purchaser’s ownership of an entity or asset, defects in title at the time of sale, employee claims arising prior to closing and in some cases losses arising from certain litigation and undisclosed liabilities. These indemnification agreements survive until the applicable statutes of limitation expire, or until the agreed upon contract terms expire. As of December 31, 2004,2006, the Company has recorded approximately $21$28 million of liabilities related to these indemnification agreements.

In connection with the issuance of preferred securities by CNA Surety Capital Trust I, CNA Surety issued a guarantee of $75 million to guarantee the payment by CNA Surety Capital Trust I of annual dividends of $1.5 million over 30 years and redemption of $30 million of preferred securities. See Note I for further description of debentures issued by CNA Surety, which are the sole assets of CNA Surety Capital Trust I.

Note L. Stockholders’ Equity and Statutory Financial Information

Capital stock (in whole numbers) is composed of the following:

Summary of Capital StockStockholders’ Equity
         
December 31 2004
 2003
Preferred stock, without par value, non-voting
        
Authorized  12,500,000   12,500,000 
Issued and outstanding:        
Series H (stated value $100,000 per share, held by Loews)  7,500   7,500 
Series I (stated value $23,200 per share, held by Loews)     32,327 
Common stock, par value $2.50
        
Authorized  500,000,000   500,000,000 
Issued  258,177,285   225,850,270 
Outstanding  255,953,958   223,617,337 
Treasury stock  2,223,327   2,232,933 

On April 20, 2004, CNAF issued 32,327,015 shares of common stock to Loews in conjunction with the conversion of the $750 million Series I convertible preferred stock issued during 2003. The number of shares was determined utilizing a conversion price per share of common stock that was based on average market prices of CNAF common stock from November 17, 2003 through November 21, 2003. The Series I convertible preferred stock was sold to Loews during 2003 and the proceeds were applied by CNAF to increase the statutory surplus of CNAF’s principal insurance subsidiary, CCC.

During 2002, CNAF sold $750 million of a then new issue of preferred stock, designated Series H Cumulative Preferred Issue (Series H Issue), to Loews. The terms of the Series H Issue were approved by a special committee of independent members of CNAF’s Board of Directors. The proceeds from the Series H Issue were applied by CNAF to increase the statutory surplus of CNAF’s principal insurance subsidiary, CCC.

The Series H Issue accrueswas held by Loews and accrued 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 aboveIn August 2006, 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 rating levels of the financial strength rating of CCC from its rating at the time of issuance by any of A.M. Best Company Standard & Poor’s or Moody’s or (ii) one year following an increase by one intermediate rating level of the financial strength rating of CCC by any one of those rating agencies. Accrued but unpaid cumulative dividends cannot be paid onrepurchased the Series H Issue unless and until one of the two triggering events described above has occurred. Beginning with the quarter following an increase of one intermediate rating level in CCC’s financial strength rating,

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however, current (but not accrued cumulative) quarterly dividends can be paid. As of December 31, 2004, the Company has $127for approximately $993 million, of undeclared (and therefore unrecorded) but accumulated dividends.

The Series H Issue is senior to CNAF’s common stock asa price equal to the paymentliquidation preference.

The Company financed the repurchase 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 Series H Issue have been paid. CNAF may not issue any equity securities ranking senior to or on par with the Series H Issue withoutproceeds from the consent of a majoritysales of: (i) 7.0 million shares of its stockholders. The Series H Issue is non-votingcommon stock in a public offering for approximately $235.5 million; (ii) $400 million of new 6.0% five-year senior notes and is not convertible into any other securities$350 million of CNAF. It may be redeemed only upon the mutual agreementnew 6.5% ten-year senior notes in a public offering; and (iii) 7.86 million shares of CNAF andits common stock to Loews in a majority of the stockholders of the preferred stock.

private placement for approximately $264.5 million.

CNA’s Board of Directors has approved a Share Repurchase Program to purchase, in the open market or through privately negotiated transactions, its outstanding common stock, as Company management deems appropriate. No shares of common stock were purchased during 20042006 or 2003.

2005.

Statutory Accounting Practices (Unaudited)

CNA’s domestic insurance subsidiaries maintain their accounts in conformity with accounting practices prescribed or permitted by state insurance regulatory authorities, which vary in certain respects from GAAP. In converting from statutory accounting principles to GAAP, typical adjustments include deferral of policy acquisition costs and the inclusion of net realizedunrealized holding gains or losses in shareholders’ equity relating to certain fixed maturity securities. The National Association of Insurance Commissioners (NAIC) developed ahas codified version of statutory accounting principles designed to foster more consistency among the states for accounting guidelines and reporting.

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CNA’s insurance subsidiaries are domiciled in various jurisdictions. These subsidiaries prepare statutory financial statements in accordance with accounting practices prescribed or permitted by the respective jurisdictions’ insurance regulators. Prescribed statutory accounting practices are set forth in a variety of publications of the NAIC as well as state laws, regulations and general administrative rules.

During 2003 and 2004,

CCC received approval from its domiciliary state insurance department forfollows a permitted practice related to the statutory provision for reinsurance, or the uncollectible reinsurance reserve. This permitted practice allows CCC to record an additional uncollectible reinsurance reserve amount through a different financial statement line item than the prescribed statutory convention. This permitted practice had no effect on CCC’s statutory surplus in 20032006 or 2004.

During 2003, two of the Company’s insurance subsidiaries received approval from their respective domiciliary state insurance departments for two permitted practices related to the statutory provision for reinsurance, or the uncollectible reinsurance reserve. The two permitted practices allowed CCC to reflect in its financial statements the statutory provision for reinsurance attributable to The Continental Insurance Company (CIC) as a result of a reinsurance agreement implemented in the fourth quarter of 2003 between these two companies. During 2004, the Company’s subsidiaries continued to utilize this accounting treatment with the approval of the respective domiciliary state insurance departments. However, in 2004 it was determined by the domiciliary state insurance departments that this accounting treatment is no longer considered a permitted practice. This accounting treatment had no effect on the combined statutory surplus for these two subsidiaries in 2004 or 2003.

During 2004, CIC received approval from its domiciliary state insurance department for a permitted practice that allows CIC to classify voluntary pools as authorized, that are unauthorized in South Carolina but were classified as authorized in New Hampshire, CIC’s former state of domicile, in order to allow credit for the related reinsurance balances. Due to CIC’s redomestication to South Carolina effective January 1, 2004, this permitted practice was requested and has been granted for the reporting periods March 31, 2004 through December 31, 2004. This permitted practice was intended to allow CIC time to work with its domiciliary state insurance department to better understand the appropriate treatment of voluntary pools for Schedule F purposes on a South Carolina basis. The Company has now determined that pool members representing approximately 80% of the participation in the underlying pools are either currently licensed or authorized in the State of South Carolina. As of December 31, 2004, the ceded reserve credit for the entire reinsurance recoverable from voluntary pools classified as authorized is $306 million. The

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2005.


impact of this permitted practice on CIC’s statutory surplus has not been fully quantified as the Company’s review with its domiciliary state insurance department is still in process.

CNAF’s ability to pay dividends and other credit obligations is significantly dependent on receipt of dividends from its subsidiaries. The payment of dividends to CNAF by its insurance subsidiaries without prior approval of the insurance department of each subsidiary’s domiciliary jurisdiction is limited by formula. Dividends in excess of these amounts are subject to prior approval by the respective state insurance departments.

Dividends from CCC are subject to the insurance holding company laws of the State of Illinois, the domiciliary state of CCC. Under these laws, ordinary dividends, or dividends that do not require prior approval of the Illinois Department of Financial and Professional Regulation Division of Insurance (the Department), may be paid only from earned surplus, which is calculated by removing unrealized gains from unassigned surplus. As of December 31, 2004,2006, CCC is in a negative earned surplus position. In December of 2004, the Department approved extraordinary dividend capacity of $125 million to be used to fund the CNAF’s 2005 debt service requirements. It is anticipated that CCC will be in a positive earned surplus position, atenabling CCC to pay approximately $556 million of dividend payments during 2007 that would not be subject to the endDepartment’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 first quarter of 2005 and be able to begin paying ordinary dividends in the second quarter of 2005 as a result of a $500 million dividend received from its subsidiary, CAC, on February 11, 2005.

CNA’sapplicable insurance company.

CNAF’s domestic insurance subsidiaries are subject to risk-based capital requirements. Risk-based capital is a method developed by the NAIC to determine the minimum amount of statutory capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The formula for determining the amount of risk-based capital specifies various factors, weighted based on the perceived degree of risk, which are applied to certain financial balances and financial activity. The adequacy of a company’s actual capital is evaluated by a comparison to the risk-based capital results, as determined by the formula. Companies below minimum risk-based capital requirements are classified within certain levels, each of which requires specified corrective action. As of December 31, 20042006 and 2003,2005, all of CNA’sCNAF’s domestic insurance subsidiaries exceeded the minimum risk-based capital requirements.

As a result of the adverse charges taken in 2003, a capital plan was developed which involved, among other actions, the issuance of CCC surplus notes to Loews. 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. The CCC surplus notes issued in February of 2004 were repaid to Loews as of December 31, 2004.

Combined statutory capital and surplus and net income, (loss), determined in accordance with accounting practices prescribed or permitted by insurance regulatory authorities for the property and casualty and the life and group insurance subsidiaries, were as follows.

Preliminary Statutory Information
                                        
   Statutory Capital and Surplus Statutory Net Income 
 Statutory Capital and Surplus Statutory Net (Loss) Income December 31 Years Ended December 31 
 December 31 (a)
 Years Ended December 31
 2006 2005 2006 2005 2004 
(In millions)
 2004
 2003
 2004
 2003
 2002
 
Property and casualty companies(a) $6,998 $6,170 $661 $(1,484) $731  $8,137 $6,940 $721 $550 $694 
Life and group insurance companies 1,178 707 334 115 37  687 627 67 65 334 

(a) Surplus includes the property and casualty companies’ equity ownership of the life and group company(ies)’company’s capital and surplus.

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Note M. Comprehensive Income

(Loss)

Comprehensive income (loss) is composed of all changes to stockholders’ equity, except those changes resulting from transactions with stockholders in their capacity as owners.stockholders. The components of comprehensive income (loss) are shown below.

Comprehensive Income (Loss)
             
Years ended December 31
(In millions)
 2004
 2003
 2002
Net income (loss) $441  $(1,433) $155 
   
 
   
 
   
 
 
             
Other comprehensive income (loss):            
Change in unrealized gains/losses on general account investments:            
Holding gains arising during the period  486   262   305 
Net unrealized gains/losses at beginning of period included in realized gains/losses during the period  (637)  199   237 
   
 
   
 
   
 
 
             
Net change in unrealized gains/losses on general account investments  (151)  461   542 
Net change in unrealized gains on separate accounts and other  (66)  6   53 
Foreign currency translation adjustment  22   50   (18)
Net change in derivative instruments designated as cash flow hedge  (4)      
Net change in minimum pension liability  (101)  (176)  2 
Allocation to participating policyholders’ and minority interests  19   (7)  (19)
   
 
   
 
   
 
 
             
Other comprehensive income (loss), before tax and cumulative effect of change in accounting principles  (281)  334   560 
Deferred income tax (expense) benefit related to other comprehensive income (loss)  90   (97)  (182)
   
 
   
 
   
 
 
             
Other comprehensive income (loss), net of tax  (191)  237   378 
   
 
   
 
   
 
 
             
Total comprehensive income (loss)
 $250  $(1,196) $533 
   
 
   
 
   
 
 
             
Years ended December 31 2006  2005  2004 
(In millions)            
Net income $1,108  $264  $425 
          
             
Other comprehensive income (loss):            
Change in unrealized gains (losses) on general account investments:            
Holding gains (losses) arising during the period, net of tax benefit (expense) of $(68), $72 and $(170)  127   (136)  316 
Net unrealized (gains) losses at beginning of period included in realized gains (losses) during the period, net of tax expense of $6, $71 and $223  (11)  (131)  (414)
          
Net change in unrealized gains (losses) on general account investments, net of tax benefit (expense) of $(62), $143 and $53  116   (267)  (98)
Net change in unrealized gains (losses) on discontinued operations, separate accounts and other, net of tax benefit of $4, $16 and $0  (6)  4   (68)
Net change in foreign currency translation adjustment  42   (24)  24 
Net change in derivative instruments designated as cash flow hedge, net of tax benefit of $0, $0 and $1        (3)
Net change in minimum pension liability, net of tax benefit (expense) of $(44), $18 and $36  80   (33)  (65)
Allocation to participating policyholders’ and minority interests  4   18   19 
          
             
Other comprehensive income (loss), net of tax benefit (expense) of $(102), $177 and $90  236   (302)  (191)
          
             
Total comprehensive income (loss)
 $1,344  $(38) $234 
          

In the preceding table, deferred income tax benefit and expense related to other comprehensive income is attributable to each of the components of other comprehensive income in equal proportion except for the foreign currency translation adjustment, for which there are no deferred taxes.

The following table displays the components of accumulated other comprehensive income included in the Consolidated Balance Sheets.

Accumulated Other Comprehensive Income
         
December 31
(In millions)
 2004
 2003
Cumulative foreign currency translation adjustment $63  $41 
Minimum pension liability, net of tax of $105 and $69  (194)  (129)
Net unrealized gains on investments and other, net of tax of $430 and $484  781   929 
   
 
   
 
Accumulated other comprehensive income
 $650  $841 
   
 
   
 
         
December 31 2006  2005 
(In millions)        
Cumulative foreign currency translation adjustment $93  $51 
Minimum pension liability, net of tax benefit of $79 and $123  (147)  (227)
Adjustment to initially apply FAS 158, net of tax benefit of $25  (46)   
Net unrealized gains on investments and other, net of tax expense of $329 and $271  649   535 
       
Accumulated other comprehensive income
 $549  $359 
       

Note N. Business Segments

As a result of the Company’s decisions to focus on property and casualty operations and to exit certain businesses, the Company revised its reportable segment structure in the first quarter of 2004 to reflect the changes in its core operations and how management makes business decisions.

CNA’s core property and casualty insurance operations are now reported in two business segments: Standard Lines and Specialty Lines. CNA’s non-core operations are managed in two segments: Life and Group Non-Core and Corporate and Other Non-Core. Standard Lines includes standard property and casualty coverages sold to small and middle market commercial businesses primarily through an independent agency distribution system, and excess and surplus lines, as well as insurance and risk management

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products sold to large corporations in the U.S. as well as globally. Specialty Lines provides a broad array of professional, financial and specialty property and casualty products and services. Life and Group Non-Core primarily includes the results of the life and group lines of business that have either been sold or placed in run-off. Corporate and Other Non-Core primarily includes the results of certain property and casualty lines of business placed in run-off, including CNA Re (formerly a stand-alone property and casualty segment).Re. This segment also includes the results related to the centralized adjusting and settlement of APMT claims as well as the results of

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CNA’s participation in voluntary insurance pools, which are primarily in run-off, and various other non-insurance operations. Prior period segment disclosures have been conformed to the current year presentation.

The changes made to the Company’s reportable segments were as follows: 1) CNA Global (formerly included in Specialty Lines) which consists of marine and global standard lines is now included in Standard Lines; 2) CNA Guaranty and Credit (formerly included in Specialty Lines) is currently in run-off and is now included in the Corporate and Other Non-Core segment; 3) CNA Re is currently in run-off and is also now included in the Corporate and Other Non-Core segment; 4) Group Operations and Life Operations (formerly separate reportable segments) have now been combined into one reportable segment where the run-off of the retained group and life products will be managed; 5) certain run-off life and group operations formerly included in the Corporate and Other segment are now included in the Life and Group Non-Core segment.

The accounting policies of the segments are the same as those described in Note A. The Company manages most of its assets on a legal entity basis, while segment operations are conducted across legal entities. As such, only insurance and reinsurance receivables, insurance reserves and deferred acquisition costs are readily identifiable by individual segment. Distinct investment portfolios are not maintained for each segment; accordingly, allocation of assets to each segment is not performed. Therefore, net investment income and realized investment gains/gains or losses are allocated primarily based on each segment’s net carried insurance reserves, as adjusted.

All significant intrasegment income and expense has been eliminated. Standard Lines’ other revenues and expenses include revenues for services provided by CNA ClaimsPlus and RSKCo to other units within the Standard Lines segment that are eliminated at the consolidated level. Intrasegment revenueother revenues and expenses eliminated at the consolidated level were approximately $93$50 million, $116$65 million and $130$93 million for the years ended December 31, 2004, 20032006, 2005 and 2002.

2004.

Income taxes have been allocated on the basis of the taxable income of the segments.

Approximately 5.0%7.1%, 3.2%6.1% and 3.5%5.0% of CNA’s gross written premiums were derived from outside the United States, primarily the United Kingdom, for the years ended December 31, 2004, 20032006, 2005 and 2002.2004. Gross written premiums from the United Kingdom were approximately 2.3%3.2%, 1.8%2.8% and 1.7%2.3% of CNA’s premiums for the years ended December 31, 2004, 20032006, 2005 and 2002.2004. Gross written premiums from any individual foreign country, other than the United Kingdom, were not significant.

In the following three tables, certain financial measures are presented to provide information used by management to monitor the Company’s operating performance. Management utilizes these financial measures to monitor the Company’s insurance operations and investment portfolio. Net operating income, which is derived from certain income statement amounts, is used by management to monitor performance of the Company’s insurance operations. The Company’s investment portfolio is monitored through analysis of various quantitative and qualitative factors and certain decisions related to the sale or impairment of investments that produce realized gains and losses. Net realized investment gains and losses are comprised of after-tax realized investment gains and losses net of participating policyholders’ and minority interests.

Net operating income is calculated by excluding from net income the after-tax effects of 1) net realized investment gains or losses, 2) gainsincome or lossesloss from discontinued operations and 3) cumulative effects of changes in accounting principles. In the calculation of net operating income, management excludes after-tax net realized investment gains or losses because net realized investment gains or losses related to the Company’s available-for-sale investment portfolio are largely discretionary, except for losses related to other-than-temporary impairments, 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 insurance operations.

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The Company’s investment portfolio is monitored by management through analyses of various factors including unrealized gains and losses on securities, portfolio duration and exposure to interest rate, market and credit risk. Based on such analyses, the Company may impair an investment security in accordance with its policy, or sell a security. Such activities will produce realized gains and losses.

The significant components of the Company’s continuing operations and selected balance sheet items are presented in the following tables.

161125


                                                
 Corporate     Corporate     
 Standard Specialty Life and Group and Other     Standard Specialty Life and Group and Other     
Year ended December 31, 2004
(In millions)
 Lines
 Lines
 Non-Core
 Non-Core
 Eliminations
 Total
Year ended December 31, 2006 Lines Lines Non-Core Non-Core Eliminations Total 
(In millions) 
Net earned premiums $4,917 $2,277 $921 $128 $(34) $8,209  $4,413 $2,555 $641 $(1) $(5) $7,603 
Net investment income 495 246 692 241  1,674  991 403 698 320  2,412 
Other revenues 129 121 91 40  (86) 295  96 154 66 9  (50) 275 
 
 
 
 
 
 
 
 
 
 
 
 
              
Total operating revenues 5,541 2,644 1,704 409  (120) 10,178  5,500 3,112 1,405 328  (55) 10,290 
  
Claims, benefits and expenses:  
Net incurred claims and benefits 3,478 1,441 1,372 165  (21) 6,435  3,093 1,546 1,195 190 1 6,025 
Policyholders’ dividends 9 5  (3)   11  18 4    22 
Amortization of deferred acquisition costs 1,109 506 36 29  1,680  981 538 14 1  1,534 
Other insurance related expenses 593 88 291 10  (13) 969  393 145 201 24  (6) 757 
Other operating expenses 94 113 76 141  (86) 338 
Restructuring and other related charges     (13)   (13)
Other expenses 128 139 58 126  (50) 401 
 
 
 
 
 
 
 
 
 
 
 
 
              
Total claims, benefits and expenses 5,283 2,153 1,772 345  (120) 9,433  4,613 2,372 1,468 328  (55) 8,726 
  
Operating income (loss) from continuing operations before income tax and minority interest 258 491  (68) 64  745  887 740  (63)   1,564 
Income tax (expense) benefit on operating income  (27)  (150) 39 14   (124)
Income tax (expense) benefit on operating income (loss)  (258)  (245) 49 4   (450)
Minority interest  (10)  (17)     (27)  (12)  (31)   (1)   (44)
 
 
 
 
 
 
 
 
 
 
 
 
              
  
Net operating income (loss) from continuing operations 221 324  (29) 78  594  617 464  (14) 3  1,070 
  
Realized investment gains (losses), net of participating policyholders’ and minority interests 219 84  (615) 64   (248) 76 28  (50) 32  86 
Income tax (expense) benefit on realized investment gains (losses)  (80)  (30) 230  (25)  95   (21)  (10) 17  (5)   (19)
 
 
 
 
 
 
 
 
 
 
 
 
              
  
Net income (loss)
 $360 $378 $(414) $117 $ $441 
Income (loss) from continuing operations
 $672 $482 $(47) $30 $ $1,137 
 
 
 
 
 
 
 
 
 
 
 
 
              
 
As of December 31, 2006
 
(In millions) 
  
Reinsurance receivables
 $5,135 $1,682 $3,284 $5,893 $ $15,994  $3,260 $1,296 $2,378 $3,013 $ $9,947 
  
Insurance receivables
 $2,013 $340 $153 $61 $ $2,567  $2,053 $424 $52 $(53) $ $2,476 
  
Insurance reserves:
  
Claim and claim adjustment expense $14,302 $4,860 $3,680 $8,678 $ $31,520  $14,934 $5,529 $3,134 $6,039 $ $29,636 
Unearned premiums 1,978 1,546 164 834  4,522  2,007 1,599 173 5  3,784 
Future policy benefits   5,883   5,883    6,645   6,645 
Policyholders’ funds 43  1,682   1,725  35  980   1,015 
  
Deferred acquisition costs
 $444 $285 $537 $2 $ $1,268  $407 $283 $500 $ $ $1,190 

162126


                                                
 Corporate     Corporate     
 Standard Specialty Life and Group and Other     Standard Specialty Life and Group and Other     
Year ended December 31, 2003
(In millions)
 Lines
 Lines
 Non-Core
 Non-Core
 Eliminations
 Total
Year ended December 31, 2005 Lines Lines Non-Core Non-Core Eliminations Total 
(In millions) 
Net earned premiums $4,530 $1,840 $2,376 $582 $(114) $9,214  $4,410 $2,475 $704 $(8) $(12) $7,569 
Net investment income 407 201 821 218  1,647  767 281 593 251  1,892 
Other revenues 199 116 163 36  (119) 395  98 124 95 159  (65) 411 
 
 
 
 
 
 
 
 
 
 
 
 
              
Total operating revenues 5,136 2,157 3,360 836  (233) 11,256  5,275 2,880 1,392 402  (77) 9,872 
  
Claims, benefits and expenses:  
Net incurred claims and benefits 4,442 1,648 2,384 1,814  (115) 10,173  3,857 1,617 1,160 343  (2) 6,975 
Policyholders’ dividends 100 3 10 1  114  19 4 1   24 
Amortization of deferred acquisition costs 1,195 408 224 138  1,965  986 532 22 3  1,543 
Other insurance related expenses 741 100 530 40  1,411  444 115 257 23  (10) 829 
Other operating expenses 197 101 66 159  (118) 405 
Other expenses 110 108 61 115  (65) 329 
 
 
 
 
 
 
 
 
 
 
 
 
              
Total claims, benefits and expenses 6,675 2,260 3,214 2,152  (233) 14,068  5,416 2,376 1,501 484  (77) 9,700 
  
Operating income (loss) from continuing operations before income tax and minority interest  (1,539)  (103) 146  (1,316)   (2,812)  (141) 504  (109)  (82)  172 
Income tax (expense) benefit on operating income 592 59  (33) 470  1,088 
Income tax (expense) benefit on operating income (loss) 110  (154) 58 91  105 
Minority interest  (4) 10    6   (10)  (14)     (24)
 
 
 
 
 
 
 
 
 
 
 
 
              
  
Net operating income (loss) from continuing operations  (951)  (34) 113  (846)   (1,718)  (41) 336  (51) 9  253 
  
Realized investment gains (losses), net of participating policyholders’ and minority interests 361 114  (141) 126  460  20 14  (30)  (14)   (10)
Income tax (expense) benefit on realized investment gains (losses)  (127)  (40) 33  (41)   (175)  (11)  (2) 11 2   
 
 
 
 
 
 
 
 
 
 
 
 
              
  
Net income (loss)
 $(717) $40 $5 $(761) $ $(1,433)
Income (loss) from continuing operations
 $(32) $348 $(70) $(3) $ $243 
 
 
 
 
 
 
 
 
 
 
 
 
              
 
As of December 31, 2005
 
(In millions) 
  
Reinsurance receivables
 $5,508 $1,497 $2,999 $6,250 $ $16,254  $3,968 $1,493 $2,707 $4,268 $ $12,436 
  
Insurance receivables
 $2,264 $320 $282 $216 $ $3,082  $2,056 $375 $105 $5 $ $2,541 
  
Insurance reserves:
  
Claim and claim adjustment expense $14,282 $4,200 $3,576 $9,672 $ $31,730  $15,084 $5,205 $3,277 $7,372 $ $30,938 
Unearned premiums 2,267 1,480 153 1,100  5,000  1,952 1,577 168 9  3,706 
Future policy benefits   8,161   8,161    6,297   6,297 
Policyholders’ funds 79 3 522  (3)  601  30  1,465   1,495 
 
Deferred acquisition costs
 $499 $257 $1,745 $32 $ $2,533  $408 $274 $515 $ $ $1,197 

163127


                                                
 Corporate     Corporate     
 Standard Specialty Life and Group and Other Elimi-   Standard Specialty Life and Group and Other     
Year ended December 31, 2002
(In millions)
 Lines
 Lines
 Non-Core
 Non-Core
 nations
 Total
Year ended December 31, 2004 Lines Lines Non-Core Non-Core Eliminations Total 
(In millions) 
Net earned premiums $4,678 $1,451 $3,408 $714 $(38) $10,213  $4,917 $2,277 $921 $128 $(34) $8,209 
Net investment income 475 172 821 262  1,730  496 246 692 246  1,680 
Other revenues 355 108 199 79  (146) 595  129 109 91 40  (86) 283 
 
 
 
 
 
 
 
 
 
 
 
 
              
Total operating revenues 5,508 1,731 4,428 1,055  (184) 12,538  5,542 2,632 1,704 414  (120) 10,172 
  
Claims, benefits and expenses:  
Net incurred claims and benefits 3,418 1,066 3,210 681  (41) 8,334  3,480 1,441 1,372 162  (21) 6,434 
Policyholders’ dividends 73 3 10   86  9 5  (3)   11 
Amortization of deferred acquisition costs 1,125 349 162 155  1,791  1,109 506 36 29  1,680 
Other insurance related expenses 354 77 630 163  (131) 1,093  593 88 291 13  (13) 972 
Other operating expenses 308 94 103 185  (12) 678 
Restructuring and other related charges     (3)   (3)
Other expenses 94 101 76 141  (86) 326 
 
 
 
 
 
 
 
 
 
 
 
 
              
Total claims, benefits and expenses 5,278 1,589 4,115 1,184  (184) 11,982  5,285 2,141 1,772 342  (120) 9,420 
Restructuring and other related charges  (8)  (1)  (1)  (27)   (37)
 
 
 
 
 
 
 
 
 
 
 
 
 
  
Operating income (loss) from continuing operations before income tax and minority interest 238 143 314  (102)  593  257 491  (68) 72  752 
Income tax (expense) benefit on operating income  (56)  (40)  (108) 33   (171)
Income tax (expense) benefit on operating income (loss)  (27)  (150) 39 12   (126)
Minority interest  (13)  (13)     (26)  (10)  (17)     (27)
 
 
 
 
 
 
 
 
 
 
 
 
              
  
Net operating income (loss) from continuing operations 169 90 206  (69)  396  220 324  (29) 84  599 
  
Realized investment gains (losses), net of participating policyholders’ and minority interests  (119)  (39)  (175) 81   (252) 219 84  (615) 64   (248)
Income tax (expense) benefit on realized investment gains (losses) 40 14 60  (11)  103   (80)  (30) 230  (25)  95 
Loss from discontinued operations, net of tax of $9    (35)    (35)
Cumulative effect of a change in accounting principle, net of tax of $7  (43)  (5)  (8)  (1)   (57)
 
 
 
 
 
 
 
 
 
 
 
 
              
  
Net income
 $47 $60 $48 $ $ $155 
Income (loss) from continuing operations
 $359 $378 $(414) $123 $ $446 
 
 
 
 
 
 
 
 
 
 
 
 
              

164128


The following table provides revenue by line of business for each reportable segment. Prior period amounts have been conformed to reflect the current product structure. Revenues are comprised of operating revenues and realized investment gains and losses, net of participating policyholders’ and minority interests.

Revenue by Line of Business
                        
Years ended December 31
(In millions)
 2004
 2003
 2002
Years ended December 31 2006 2005 2004 
(In millions) 
Standard Lines
  
Property $664 $668 $589  $1,249 $1,108 $1,180 
Casualty 4,195 3,944 4,049  3,576 3,532 3,938 
CNA Global 901 885 751  751 655 643 
 
 
 
 
 
 
        
  
Standard Lines revenue
 5,760 5,497 5,389  5,576 5,295 5,761 
 
 
 
 
 
 
        
 
Specialty Lines
  
Professional Liability Insurance (CNA Pro) 2,053 1,612 1,083 
US Specialty Lines 2,417 2,205 2,053 
Surety 361 346 325  436 393 361 
Warranty 314 313 284  287 296 302 
 
 
 
 
 
 
        
  
Specialty Lines revenue
 2,728 2,271 1,692  3,140 2,894 2,716 
 
 
 
 
 
 
        
  
Life and Group Non-Core
  
Life & Annuity  (45) 1,030 911  384 311 435 
Health 1,053 2,026 3,098  889 900 1,025 
Other 81 163 244  82 151  (371)
 
 
 
 
 
 
        
  
Life and Group Non-Core revenue
 1,089 3,219 4,253  1,355 1,362 1,089 
 
 
 
 
 
 
        
  
Corporate and Other Non-Core revenue
  
CNA Re 220 688 869  129 71 225 
Other 253 274 267  231 317 253 
 
 
 
 
 
 
        
  
Corporate and Other Non-Core revenue
 473 962 1,136  360 388 478 
 
 
 
 
 
 
        
  
Intersegment eliminations
  (120)  (233)  (184)
Eliminations
  (55)  (77)  (120)
 
 
 
 
 
 
        
  
Total revenue
 $9,930 $11,716 $12,286  $10,376 $9,862 $9,924 
 
 
 
 
 
 
        

Note O. Restructuring and Other Related Charges

In 2001, the Company finalized and approved two separate restructuring plans. The first plan related to the Company’s Information Technology operations (the IT Plan).operations. The initial restructuring and other related charges amounted to $62 million in 2001. The remaining accrual related to this restructuring charge of $3 million was released duringin 2004.
The second plan related to restructuring the property and casualty segments and Life and Group Non-Core segment, discontinuation of the variable life and annuity business and consolidation of real estate locations (the 2001 Plan).

2001 Plan

The overall goallocations. During the second quarter of 2006, management reevaluated the sufficiency of the 2001 Plan wasremaining accrual, which related to createlease termination costs, and determined that the liability is no longer required as the Company has completed its lease obligations. As a simplified and leaner organization for customers and business partners. The major components ofresult, the plan included a reduction in the number of strategic business units (SBUs) in the property and casualty operations, changes in the strategic focus of the Life and Group Non-Core segment (formerly Life Operations and Group Operations) and consolidation of real estate locations. The reduction in the number of property and casualty SBUs resulted in consolidation of SBU functions, including underwriting, claims, marketing and finance. The strategic changes in Group Operations included a decision to discontinue the variable life and annuity business.

165


The following table summarizes the 2001 Plan accrual and the activity in that accrual since inception.

2001 Plan Accrual

                     
  Employee        
  Termination Lease Impaired    
  and Related Termination Asset Other  
(In millions)
 Benefit Costs
 Costs
 Charges
 Costs
 Total
2001 Plan Initial Accrual $68  $56  $30  $35  $189 
Costs that did not require cash           (35)  (35)
Payments charged against liability  (2)           (2)
   
 
   
 
   
 
   
 
   
 
 
Accrued costs December 31, 2001  66   56   30      152 
Costs that did not require cash  (1)  (3)  (9)     (13)
Payments charged against liability  (53)  (12)  (4)     (69)
Reduction of accrual  (10)  (7)  (15)     (32)
   
 
   
 
   
 
   
 
   
 
 
Accrued costs December 31, 2002  2   34   2      38 
Costs that did not require cash        (1)     (1)
Payments charged against liability  (2)  (15)        (17)
   
 
   
 
   
 
   
 
   
 
 
Accrued costs December 31, 2003     19   1      20 
Payments charged against liability     (5)        (5)
   
 
   
 
   
 
   
 
   
 
 
Accrued costs December 31, 2004
 $  $14  $1  $  $15 
   
 
   
 
   
 
   
 
   
 
 

During 2002, $32 million pretax, or $21 million after-tax, of thisexcess remaining accrual was reduced. Noreleased in 2006, resulting in pretax income of $13 million for the year ended December 31, 2006. During 2005 and 2004, approximately $1 million and $5 million of costs were paid. The initial restructuring and other related charges relatedamounted to the 2001 Plan were incurred$189 million in 2003 or 2004.

2001.

Note P. Significant Transactions

CNA TrustSpecialty Medical Business

On August 1, 2004,January 6, 2005, the Company completed the sale of the retirement plan trust and recordkeepingits specialty medical business portfolio of CNA Trust to Union Bank of California, N.A. (Union Bank) for approximately $12 million.Aetna Inc. As a result of the sale, CNA recorded a realized investment gain of approximately $9 million pretax ($5 million after-tax) for the year ended December 31, 2004.

Union Bank assumed assets and liabilities of $172 million and $172 million at August 1, 2004. The assets and liabilities of CNA Trust were $216 million and $184 million at December 31, 2003.in 2005. The revenues of the business sold through the sale date were $11 million, $27$17 million and $28$166 million for the years ended December 31, 2004, 20032005 and 2002.2004. Net results of operations ofincome related to this business through the sale date were a net loss of $2was $18 million and net income of $0 million and $2$16 million for the years ended December 31, 2004, 20032005 and 2002.2004.

129

On November 19, 2004, the charter of CNA Trust was sold to Nevada Security Bank for a nominal fee. As part of the sale, CNA Trust was merged into Nevada Security Bank, and is no longer a subsidiary of CNA.


Individual Life Sale

On April 30, 2004, the Company completed the sale of its individual life insurance business to Swiss Re. The business sold included term, universal and permanent life insurance policies and individual annuity products. CNA’s individual long term care and structured settlement businesses were excluded from the sale. Swiss Re acquired VFL and CNA’s Nashville, Tennessee insurance servicing and administration building as part of the sale. In connection with the sale, CNA entered into a reinsurance agreement in which CAC ceded its individual life insurance business to Swiss Re on a 100% indemnity reinsurance basis. Subject to certain exceptions, Swiss Re

166


assumed the credit risk of the business that was previously reinsured to other carriers. As a result of this reinsurance agreement with Swiss Re, approximately $1 billion of future policy benefit reserves were ceded.ceded to Swiss Re. CNA received consideration of approximately $700 million and recorded a realized investment loss of $622 million pretax ($389 million after-tax).

Swiss Re assumed assets and liabilities of $6.6 billion and $5.2 billion at April 30, 2004. The assets and liabilities of the individual life business sold were $6.6 billion and $5.4 billion at December 31, 2003.

The revenues of the individual life business through the sale date were $151 million $625 million and $652 million for the yearsyear ended December 31, 2004, 2003 and 2002.2004. The net results for this business through the sale date were a net loss of $6 million for the year ended December 31, 2004.
Note Q. Discontinued Operations
CNA has discontinued operations which consist of run-off insurance operations acquired in its merger with The Continental Corporation in 1995. The business consists of facultative property and net incomecasualty, treaty excess casualty and treaty pro-rata reinsurance with underlying exposure to a diverse, multi-line domestic and international book of $43business encompassing property, casualty, the London Market and marine liabilities. The run-off operations are concentrated in United Kingdom and Bermuda subsidiaries also acquired in the merger.
The Company has initiated and is actively pursuing a plan to sell a portion of the discontinued operations. The Company expects a sale to be completed in 2007.
Results of the discontinued operations were as follows:
Discontinued Operations
             
Years ended December 31 2006  2005  2004 
(In millions)            
Revenues:            
Net investment income $17  $15  $17 
Realized investment gains (losses) and other  (2)  7   (7)
          
Total revenues  15   22   10 
Insurance related (expenses) benefits  (51)  1   (30)
        �� 
Income (loss) before income taxes  (36)  23   (20)
Income tax (expense) benefit  7   (2)  (1)
          
Income (loss) from discontinued operations, net of tax $(29) $21  $(21)
          
The results for 2006 reflect an impairment loss of approximately $29 million related to the anticipated sale of a portion of the discontinued operations. The assets and liabilities that would be subject to a sale were $239 million and $55$157 million at December 31, 2006. Excluding the impairment loss on the anticipated sale, net loss for this business was $1 million and $3 million for the years ended December 31, 2006 and 2004, 2003 and 2002.

Group Benefits Sale

On December 31, 2003, the Company completed the sale of the majority of its Group Benefits business through the sale of CNAGLA to Hartford Financial Services Group, Inc. (Hartford). The business sold included group life and accident, short and long term disability and certain other products. CNA’s group long term care and specialty medical businesses were excluded from the sale. In connection with the sale, CNA received consideration of approximately $530 million and recorded a realized investment loss on the sale of $163 million pretax ($122 million after-tax), including an after-tax realized investment gain of $8 million ($13 million pretax) recorded in the second quarter of 2004.

As a result of this agreement, Hartford assumed assets and liabilities of $2.4 billion and $1.6 billion at December 31, 2003. The assets and liabilities of the CNA Group Benefits business sold were $2.2 billion and $1.6 billion at December 31, 2002. The revenues of the Group Benefits business were $1,204 million and $1,137 million for the years ended December 31, 2003 and 2002. Netnet income was $52 million and $38 million for the years ended December 31, 2003 and 2002.

Assumed Reinsurance Renewal Rights Sale

In October of 2003, the Company entered into an agreement to sell the renewal rights for most of the treaty business of CNA Re to Folksamerica Reinsurance Company (Folksamerica). Under the terms of the transaction, Folksamerica will compensate CNA based upon the amount of premiums renewed by Folksamerica over the next two contract renewals. The renewal rights transaction did not have a material effect on results of operations. Concurrent with the sale, CNA withdrew from the assumed reinsurance business (the CNA Re segment) and is managing the run-off of its retained liabilities.

National Postal Mail Handlers Union Contract Termination

In 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. 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 revenues of Claims Administration Corporation and the Mail Handlers Plan were $1,151$13 million for the year ended December 31, 2002. Net income from Claims Administration2005. The Company’s subsidiary, The Continental Corporation, and Mail Handlers Plan was $5 million, includingprovides a guarantee for a portion of the non-recurring fee income forsubject liabilities related to certain marine products. Any sale is expected to include provisions that would significantly limit the year ended December 31, 2002.

CNA Re U.K. and Other Dispositions of Certain Businesses

On October 31, 2002, the Company completed the sale of CNA Re U.K.Company’s exposure related to Tawa UK Limited (Tawa), a subsidiary of 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 CCC as discussed below.

this guarantee.

167130


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 purchase price adjustment recorded in 2003 related to foreign currency losses and resulted in CNA contributing additional capital to CNA Re U.K. of $11 million. Also in 2003, the Company finalized its impairment analysis based upon the terms of the completed transactions and reduced a previously recorded impairment loss by approximately $39 million after-tax. The reduction of the impairment was included in net realized investment gains.

Under the terms of the purchase price adjustment, CCC was entitled to receive $5 million from Tawa after Tawa was able to legally withdraw funds from the former CNA Re U.K. entities; at December 31, 2004, CCC had received all amounts owed to it, totaling approximately $5 million. CNA 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 Financial Services Authority (FSA) deem those entities to be undercapitalized.

Concurrent with the sale, several reinsurance agreements under which CCC had provided retrocessional protection to CNA Re U.K. were terminated. As part of the sale, CNA Re U.K.’s net exposure to all IGI Program liabilities was assumed by CCC. Further, CCC provided 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.

Personal Insurance Transaction

As part of the sale of CNA’s personal insurance business to The Allstate Corporation on October 1, 1999, the Company shared in payments of claim and allocated claim adjustment expenses related to losses incurred prior to October 1, 1999 on the CNA policies transferred to Allstate when they exceeded the claim and allocated claim adjustment expense reserves of approximately $1 billion at the date of sale. The Company’s remaining obligation with respect to claim and allocated claim adjustment expense reserves, valued as of October 1, 2003, was settled in March of 2004 and the sharing agreement was terminated. This settlement did not have a material impact on the 2004 results of operations of the Company.

Note Q. Discontinued Operations

CNA reports net

Net assets of discontinued operations, which primarily consist of run-off operations discontinuedincluding the assets and liabilities subject to the sale discussed above, are included in Other assets in the mid-1990’s, inConsolidated Balance Sheets and were as follows:
Discontinued Operations
         
December 31 2006  2005 
(In millions)        
Assets:        
Investments $317  $358 
Reinsurance receivables  33   78 
Cash  40   29 
Other assets  3   5 
       
Total assets  393   470 
         
Liabilities:        
Insurance reserves  308   338 
Other liabilities  17   19 
       
Total liabilities  325   357 
       
         
Net assets of discontinued operations $68  $113 
       
The Accumulated other assetscomprehensive income, net of tax, reported on the Consolidated Balance Sheets. The following table provides more detailed information regarding those net assets.

Discontinued Operations

         
December 31
(In millions)
 2004
 2003
Total investments $410  $458 
Other assets  345   358 
Insurance reserves  (439)  (480)
Other liabilities  (16)  (28)
   
 
   
 
 
         
Net assets of discontinued operations $300  $308 
   
 
   
 
 

CNA Vida Disposition

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 $73Sheets includes $1 million and $11 million related to unrealized gains and $15 million and $6 million related to the cumulative foreign currency translation adjustment for discontinued operations as of December 31, 2006 and 2005.

CNA’s accounting and reporting for discontinued operations is in accordance with APB Opinion No. 30,Reporting the Results of Operations — Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions (APB 30). At December 31, 2006 and 2005, the insurance reserves are net of discount of $94 million and $105 million. Excluding the impairment loss recorded an after-tax lossin 2006 discussed above, the income (loss) from discontinued operations reported above primarily represents the net investment income, realized investment gains and losses, foreign currency gains and losses, effects of $35 million. This loss is composedthe accretion 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. CNA Vida’s results of operations, including the loss on sale, are presented asreserve discount and re-estimation of the ultimate claim and claim adjustment expense of the discontinued operations for the year ended 2002 in the Consolidated Statements of Operations.

operations.

168131


Note R. Quarterly Financial Data (Unaudited)

The following tables set forth unaudited quarterly financial data for the years ended December 31, 20042006 and 2003.2005.
                     
Quarterly Financial Data                 Full 
  First  Second  Third  Fourth  Year 
(In millions, except per share data)                    
2006
                    
Revenues $2,501  $2,412  $2,620  $2,843  $10,376 
                
                     
Income from continuing operations before income tax $343  $341  $436  $486  $1,606 
Income tax expense  (108)  (100)  (131)  (130)  (469)
                
                     
Income from continuing operations  235   241   305   356   1,137 
Income (loss) from discontinued operations, net of tax  (6)  (2)  6   (27)  (29)
                
                     
Net income
 $229  $239  $311  $329  $1,108 
                
                     
Basic Earnings Per Share
                    
                     
Income from continuing operations $0.84  $0.87  $1.13  $1.33  $4.17 
Income (loss) from discontinued operations  (0.02)  (0.01)  0.02   (0.10)  (0.11)
                
                     
Basic earnings per share available to common stockholders
 $0.82  $0.86  $1.15  $1.23  $4.06 
                
                     
Diluted Earnings Per Share
                    
                     
Income from continuing operations $0.84  $0.87  $1.13  $1.32  $4.16 
Income (loss) from discontinued operations  (0.02)  (0.01)  0.02   (0.10)  (0.11)
                
                     
Diluted earnings per share available to common stockholders
 $0.82  $0.86  $1.15  $1.22  $4.05 
                
                     
Quarterly Financial Data                 Full 
  First  Second  Third  Fourth  Year 
(In millions, except per share data)                    
2005
                    
Revenues $2,364  $2,570  $2,520  $2,408  $9,862 
                
                     
Income (loss) from continuing operations before income tax $234  $336  $(48) $(384) $138 
Income tax (expense) benefit  (56)  (48)  51   158   105 
                
                     
Income (loss) from continuing operations  178   288   3   (226)  243 
Income from discontinued operations, net of tax  7   2   3   9   21 
                
                     
Net income (loss)
 $185  $290  $6  $(217) $264 
                
                     
Basic and Diluted Earnings (Loss) Per Share
                    
                     
Income (loss) from continuing operations $0.63  $1.06  $(0.06) $(0.95) $0.68 
Income from discontinued operations  0.03      0.02   0.03   0.08 
                
                     
Basic and diluted earnings (loss) per share available to common stockholders
 $0.66  $1.06  $(0.04) $(0.92) $0.76 
                

132

Quarterly Financial Data

                     
                  Full
(In millions, except per share data)
 First
 Second
 Third
 Fourth
 Year
2004
                    
Revenues $2,265  $2,663  $2,317  $2,685  $9,930 
   
 
   
 
   
 
   
 
   
 
 
Income (loss) from continuing operations before income tax $(179) $318  $(80) $411  $470 
Income tax (expense) benefit  54   (29)  52   (106)  (29)
   
 
   
 
   
 
   
 
   
 
 
Net income (loss)
 $(125) $289  $(28) $305  $441 
   
 
   
 
   
 
   
 
   
 
 
Basic and diluted earnings (loss) per share available to common stockholders
 $(0.55) $1.07  $(0.17) $1.12  $1.47 
   
 
   
 
   
 
   
 
   
 
 
2003
                    
Revenues $2,845  $3,099  $2,725  $3,047  $11,716 
Income (loss) from continuing operations before income tax $101  $75  $(2,766) $244  $(2,346)
Income tax (expense) benefit  (18)  (5)  1,006   (70)  913 
   
 
   
 
   
 
   
 
   
 
 
Net income (loss)
 $83  $70  $(1,760) $174  $(1,433)
   
 
   
 
   
 
   
 
   
 
 
Basic and diluted earnings (loss) per share available to common stockholders
 $0.30  $0.25  $(7.94) $0.67  $(6.58)
   
 
   
 
   
 
   
 
   
 
 


During the fourth quarter of 2006, the Company commuted a significant reinsurance contract that resulted in unfavorable development of $110 million, which was partially offset by the release of previously established allowance for uncollectible reinsurance. This commutation resulted in an unfavorable impact of $48 million. Additionally, the Company recorded $74 million of non-commutation related unfavorable net prior year development.
During the fourth quarter of 2005, the Company recorded unfavorable net prior year development of $591 million, which included $377 million from significant commutations and established surety losses related to a national contractor of $70 million.
Note S. Related Party Transactions

CNA reimburses Loews, or pays directly, for management fees, travel and related expenses and expenses of investment facilities and services provided to CNA. The amounts reimbursed or paid by CNA were approximately $21$27 million, $21$23 million and $19$21 million for the years ended December 31, 2004, 20032006, 2005 and 2002. In addition, CNAF and its eligible subsidiaries are2004. The CNA Tax Group is included in the consolidated federal income tax return of Loews and its eligible subsidiaries. See Note E for a detailed description of the income tax agreement and tax payments made between the Company andwith Loews. Also,In addition, CNA writes, at standard rates, a limited amount of insurance for Loews and its affiliates.subsidiaries. The total related premiums from Loews for the year ended December 31, 20042006 were not significant.$1 million. The total premium from Loews and its affiliates was $4 millionrelated premiums for each of the years ended December 31, 20032005 and 2002.

2004 were less than $1 million.

In August 2006, the Company repurchased the Series H Issue from Loews. In addition, the Company sold 7.86 million shares of its common stock to Loews. See Note L for further discussion. In conjunction with the sale, the Company and Loews also entered into a Registration Rights Agreement pursuant to which Loews has the right to demand that the Company register up to an aggregate of 7.86 million shares for resale in a public offering and may request that the Company include those shares in certain registration statements that it may file in the future.
CNA previously sponsored a stock ownership plan whereby the Company financed the purchase of Company common stock by certain officers, including executive officers. Interest charged on the principal amount of these outstanding stock purchase loans is generally equivalent to the long term applicable federal rate, compounded semi-annually, in effect on the disbursement date of the loan. Loans made pursuant to the plan are generally full recourse with a ten-year term maturing between October of 2008 and May of 2010, and are secured by the stock purchased. The balancecarrying value of the loans as of December 31, 20042006 exceeds the fair value of the related common stock collateral by $35$7 million.

CNA Surety Corporation - Loans to National Contractor
CNA Surety has provided significant surety bond protection for a large national contractor that undertakes projects for the construction of government and private facilities, a substantial portion of which have been reinsured by CCC. In order to help this contractor meet its liquidity needs and complete projects which had been bonded by CNA Surety, commencing in 2003 CNAF has provided loans to the contractor through a credit facility. InDue to reduced operating cash flow at the contractor these loans were fully impaired through realized investment losses in 2004 and 2005. For the years ended December of31, 2005 and 2004, the credit facility was amended to increase the maximum available loans to $106Company recorded a pretax impairment charge of $34 million from $86and $56 million. The amendment alsoCompany no longer provides that CNAF may in its sole discretion further increaseadditional liquidity to the amounts available forcontractor and has not recognized interest income related to the loans since June 30, 2005.
In addition to the impairment of loans outstanding under the credit facility, upthe Company determined that the contractor would likely be unable to an aggregate maximummeet its obligations under the surety bonds. Accordingly, during 2005, CNA Surety established $110 million of $126 million. Assurety loss reserves in anticipation of future loss payments, $50 million of which was ceded to CCC under the reinsurance agreements discussed below. Further deterioration of the contractor’s operating cash flow could result in higher loss estimates and trigger additional reserve actions. If any such reserve additions were required, CCC would have all further surety bond exposure through the reinsurance arrangements. During the years ended December 31, 20042006 and 2003, there were $99

2005, CNA Surety paid $34 million and $26 million related to surety losses of the contractor.

169133


million and $80 million of total debt outstanding under the credit facility. Additional loans in January and February of 2005 brought the total debt outstanding under the credit facility, less accrued interest, to $104 million as of February 24, 2005. Loews, through a participation agreement with CNAF, provided funds for and owned a participation of $29 million and $25 million of the loans outstanding as of December 31, 2004 and 2003 and has agreed to participation of one-third of any additional loans which may be made above the original $86 million credit facility limit up to the $126 million maximum available line.

In connection with the amendment to increase the maximum available line under the credit facility in December of 2004, the term of the loan under the credit facility was extended to mature in March of 2009 and the interest rate was reduced prospectively from 6% over prime rate to 5% per annum, effective as of December 27, 2004, with an additional 3% interest accrual when borrowings under the facility are at or below the original $86 million limit.

Loans under the credit facility are secured by a pledge of substantially all of the assets of the contractor and certain of its affiliates. In connection with the credit facility, CNAF has also guaranteed or provided collateral for letters of credit which are charged against the maximum available line and, if drawn upon, would be treated as loans under the credit facility. As of December 31, 2004 and 2003, these guarantees and collateral obligations aggregated $13 million and $7 million.

As of December 31, 2004, the aggregate amount of outstanding principal and accrued interest under the credit facility was $70 million, net of participation by Loews in the amount of $29 million.

The contractor implemented a restructuring plan intended to reduce costs and improve cash flow, and appointed a chief restructuring officer to manage execution of the plan. In the course of addressing various expense, operational and strategic issues, however, the contractor has decided to substantially reduce the scope of its original business and to concentrate on those segments determined to be potentially profitable. As a consequence, operating cash flow, and in turn the capacity to service debt, has been reduced below previous levels. Restructuring plans have also been extended to accommodate these circumstances. In light of these developments, CNA has taken an impairment charge of $56 million pretax for the fourth quarter of 2004, net of the participation by Loews, with respect to amounts loaned under the facility. Any draws under the credit facility beyond $106 million or further changes in the national contractor’s business plan or projections may necessitate further impairment charges.

As a result of the impairment taken in the fourth quarter of 2004, CNAF plans to recognize income using the effective interest rate method starting in the first quarter of 2005. Under this method, interest income recognized will be accrued on the net carrying amount of the loan at the effective interest rate used to discount the impaired loan’s estimated future cash flows. The excess of the cash received over the interest income recognized will reduce the carrying amount of the loan. The change in present value, if any, of the loan that is attributable to changes in the amount or timing of future cash flows will be recorded similar to the impairment charges previously recorded.

CNA Surety has advised that it intends to continue tomay provide surety bonds on a limited basis on behalf of the contractor during this extendedto support its revised restructuring period,plan, subject to the contractor’s initial and ongoing compliance with CNA Surety’s underwriting standards and ongoing management of CNA Surety’s exposure in relation to the contractor. All surety bonds written for the national contractor are issued by CCC and its affiliates, other than CNA Surety, and are subject to underlying reinsurance treaties pursuant to which all bonds written on behalf of CNA Surety are 100% reinsured to one of CNA Surety’s insurance subsidiaries. This arrangement underlies the more limited
CCC provides reinsurance coverages discussed below.

Through facultative reinsurance contracts with CCC,protection to CNA Surety’s exposure on bonds written from October 1, 2002 through October 31, 2003 has been limited to $20 million per bond, with CCC to incur 100%Surety for losses in excess of losses above that level. For bonds written on or subsequent to November 1, 2003, CNA Surety’s exposure is limited to $14.5 million per bond, subject to a per principal retentionan aggregate of $60 million and an aggregate limit of $150 million, under all facultative insurance coverage and two excess of loss treaties between CNA Surety and CCC. The first excess of loss contract, $40 million excess of $60 million,associated with the contractor. This treaty provides CNA Surety coverage exclusively for the national contractor, while the second excess of loss contract, $50 million excess of $100 million, provides CNA Surety with coverage for the national contractor as well as other CNA Surety risks. Forlife of bonds either in force or written prior to September 30, 2002 there is no facultative reinsurance and CCC retains 100% of the losses above the per principal retention of $60 million.

170


Renewals of both excess of loss contracts were effectivefrom January 1, 2005 to December 31, 2005. CCC and CNA Surety are presently discussing a possible restructuring of the reinsurance arrangements discussed in the paragraph above, under which all bonds writtenagreed by addendum to extend this contract for the national contractor would be reinsured by CCC under an excess of $60 million treaty and other CNA Surety accounts would be covered by a separate $50 million excess of $100 million treaty.

twenty four months, expiring on December 31, 2007.

CCC and CNA Surety continue to engage in periodic discussions with insurance regulatory authorities regarding the level of surety bonds provided for this principalcontractor and will continue to apprise those authorities regardingof the status of their ongoing exposure to this account.

Indemnification and subrogation rights, including rights to contract proceeds on construction projects in the event of default, exist that reduce CNA Surety’s and ultimately the Company’s exposure to loss. While CNAFthe Company believes that the contractor’s continuing restructuring efforts may be successful, and provide sufficient cash flow for its operations, the contractor’s failure to ultimately achieve its extended restructuring plan or perform its contractual obligations under the credit facility or under the Company’s surety bonds could have a material adverse effect on the Company’s results of operations and/ or equity.operations. If such failures occur, the Company estimates the additional surety loss, net of indemnification and subrogation recoveries, but before the effects of minority interest, could be up to be approximately $200$90 million pretax. In addition, such failures could cause
CNAF has also guaranteed or provided collateral for the remaining unimpaired amount due under the credit facility to be uncollectible.

contractor’s letters of credit. As of December 31, 2006 and December 31, 2005, these guarantees and collateral obligations aggregated $9 million and $13 million.

CNA Surety CorporationReinsurance

CCC provided an excess of loss reinsurance contract to the insurance subsidiaries of CNA Surety over a period that expired on December 31, 2000 (the stop loss contract). The stop loss contract limits the net loss ratios for CNA Surety with respect to certain accounts and lines of insurance business. In the event that CNA Surety’s accident year net loss ratio exceeds 24% for 1997 through 2000 (the contractual loss ratio), the stop loss contract requires CCC to pay amounts equal to the amount, if any, by which CNA Surety’s actual accident year net loss ratio exceeds the contractual loss ratio multiplied by the applicable net earned premiums. The minority shareholders of CNA Surety do not share in any losses that apply to this contract. There were no reinsurance balances payable under this stop loss contract as of December 31, 2004 and 2003.

Effective October 1, 2002, CCC provided an excess of loss protection for new and renewal bonds for CNA Surety for each principal exposure that exceeds $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. Effective January 1, 2004, this contract was commuted and CCC paid CNA Surety $11 million in return premium in the first quarter of 2004 based on experience under the contract. Effective October 1, 2003, CCC entered into a $3 million excess of $12 million excess of loss contract with CNA Surety. The reinsurance premium for the coverage provided by the $3 million excess of $12 million contract was $0.3 million plus, if applicable, additional premiums based on paid losses. The contract provided for aggregate coverage of $12 million. This contract expired on December 31, 2004. Effective January 1, 2004, the Company obtained replacement coverage from third party reinsurers as part of the 2004 Excess of Loss Treaty.

171134


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
CNA Financial Corporation
Chicago, Illinois

We have audited the accompanying consolidated balance sheets of CNA Financial Corporation (an affiliate of Loews Corporation) and subsidiaries (the “Company”), as of December 31, 20042006 and 2003,2005, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004.2006. Our audits also included the financial statement schedules listed in the Index at Item 15. These financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on thethese financial statements and financial statement schedules based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of CNA Financial Corporation and subsidiariesthe Company as of December 31, 20042006 and 2003,2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004,2006, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

As discussed in Note A to the consolidated financial statements, the Company changed its method of accounting for defined benefit pension and other postretirement plans in 2006.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004,2006, based on the criteria established in Internal Control—Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 200522, 2007 expressed an unqualified opinion on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

As discussed in Note A to the consolidated financial statements, the Company changed its method of accounting for certain separate account products in 2004.

Deloitte

/s/ DELOITTE & ToucheTOUCHE LLP

Chicago, ILIllinois
February 25, 2005

22, 2007

172135


MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The management of CNA Financial Corporation (CNAF) and its subsidiaries(CNAF or the Company) is responsible for establishing and maintaining adequate internal control over financial reporting. CNAF’s internal control system was designed to provide reasonable assurance to the Company’s management, its Audit Committee and Board of Directors regarding the preparation and fair presentation of published financial statements.

There are inherent limitations to the effectiveness of any internal control or system of control, however well designed, including the possibility of human error and the possible circumvention or overriding of such controls or systems. Moreover, because of changing conditions the reliability of internal controls may vary over time. As a result even effective internal controls can provide no more than reasonable assurance with respect to the accuracy and completeness of financial statements and their process of preparation.

CNAF management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004.2006. In making this assessment, it has used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control Integrated Framework. Based on those criteria and our assessment we believe that, as of December 31, 2004,2006, the Company’s internal control over financial reporting is effective based on those criteria.

was effective.

CNAF’s independent registered public accountant, Deloitte & Touche LLP, has issued an audit report covering our assessment of the Company’s internal control over financial reporting. This report appears on page 174.

137.

CNA Financial Corporation
Chicago, Illinois
February 25, 2005

22, 2007

173136


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of
CNA Financial Corporation
Chicago, Illinois

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that CNA Financial Corporation (an affiliate of Loews Corporation) and subsidiaries (the “Company”) maintained effective internal control over financial reporting as of December 31, 2004,2006, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that the Company maintained effective internal control over financial reporting as of December 31, 2004,2006, is fairly stated, in all material respects, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004,2006, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

137


We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedules as of and for the year ended December 31, 20042006 of the Company and our report dated February 25, 2005 expressed22, 2007 expresses an unqualified opinion on those consolidated financial statements and financial statement schedules and includedincludes an explanatory paragraph regarding theconcerning a change in the method of accounting for certain separate account productsdefined benefit pension and other postretirement plans in 2004.

Deloitte2006.

/s/ DELOITTE & ToucheTOUCHE LLP

Chicago, ILIllinois
February 25, 2005

22, 2007

174138


ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

As of December 31, 2004,2006, the Company’s management, including the Company’s Chief Executive Officer (CEO) and Chief Financial Officer (CFO), have conducted an evaluation of the effectiveness of itsthe Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based on thatthis evaluation, the CEO and CFO have concluded that the Company’s disclosure controls and procedures are effective in ensuring that all material information required to be filed in this annual report has been made known to them in a timely manner.

effective.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, and the implementing rules of the Securities and Exchange Commission, the Company included a report of management’s assessment of the design and effectiveness of its internal controls as part of this Annual Report on Form 10-K for the fiscal year ended December 31, 2004.2006. The independent registered public accounting firm of the Company also attested to, and reported on, management’s assessment of the effectiveness of internal control over financial reporting. Management’s report and the independent registered public accounting firm’s attestation report are included in the Company’s 2004 Financial StatementsItem 8 under the captions entitled “Management’s Report on Internal Control Over Financial Reporting” and “Report of Independent Registered Public Accounting Firm” and are incorporated herein by reference.

There has been no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended December 31, 20042006 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

ITEM 9B. OTHER INFORMATION

None.

None.

175139


PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
EXECUTIVE OFFICERS OF THE REGISTRANT

EXECUTIVE OFFICERS OF THE REGISTRANT

        
 FIRST  
             POSITION AND BECAME  
 FIRST BECAME   OFFICES EXECUTIVE  
 POSITION AND OFFICES EXECUTIVE OFFICER   HELD WITH OFFICER OF  
NAME
 HELD WITH REGISTRANT
 AGE
 OF CNA
 PRINCIPAL OCCUPATION DURING PAST FIVE YEARS
 REGISTRANT AGE CNA PRINCIPAL OCCUPATION DURING PAST FIVE YEARS
Stephen W. Lilienthal Chief Executive
Officer, CNA
Financial
Corporation
  54   2001  Chief Executive Officer of CNA Financial Corporation and subsidiaries since August, 2002. Prior to that, President and Chief Executive Officer, Property and Casualty Operations of the CNA insurance companies since July 2001. From June 1993 to June 1998, senior officer of USF&G Corporation (USF&G). In April 1998, USF&G was acquired by the St. Paul Companies. Mr. Lilienthal was Executive Vice President of the St. Paul Companies until July 2001. Chief Executive
Officer, CNA
Financial
Corporation
  56   2001  
Chief Executive Officer of CNA Financial Corporation and subsidiaries since August, 2002. Prior to that time, President and Chief Executive Officer, Property and Casualty Operations of the CNA insurance companies.
                        
Michael Fusco Executive Vice
President, Chief
Actuary, CNA
insurance companies
  56   2004  Executive Vice President, Chief Actuary of the CNA insurance companies since March, 2002. Prior to that time, he was Senior Vice President of the CNA insurance companies since November, 2000. From 1988 until November of 2000, Mr. Fusco held various positions at Insurance Services Offices, including Executive Vice President. Executive Vice
President, Chief
Actuary, CNA
insurance companies
  58   2004  
Executive Vice President, Chief Actuary of the CNA insurance companies since March, 2002. Prior to that time, Senior Vice President of the CNA insurance companies.
                        
Jonathan D. Kantor Executive Vice President, General Counsel and Secretary  49   1997  Executive Vice President, General Counsel and Secretary of CNA Financial Corporation since March, 1998. Executive Vice President, General Counsel and Secretary of the CNA insurance companies since April, 1997 to current date. Executive Vice President, General Counsel and Secretary  51   1997  
Executive Vice President, General Counsel and Secretary of CNA Financial Corporation.
                        
James R. Lewis President and Chief Executive Officer, Property and Casualty Operations, CNA insurance companies  55   2002  President and Chief Executive Officer, Property and Casualty Operations of the CNA insurance companies since August, 2002. From August 2001 to August 2002, Executive Vice President, U.S. Insurance Operations, Property and Casualty Operations of the CNA insurance companies. From November 1992 to August 2001, Senior Vice President of USF&G Corporation. President and Chief Executive Officer, Property and Casualty Operations, CNA insurance companies  57   2002  
President and Chief Executive Officer, Property and Casualty Operations of the CNA insurance companies since August, 2002. Prior to that time, Executive Vice President, U.S. Insurance Operations, Property and Casualty Operations of the CNA insurance companies.
                        
D. Craig Mense Executive Vice
President & Chief
Financial Officer
  53   2004  Executive Vice President and Chief Financial Officer since November, 2004. Prior to that, he served as President and Chief Executive Officer of Global Run-Off Operations at St. Paul Travelers. From May, 2003 to May, 2004, he was Chief Operating Officer of the Gulf Insurance Group at Travelers Property Casualty Corp. Previously, at Travelers Property Casualty Corp., Mr. Mense was Senior Vice President and Chief Financial Officer (Bond) from April, 1996 to July, 2002, and Chief Financial and Administrative Officer (Personal Lines) from July, 2002 to March, 2003. Executive Vice
President & Chief
Financial Officer
  55   2004  
Executive Vice President and Chief Financial Officer since November, 2004. Prior to that time, President and Chief Executive Officer of Global Run-Off Operations at St. Paul Travelers from June, 2004 to November, 2004. Prior to that time, the following positions at Travelers Property Casualty Corp.: Chief Operating Officer of the Gulf Insurance Group (May, 2003 to May, 2004); Chief Financial and Administrative Officer (Personal Lines) (July, 2002 to March, 2003); and Senior Vice President and Chief Financial Officer (Bond) (April, 1996 to July, 2002).

Officers are elected and hold office until their successors are elected and qualified, and are subject to removal by the Board of Directors.

Additional information required in Item 10, Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year.

140


ITEM 11. EXECUTIVE COMPENSATION

Information required in Item 11, Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year.

176


ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Equity Compensation Plan

The table below provides the securities authorized for issuance under equity compensation plans.

Executive Compensation Information
             
          Number of securities
  Number of securities to     remaining available for
  be issued upon Weighted-average exercise future issuance under
  exercise of outstanding price of outstanding equity compensation plans
  options, warrants and options, warrants and (excluding securities
  rights rights reflected in column (a))
December 31, 2004 (a)
 (b)
 (c)
Plan Category            
Equity compensation plans approved by security holders  1,474,000  $29.17   511,175 
Equity compensation plans not approved by security holders         
   
 
   
 
   
 
 
Total
  1,474,000  $29.17   511,175 
   
 
   
 
   
 
 
December 31, 2006

             
          Number of securities 
  Number of securities to      remaining available for 
  be issued upon  Weighted average exercise  future issuance under 
  exercise of outstanding  price of outstanding  equity compensation plans 
  options, warrants and  options, warrants and  (excluding securities 
  rights  rights  reflected in column (a)) 
  (a)  (b)  (c) 
Plan Category            
             
Equity compensation plans approved by security holders  1,694,900  $28.86   2,011,725 
Equity compensation plans not approved by security holders         
          
             
Total
  1,694,900  $28.86   2,011,725 
          
Additional Informationinformation required in Item 12, Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Information required in Item 13, Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

Information required in Item 14, Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year.

177141


PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
         
      Page
      Number
(a) 1. FINANCIAL STATEMENTS:    
    Statements of Operations — Years Ended December 31, 2004, 2003 and 2002  94 
    Balance SheetsStatements of Operations Years Ended December 31, 20042006, 2005 and 20032004  9565 
    Statements of Cash FlowsBalance Sheets Years Ended December 31, 2004, 20032006 and 20022005  9766 
    Statements of Stockholders’ EquityCash Flows — Years Ended December 31, 2004, 20032006, 2005 and 20022004  9967 
    Notes to Condensed Financial Statements of Stockholders’ Equity — Years Ended December 31, 2006, 2005 and 2004  10069 
    Notes to Consolidated Financial Statements70
Report of Independent Registered Public Accounting Firm  172135
 
(a) 2. FINANCIAL STATEMENT SCHEDULES:    
    Schedule I Summary of Investments  181 
    Schedule II Condensed Financial InformationI     Summary of Registrant (Parent Company)Investments  182145 
    Schedule III Supplementary InsuranceII    Condensed Financial Information of Registrant (Parent Company)  190146 
    Schedule IV ReinsuranceIII   Supplementary Insurance Information  191151 
    Schedule V Valuation and Qualifying AccountsIV    Reinsurance  191152 
    Schedule V     Valuation and Qualifying Accounts152
Schedule VI    Supplemental Information Concerning Property and Casualty Insurance Operations  191152
 
(a) 3. EXHIBITS:    
         
      Exhibit
    Description of Exhibit
 Number
  (3)(3) Articles of Incorporationincorporation and by-laws:    
    Certificate of Incorporation of CNA Financial Corporation, as amended May 20,6, 1987 (Exhibit 3.1 to 1987 Form 10-K incorporated herein by reference)3.1
Certificate of Amendment of Certificate of Incorporation, dated May 14, 19983.1a
Certificate of Amendment of Certificate of Incorporation, dated May 10, 1999 (Exhibit 3.1 to 1999 Form 10-K incorporated herein by reference.)reference)  3.13.1b 
    By-Laws of CNA Financial Corporation, as amended April 28, 2004 (Exhibit 3.2 to 2004 Form 10-K incorporated herein by reference)  3.2 
  (4)
(4) Instruments defining the rights of security holders, including indentures:    
    CNA Financial Corporation hereby agrees to furnish to the Commission upon request copies of instruments with respect to long term debt, pursuant to Item 601(b) (4) (iii) of Regulation S-K  4.1 
  (10)
(10) Material contracts:    

142


Exhibit
Description of ExhibitNumber
    Federal Income Tax Allocation Agreement, dated February 29, 1980 between CNA Financial Corporation and Loews Corporation (Exhibit 10.2 to 1987 Form 10-K incorporated herein by reference.)reference)  10.1 
  CNA Employees’ Supplemental Savings Plan, as amended through January 1, 1994 (Exhibit 10.3 to 1999 Form 10-K incorporated herein by reference.)10.2

178


         
      ExhibitCNA Supplemental Executive Retirement Plan, restated as of January 1, 2003 (Exhibit 99.2 to Form 8-K filed January 6, 2005 incorporated herein by reference)10.2
    Description of Exhibit
 Number
    First Amendment to the CNA Employees’Supplemental Executive Retirement Benefit Equalization Plan, as amended throughdated February 27, 2004 (Exhibit 99.3 to Form 8-K filed January 1, 1994 (Exhibit 10.4 to 1999 Form 10-K6, 2005 incorporated herein by reference)  10.3 
    Continental Casualty Company “CNA” Annual Incentive Bonus
Second Amendment to the CNA Supplemental Executive Retirement Plan, Provisionsdated March 23, 2004 (Exhibit 10.199.4 to 1994 Form 10-K8-K filed January 6, 2005 incorporated herein by reference)  10.4 
Third Amendment to the CNA Supplemental Executive Retirement Plan, dated December 31, 2004 (Exhibit 99.1 to Form 8-K filed January 6, 2005 incorporated herein by reference)10.5
    CNA Financial Corporation 2000 Long Term Incentive Plan, dated August 4, 1999 (Exhibit 4.1 to 1999 Form S-8 filed August 4, 1999, incorporated herein by reference)  10.510.6 
    Employment Agreement between CNA Financial Corporation and Robert V. Deutsch, dated August 16, 1999 (Exhibit 10 to September 30, 1999 Form 10-Q incorporated herein by reference)  10.6 
CNA Financial Corporation 2000 Incentive Compensation Plan, as amended and restated, effective as of February 9, 2005 (Exhibit A to Form DEF 14A, filed March 31, 2005, incorporated herein by reference (as indicated in Form 8-K, filed May 2, 2005, CNAF shareholders voted to approve this plan on April 27, 2005))10.7
    Share Purchase Agreement between CNA and TAWA UK Limited, dated July 15, 2002 for the entire issued share capital of CNA Re Management Company Limited (Exhibit 2.1 to September 30, 2002 Form 10-Q incorporated herein by reference)  10.710.8 
    Employment Agreement between CNA Financial Corporation and Stephen W. Lilienthal, dated July 25, 2002October 26, 2005 (Exhibit 10.1010.22 to December 31, 2002September 30, 2005 Form 10-K incorporated herein by reference)10.8
Employment Agreement between CNA Financial Corporation and James R. Lewis, dated August 9, 2002 (Exhibit 10.11 to December 31, 2002 Form 10-K10-Q incorporated herein by reference)  10.9 
    Continuing Services
Employment Agreement between CNA Financial CorporationContinental Casualty Company and Bernard Hengesbaugh,James R. Lewis, dated AugustOctober 26, 20022005 (Exhibit 10.1210.21 to December 31, 2002September 30, 2005 Form 10-K10-Q incorporated herein by reference)  10.10 
  (10) Material contracts (continued):    
    Amendment to Employment Agreement between CNA Financial CorporationContinental Casualty Company and Robert V. Deutsch,Jonathan D. Kantor, dated February 25, 2003March 16, 2005 (Exhibit 10.1399.1 to December 31, 2002June 13, 2005 Form 10-K8-K incorporated herein by reference)  10.11 
    Employment Agreement between CNA Financial Corporation and Jonathan D. Kantor, dated March 20, 2003 (Exhibit 10.14 to March 31, 2003 Form 10-Q incorporated herein by reference)  10.12 
    Capital Support Agreement among CNA Financial Corporation, Loews Corporation and Continental Casualty Company, dated November 12, 2003 (Exhibit 10.15 to December 31, 2003 Form 10-K incorporated herein by reference)10.12
Employment Agreement between Continental Casualty Company and D. Craig Mense, dated December 2, 2004 (Exhibit 99.1 to December 8, 2004 Form 8-K incorporated herein by reference)  10.13 

179143


              
 Exhibit Exhibit
 Description of Exhibit
 Number
 Description of Exhibit Number
   Employment Agreement between CNA Financial Corporation and D. Craig Mense, dated December 2, 2004 (Exhibit 99.1 to December 8, 2004 Form 8-K incorporated herein by reference) 10.14      Addendum to Employment Agreement between Continental Casualty Company and D. Craig Mense, dated December 2, 2004 (Exhibit 99.2 to December 8, 2004 Form 8-K incorporated herein by reference)  10.14 
   Amendment to Employment Agreement between CNA Financial Corporation and D. Craig Mense, dated December 2, 2004 (Exhibit 99.2 to December 8, 2004 Form 8-K incorporated herein by reference) 10.15           
   Employment Agreement between CNA Financial Corporation and Michael Fusco, dated August 18, 2004 10.16      Employment Agreement between Continental Casualty Company and Michael Fusco, dated April 1, 2004 (Exhibit 10.16 to 2004 Form 10-K incorporated herein by reference)  10.15 
   CNA Supplemental Executive Savings and Capital Accumulation Plan, dated July 1, 2003 10.17           
   First Amendment to the CNA Supplemental Executive Savings and Capital Accumulation Plan, dated March 23, 2004 10.18      CNA Supplemental Executive Savings and Capital Accumulation Plan, dated July 1, 2003 (Exhibit 10.17 to 2004 Form 10-K incorporated herein by reference)  10.16 
   Second Amendment to the CNA Supplemental Executive Savings and Capital Accumulation Plan, dated March 23, 2004 10.19           
   CNA Financial Board of Directors Term Sheet — Director and Committee Member Fee Schedule - 2004 Annual Retainers 10.20      First Amendment to the CNA Supplemental Executive Savings and Capital Accumulation Plan, dated February 27, 2004 (Exhibit 10.18 to 2004 Form 10-K incorporated herein by reference)  10.17 
 (21) Primary Subsidiaries of CNAF 21.1           
 (23) Consent of Independent Registered Public Accounting Firm 23.1      Second Amendment to the CNA Supplemental Executive Savings and Capital Accumulation Plan, dated March 23, 2004 (Exhibit 10.19 to 2004 Form 10-K incorporated herein by reference)  10.18 
   Exhibits:           
     Form of Award Letter for Long-Term Incentive Cash Award to Executive Officers for the Performance Period Beginning January 1, 2006 and Ending December 31, 2008, Delivered on April 14, 2006 (Exhibit 99.1 to April 19, 2006 Form 8-K incorporated herein by reference)  10.19 
          
     Form of Award Terms for Long-Term Incentive Cash Award to Executive Officers for the Performance Period Beginning January 1, 2006 and Ending December 31, 2008, Delivered on April 14, 2006 (Exhibit 99.2 to April 19, 2006 Form 8-K incorporated herein by reference)  10.20 
          
     Registration Rights Agreement, dated August 8, 2006, between CNA Financial Corporation and Loews Corporation (Exhibit 10.1 to August 8, 2006 Form 8-K incorporated herein by reference)  10.21 
          
     Amendment to Employment Agreement between Continental Casualty Company and Michael Fusco, dated February 7, 2007  10.22 
          
  (21) Significant Subsidiaries of CNAF  21.1 
          
  (23) Consent of Independent Registered Public Accounting Firm  23.1 
          
  (31) Certification of Chief Executive Officer  31.1 
          
     Certification of Chief Financial Officer  31.2 
          
  (32) Written Statement of the Chief Executive Officer of CNA Financial Corporation Pursuant to 18 U.S.C Section 1350 (As adopted by Section 906 of the Sarbanes-Oxley Act of 2002)  32.1 
          
     Written Statement of the Chief Financial Officer of CNA Financial Corporation Pursuant to 18 U.S.C Section 1350 (As adopted by Section 906 of the Sarbanes-Oxley Act of 2002)  32.2 
          
(b)     Exhibits:    
               None.    
          
(c)   None.      Condensed Financial Information of Unconsolidated Subsidiaries:    
   Condensed Financial Information of Unconsolidated Subsidiaries:                None.    
(d)   None. 

The

Except for Exhibits 3.1a, 10.22, 21.1, 23.1, 31.1, 31.2, 32.1 and 32.2, the above exhibits are not included in this Form 10-K, but are
on file with the Securities and Exchange Commission.

180144


SCHEDULE I. SUMMARY OF INVESTMENTS – OTHER THAN INVESTMENTS IN RELATED PARTIES

            
             December 31, 2006 
 December 31, 2004
 Cost or Estimated   
 Cost or Estimated   Amortized Fair Carrying 
 Amortized Fair Carrying Cost Value Value 
(In millions)
 Cost
 Value
 Value
    
Fixed maturity securities available-for-sale:  
Bonds:  
United States Government and government agencies and authorities – taxable $4,623 $4,742 $4,742 
U.S. Government and government agencies and authorities – taxable $5,368 $5,445 $5,445 
States, municipalities and political subdivisions – tax exempt 8,699 8,857 8,857  4,915 5,146 5,146 
Foreign governments and political subdivisions 1,957 2,095 2,095  2,679 2,779 2,779 
Public utilities 856 998 998  753 850 850 
All other corporate bonds 13,599 14,099 14,099  20,331 20,515 20,515 
Redeemable preferred stocks 142 146 146  885 912 912 
 
 
 
 
 
 
        
 
Total fixed maturity securities available-for-sale 29,876 30,937 30,937  34,931 35,647 35,647 
       
 
 
 
 
 
 
  
Fixed maturity securities trading:  
Bonds:  
United States Government and government agencies and authorities – taxable 27 27 27 
U.S. Government and government agencies and authorities – taxable 2 2 2 
Foreign governments and political subdivisions 32 32 32  14 14 14 
Public utilities 3 3 3 
All other corporate bonds 324 324 324  188 188 188 
Redeemable preferred stocks 4 4 4 
       
 
 
 
 
 
 
  
Total fixed maturity securities trading 390 390 390  204 204 204 
       
 
 
 
 
 
 
  
Equity securities available-for-sale:  
Common stocks:  
Banks, trusts and insurance companies 3 5 5  3 5 5 
Industrial and other 145 255 255  211 447 447 
Non-redeemable preferred stocks 126 150 150  134 145 145 
 
 
 
 
 
 
        
 
Total equity securities available-for-sale 274 410 410  348 597 597 
       
 
 
 
 
 
 
  
Equity securities trading:  
Common stocks:  
Industrial and other 38 38 38  60 60 60 
Non-redeemable preferred stocks 8 8 8 
       
 
 
 
 
 
 
  
Total equity securities trading 46 $46 46  60 $60 60 
       
 
 
 
 
 
 
  
Limited partnership investments 1,549 1,549  1,852 1,852 
Other invested assets 57 36  26 26 
Short term investments available-for-sale 5,403 5,404  5,537 5,538 
Short term investments trading 459 459  172 172 
 
 
 
 
      
 
Total investments
 $38,054 $39,231  $43,130 $44,096 
 
 
 
 
      

181145


SCHEDULE II. CONDENSED FINANCIAL INFORMATION OF REGISTRANT (PARENT COMPANY)

CNA Financial Corporation
Statements of Operations
                        
Years ended December 31
(In millions)
 2004
 2003
 2002
Years ended December 31 2006 2005 2004 
(In millions) 
Revenues:
  
Net investment income $14 $16 $8  $21 $18 $14 
Realized investment gains (losses)  (62)  (3) 3 
Realized investment losses  (7)  (29)  (62)
Other income 5 12 13  1  5 
 
 
 
 
 
 
        
 
Total revenues  (43) 25 24  15  (11)  (43)
       
 
 
 
 
 
 
  
Expenses:
  
Administrative and general 5 7 3  2 9 5 
Interest 104 120 131  118 110 104 
 
 
 
 
 
 
        
 
Total expenses 109 127 134  120 119 109 
 
 
 
 
 
 
        
Loss from operations before income taxes, equity in net income of subsidiaries and the cumulative effects of changes in accounting principles  (152)  (102)  (110)
 
Loss from operations before income taxes and equity in net income of subsidiaries  (105)  (130)  (152)
Income tax benefit 53 36 39  37 46 53 
 
 
 
 
 
 
        
Loss before equity in net income of subsidiaries and the cumulative effects of changes in accounting principles  (99)  (66)  (71)
Equity in net income (loss) of subsidiaries 540  (1,367) 227 
Cumulative effect of changes in accounting principles, net of tax    (1)
 
 
 
 
 
 
  
Net income (loss)
 $441 $(1,433) $155 
Loss before equity in net income of subsidiaries  (68)  (84)  (99)
Equity in net income of subsidiaries 1,176 348 524 
 
 
 
 
 
 
        
 
Net income
 $1,108 $264 $425 
       

See accompanying Notes to Condensed Financial Information.

182146


CNA Financial Corporation
Balance Sheets
                
December 31
(In millions)
 2004
 2003
December 31 2006 2005 
(In millions) 
Assets:
  
Investment in subsidiaries $10,446 $10,509  $11,512 $10,263 
Fixed maturity securities available-for-sale, at fair value, (amortized cost of $23 and $131) 23 131 
Equity securities available-for-sale, at fair value, (cost of $1 and $1) 1 1 
Other invested assets  (1)  (1)
Short term investments, at fair value which approximates cost 749 37 
Fixed maturity securities available-for-sale, at fair value (amortized cost of $9 and $1) 9 1 
Equity securities available-for-sale, at fair value (cost of $1 and $1) 1 1 
Short term investments 280 198 
Receivables for securities sold 3 1  1 10 
Amounts due from affiliates 70 18  37 44 
Other  1 
Other assets 7  
 
 
 
 
      
  
Total assets
 $11,291 $10,697  $11,847 $10,517 
 
 
 
 
      
  
Liabilities and Stockholders’ Equity:
  
Liabilities:  
Short term debt 493 250   250 
Long term debt 1,536 1,482  2,035 1,287 
Other 55 13  44 30 
 
 
 
 
      
  
Total Liabilities
 2,084 1,745 
Total liabilities
 2,079 1,567 
 
 
 
 
      
  
Stockholders’ equity:  
Preferred stock (12,500,000 shares authorized) 
Series H Issue (no par value; $100,000 stated value; 7,500 shares issued; held by Loews Corporation) 750 750 
Series I Issue (no par value; $23,200 stated value; 32,327 shares issued; held by Loews Corporation)  750 
Common stock ($2.50 par value; 500,000,000 shares authorized; 258,177,285 shares and 225,850,270 issued; and 255,953,958 and 223,617,337 shares outstanding) 645 565 
Preferred stock (12,500,000 shares authorized)
Series H Issue (no par value; $100,000 stated value; no shares and 7,500 shares issued;
held by Loews Corporation)
  750 
Common stock ($2.50 par value; 500,000,000 shares authorized; 273,040,543 and 258,177,285 shares issued; and 271,108,780 and 256,001,968 shares outstanding) 683 645 
Additional paid-in capital 1,701 1,031  2,166 1,701 
Retained earnings 5,601 5,160  6,486 5,621 
Accumulated other comprehensive income 650 841  549 359 
Treasury stock (2,223,327 and 2,232,933 shares), at cost  (69)  (69)
Treasury stock (1,931,763 and 2,175,317 shares), at cost  (58)  (67)
 
 
 
 
      
  
 9,278 9,028  9,826 9,009 
Notes receivable for the issuance of common stock  (71)  (76)  (58)  (59)
 
 
 
 
      
  
Total stockholders’ equity
 9,207 8,952  9,768 8,950 
 
 
 
 
      
  
Total liabilities and stockholders’ equity
 $11,291 $10,697  $11,847 $10,517 
 
 
 
 
      

See accompanying Notes to Condensed Financial Information.

183147


CNA Financial Corporation
Statements of Cash Flows
             
Years ended December 31
(In millions)
 2004
 2003
 2002
Cash flows from operating activities:
            
Net income (loss) $441  $(1,433) $155 
Adjustments to reconcile net income (loss) to net cash flows from operating activities:            
Loss (income) of subsidiaries  (540)  1,367   (227)
Cumulative effect of a change in accounting principle, net of tax        1 
Dividends received from subsidiaries  307   93   118 
Realized (gains) losses  62   3   (3)
Changes in:            
Federal income taxes recoverable (amounts due to/from affiliates)     (1)   
Other, net  211   107   148 
   
 
   
 
   
 
 
Total Adjustments  40   1,569   37 
   
 
   
 
   
 
 
Net cash flows provided by operating activities
  481   136   192 
   
 
   
 
   
 
 
Cash flows from investing activities:
            
Sales of fixed maturity securities  86   236   428 
Purchases of fixed maturity securities  (27)  (244)  (440)
Purchases of equity securities     2   (1)
Change in short term investments  (710)  349   (381)
Capital contributions to subsidiaries  (156)  (1,201)  (304)
Return of capital from subsidiaries  18   5    
Change in notes receivable from affiliates     309   32 
Other, net  7   (94)  (19)
   
 
   
 
   
 
 
Net cash flows used by investing activities
  (782)  (638)  (685)
   
 
   
 
   
 
 
Cash flows from financing activities:
            
Proceeds from issuance of debt  546       
Principal payments on debt  (250)  (245)  (252)
Issuance of common stock         
Issuance of cumulative Series I preferred stock        750 
Issuance of cumulative Series H preferred stock     750    
Purchase of treasury stock     1    
Other, net  5   (4)  (5)
   
 
   
 
   
 
 
Net cash flows provided by financing activities
  301   502   493 
   
 
   
 
   
 
 
Net change in cash         
Cash, beginning of year         
   
 
   
 
   
 
 
Cash, end of year
 $  $  $ 
   
 
   
 
   
 
 
Supplemental disclosures of cash flow information:
            
Cash paid (received):            
Interest $102  $123  $133 
Federal income taxes  (627)  (369)  (616)
Non-cash transactions:            
Notes receivable for the issuance of common stock     4   4 
             
Years ended December 31 2006  2005  2004 
(In millions)            
Cash flows from operating activities:
            
Net income $1,108  $264  $425 
Adjustments to reconcile net income to net cash flows from operating activities:            
Income of subsidiaries  (1,176)  (348)  (524)
Dividends received from subsidiaries  91   127   307 
Realized investment losses  7   29   62 
Other, net  7   (59)  233 
          
             
Total adjustments  (1,071)  (251)  78 
          
             
Net cash flows provided by operating activities
  37   13   503 
          
             
Cash flows from investing activities:
            
Sales of fixed maturity securities  1   8   85 
Purchases of fixed maturity securities        (27)
Change in short term investments  (60)  563   (710)
Capital contributions to subsidiaries  (3)  (41)  (156)
Return of capital from subsidiaries  19      18 
Other, net  (7)  (64)  (14)
          
             
Net cash flows provided (used) by investing activities
  (50)  466   (804)
          
             
Cash flows from financing activities:
            
Proceeds from the issuance of long-term debt  746      546 
Principal payments on debt  (250)  (493)  (250)
Payment to repurchase Series H issue preferred stock  (993)      
Proceeds from the issuance of common stock  499       
Stock options exercised  10   2    
Other, net  1   12   5 
          
             
Net cash flows provided (used) by financing activities
  13   (479)  301 
          
             
Net change in cash         
Cash, beginning of year         
          
             
Cash, end of year
 $  $  $ 
          

See accompanying Notes to Condensed Financial Information.

184148


Notes to Condensed Financial Information

A. Basis of Presentation

The condensed financial information of CNA Financial Corporation (CNAF or the Parent Company) should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in Part II, Item 8 of this Form 10-K. CNAF’s subsidiaries are accounted for using the equity method of accounting. Equity in net income of these affiliates is reported as equity in net income of subsidiaries.

Certain amounts applicable to prior years have been reclassified to conform to classifications followed in 2004.

The preparation of Condensed Financial Statements in conformity with accounting principles generally accepted in the United States of America (GAAP) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date Loews Corporation (Loews) owned approximately 89% of the financial statements and the reported amountsoutstanding common stock of revenues and expenses during the reporting period. Actual results may differ from those estimates.

CNAF as of December 31, 2006.

B. Investments

CNAF 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.

CNAF’s investments in fixed maturity securities are composed entirely of corporate bonds.

185

Debt


C. Debt

Debt is composed of the following obligations.

Debt
         
December 31
(In millions)
 2004
 2003
Variable rate debt:        
Credit facility due April 30, 2004 $  $250 
Senior notes:        
6.50%, face amount of $493, due April 15, 2005  493   492 
6.75%, face amount of $250, due November 15, 2006  249   249 
6.45%, face amount of $150, due January 15, 2008  149   149 
6.60%, face amount of $200, due December 15, 2008  199   199 
5.85%, face amount of $549, due December 15, 2014  546    
6.95%, face amount of $150, due January 15, 2018  149   149 
Debenture, 7.25%, face amount of $243, due November 15, 2023  241   241 
Urban Development Action Grant, 1.00%, due May 7, 2019  3   3 
   
 
   
 
 
Total
 $2,029  $1,732 
   
 
   
 
 
Short term debt $493  $250 
Long term debt  1,536   1,482 
   
 
   
 
 
Total
 $2,029  $1,732 
   
 
   
 
 
         
December 31 2006  2005 
(In millions)        
Senior notes:        
6.750%, face amount of $250, due November 15, 2006 $  $250 
6.450%, face amount of $150, due January 15, 2008  150   149 
6.600%, face amount of $200, due December 15, 2008  200   199 
6.000%, face amount of $400, due August 15, 2011  398    
5.850%, face amount of $549, due December 15, 2014  546   546 
6.500%, face amount of $350, due August 15, 2016  348    
6.950%, face amount of $150, due January 15, 2018  149   149 
Debenture, 7.250%, face amount of $243, due November 15, 2023  241   241 
Urban Development Action Grant, 1.00%, due May 7, 2019  3   3 
       
         
Total
 $2,035  $1,537 
       
         
Short term debt $  $250 
Long term debt  2,035   1,287 
       
         
Total
 $2,035  $1,537 
       

On December 15, 2004 CNA Financial completed

In November of 2006, CNAF retired its sale$250 million 6.75% senior notes. A portion of $549the proceeds from the public offering discussed below were used to repay these notes.
In August of 2006, CNAF sold $400 million of 5.85%6.0% five-year senior notes and $350 million of 6.5% ten-year senior notes in a public offering.

D. Management and Administrative Expenses

Certain administrative expenses resulting principally from shareholder expenses, consulting and fees and dues to states of incorporation of $5 million, $7 million and $3 million were paid directly by CNAF in 2004, 2003 and 2002.

E.

C. Commitments and Contingencies

In the normal course of business, CNAF guarantees the indebtedness of certain of its subsidiaries which expire through 2025.to the debt maturity or payoff, whichever comes first. These guarantees arise in the normal course of business and are given to induce a lender to enter into an agreement with CNAF’s subsidiaries. CNAF would be required to remit prompt and complete payment when due, should the primary obligor default. The maximum potential amount of future payments that CNAF could be required to pay under these guarantees are approximately $19$22 million at December 31, 2004.

2006.

In the course of selling business entities and assets to third parties, CNAF has provided parent company guarantees, which expireagreed to indemnify purchasers for losses arising out of breaches of representation and warranties with respect to the business entities or assets being sold, including, in 2015, relatedcertain cases, losses arising from undisclosed liabilities or certain named litigation. Such indemnification provisions generally survive for periods ranging from nine months following the applicable closing date to lease obligationsthe expiration of certain subsidiaries. Certainthe relevant statutes of those subsidiaries have been sold; however,limitation. As of December 31, 2006, the lease 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 potentialaggregate amount of future paymentsquantifiable indemnification agreements in effect for sales of business entities and assets was $259 million.
In addition, CNAF has agreed to provide indemnification to third party purchasers for certain losses associated with sold business entities or assets that CNAF could be required to pay under these guarantees are approximately $8 million atnot limited by a contractual monetary amount. As of December 31, 2004.

2006,

CNA Surety has provided significant surety bond protection for a large national contractor that undertakes projects for the construction of government and private facilities, a substantial portion of which have been reinsured by CCC. In order to help this contractor meet its liquidity needs and complete projects which had been bonded by CNA Surety, commencing in 2003 CNAF has provided loans to the contractor through a credit facility. In December of 2004, the credit facility was amended to increase the maximum available loans to $106 million from $86 million. The amendment also provides that CNAF may in its sole discretion further increase the amounts available for loans

186149


under

CNAF had outstanding unlimited indemnifications in connection with the credit facility, upsales of certain of its business entities or assets for tax liabilities arising prior to a purchaser’s ownership of an aggregate maximumentity or asset, defects in title at the time of $126 million.sale, employee claims arising prior to closing and in some cases losses arising from certain litigation and undisclosed liabilities. These indemnification agreements survive until the applicable statutes of limitation expire, or until the agreed upon contract terms expire. As of December 31, 2004 and 2003, there were $99 million and $802006, CNAF has recorded approximately $10 million of total debt outstanding under the credit facility. Additional loans in January and February of 2005 brought the total debt outstanding under the credit facility, less accrued interest,liabilities related to $104 million as of February 24, 2005. Loews, through a participation agreement with CNAF, provided funds for and owned a participation of $29 million and $25 million of the loans outstanding as of December 31, 2004 and 2003 and has agreed to participation of one-third of any additional loans which may be made above the original $86 million credit facility limit up to the $126 million maximum available line.

In connection with the amendment to increase the maximum available line under the credit facility in December of 2004, the term of the loan under the credit facility was extended to mature in March of 2009 and the interest rate was reduced prospectively from 6% over prime rate to 5% per annum, effective as of December 27, 2004, with an additional 3% interest accrual when borrowings under the facility are at or below the original $86 million limit.

Loans under the credit facility are secured by a pledge of substantially all of the assets of the contractor and certain of its affiliates. In connection with the credit facility, CNAF has also guaranteed or provided collateral for letters of credit which are charged against the maximum available line and, if drawn upon, would be treated as loans under the credit facility. As of December 31, 2004 and 2003, these guarantees and collateral obligations aggregated $13 million and $7 million.

As of December 31, 2004, the aggregate amount of outstanding principal and accrued interest under the credit facility was $70 million, net of participation by Loews in the amount of $29 million.

The contractor implemented a restructuring plan intended to reduce costs and improve cash flow, and appointed a chief restructuring officer to manage execution of the plan. In the course of addressing various expense, operational and strategic issues, however, the contractor has decided to substantially reduce the scope of its original business and to concentrate on those segments determined to be potentially profitable. As a consequence, operating cash flow, and in turn the capacity to service debt, has been reduced below previous levels. Restructuring plans have also been extended to accommodate these circumstances. In light of these developments, CNA has taken an impairment charge of $56 million pretax for the fourth quarter of 2004, net of the participation by Loews, with respect to amounts loaned under the facility. Any draws under the credit facility beyond $106 million or further changes in the national contractor’s business plan or projections may necessitate further impairment charges.

As a result of the impairment taken in the fourth quarter of 2004, CNAF plans to recognize income using the effective interest rate method starting in the first quarter of 2005. Under this method, interest income recognized will be accrued on the net carrying amount of the loan at the effective interest rate used to discount the impaired loan’s estimated future cash flows. The excess of the cash received over the interest income recognized will reduce the carrying amount of the loan. The change in present value, if any, of the loan that is attributable to changes in the amount or timing of future cash flows will be recorded similar to the impairment charges previously recorded.

CNA Surety has advised that it intends to continue to provide surety bonds on behalf of the contractor during this extended restructuring period, subject to the contractor’s initial and ongoing compliance with CNA Surety’s underwriting standards and ongoing management of CNA Surety’s exposure to the contractor. All bonds written for the national contractor are issued by CCC and its affiliates, other than CNA Surety, and are subject to underlying reinsurance treaties pursuant to which all bonds on behalf of CNA Surety are 100% reinsured to one of CNA Surety’s insurance subsidiaries. This arrangement underlies the more limited reinsurance coverages discussed below.

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, with CCC to incur 100% of losses above that level. For bonds written subsequent to November 1, 2003, CNA Surety’s exposure is limited to $14.5 million per bond, subject to a per principal retention of $60 million and an aggregate limit of $150 million, under all facultative insurance coverage and two excess of loss treaties between CNA Surety and CCC. The first excess of loss contract, $40 million excess of $60 million, provides CNA Surety coverage exclusively for the national contractor, while the second excess of loss contract, $50 million excess of $100 million, provides CNA Surety with coverage for the national contractor as well as other CNA Surety risks. For bonds written prior to September 30, 2002 there is no facultative reinsurance and CCC retains 100% of the losses above the per principal retention of $60 million.

187


Renewals of both excess of loss contracts were effective January 1, 2005. CCC and CNA Surety are presently discussing a possible restructuring of the reinsurance arrangements discussed in the paragraph above, under which all bonds written for the national contractor would be reinsured by CCC under an excess of $60 million treaty and other CNA Surety accounts would be covered by a separate $50 million excess of $100 million treaty.

CCC and CNA Surety continue to engage in periodic discussions with insurance regulatory authorities regarding the level of bonds provided for this principal and will continue to apprise those authorities regarding their ongoing exposure to this account.

Indemnification and subrogation rights, including rights to contract proceeds on construction projects in the event of default, exist that reduce CNA Surety’s and ultimately the Company’s exposure to loss. While CNAF believes that the contractor’s continuing restructuring efforts may be successful and provide sufficient cash flow for its operations, the contractor’s failure to ultimately achieve its extended restructuring plan or perform its contractual obligations under the credit facility or under the Company’s surety bonds could have a material adverse effect on the Company’s results of operations and/or equity. If such failures occur, the Company estimates the surety loss, net of indemnification and subrogation recoveries, but before the effects of minority interest, to be approximately $200 million pretax. In addition, such failures could cause the remaining unimpaired amount due under the credit facility to be uncollectible.

agreements.

CNAF has provided guarantees of the indebtedness of certain of its subsidiaries’ independent insurance producers, whichproducers. These guarantees expire in 2008. CNAF would be required to remit prompt and complete payment when due, should the primary obligor default. In the event of default on the part of the primary obligor, CNAF holds an interest in andhas a right to any and all shares of common stock of the primary obligor. The maximum potential amount of future payments that CNAF could be required to pay under these guarantees iswas approximately $7$6 million at December 31, 2004.

2006.

In the normal course of business, CNAF has provided guarantees to holders of structured settlement annuities (SSA) provided by certain of its subsidiaries, which expire through 2120. CNAF would be required to remit SSA payments due to claimants if the primary obligor failed to perform on these contracts. The maximum potential amount of future payments that CNAF could be required to pay under these guarantees are approximately $1,624 million$1.8 billion at December 31, 2004.

F. Capital Transactions with Subsidiaries

2006.

CNA Surety Corporation - Loans to National Contractor
CNA Surety, a 63% owned and consolidated subsidiary of Continental Casualty Company (CCC), a wholly-owned subsidiary of CNAF, has provided significant surety bond protection for a large national contractor that undertakes projects for the construction of government and private facilities, a substantial portion of which have been reinsured by CCC. In order to help this contractor meet its liquidity needs and complete projects which had been bonded by CNA Surety, commencing in 2003 CNAF provided loans to the contractor through a credit facility. Due to reduced operating cash flow at the contractor these loans were fully impaired through realized investment losses in 2004 2003 and 2002,2005. For the years ended December 31, 2005 and 2004, CNAF contributed capitalrecorded a pretax impairment charge of approximately $156 million, $1,201$34 million and $304 million to its subsidiaries. In 2004 and 2003,$56 million. CNAF subsidiaries returned capital of approximately $18 million and $5 million. In 2002, there was no return of capital from subsidiaries.

G. Dividends from Subsidiaries and Affiliates

In 2004, 2003 and 2002, CNAF received approximately $307 million, $93 million and $118 million in dividends from subsidiaries.

CNAF’s ability to pay dividends and other credit obligations is significantly dependent on receipt of dividends from its subsidiaries. The payment of dividends to CNAF by its insurance subsidiaries without prior approval of the insurance department of each subsidiary’s domiciliary jurisdiction is limited by formula. Dividends in excess of these amounts are subject to prior approval by the respective state insurance departments.

Dividends from CCC are subjectlonger provides additional liquidity to the insurance holding company lawscontractor and has not recognized interest income related to the loans since June 30, 2005.

CNAF has also guaranteed or provided collateral for the contractor’s letters of the State of Illinois, the domiciliary state of CCC. Under these laws, ordinary dividends, or dividends that do not require prior approval of the Illinois Department Financial and Professional Regulation – Division of Insurance (the Department), may be paid only from earned surplus, which is calculated by removing unrealized gains from unassigned surplus.credit. As of December 31, 2004, CCC is in a negative earned surplus position. In December of 2004, the Department approved extraordinary dividend capacity of $125 million to be used to fund CNAF’s 2005 debt service requirements. It is anticipated that CCC will be in a positive earned surplus position at the end of the first quarter of 20052006 and be able to begin

188


paying ordinary dividends in the second quarter of 2005 as a result of a $500 million dividend received from its subsidiary, CAC, on February 11, 2005.

In addition, by agreement with the New Hampshire Insurance Department, the CIC Group may not pay dividends to CCC until after January 1, 2006.

CNAF’s domestic insurance subsidiaries are subject to risk-based capital requirements. Risk-based capital is a method developed by the NAIC to determine the minimum amount of statutory capital appropriate for an insurance company to support its overall business operations in consideration of its size and risk profile. The formula for determining the amount of risk-based capital specifies various factors, weighted based on the perceived degree of risk, which are applied to certain financial balances and financial activity. The adequacy of a company’s actual capital is evaluated by a comparison to the risk-based capital results, as determined by the formula. Companies below minimum risk-based capital requirements are classified within certain levels, each of which requires specified corrective action. As of December 31, 20042005, these guarantees and 2003, all of CNAF’s domestic insurance subsidiaries exceeded the minimum risk-based capital requirements.

H. Preferred Stock

The capital plan established in November of 2003 consisted of the sale of $750collateral obligations aggregated $9 million of a new series of CNA convertible preferred stock to Loews. The preferred stock converted into 32,327,015 shares of CNAF common stock on April 20, 2004. The number of shares was determined utilizing a conversion price per share of common stock that was based on average market prices of CNAF common stock from November 17, 2003 through November 21, 2003. The terms of the Series I Issue were approved by a special committee of independent members of CNAF’s Board of Directors.

During 2002, CNAF sold $750 million of a then new issue of preferred stock, designated Series H Cumulative Preferred Issue (Series H Issue), to Loews. The terms of the Series H Issue were approved by a special committee of independent members of CNAF’s Board of Directors. The proceeds from the Series H Issue were applied by CNAF to increase the statutory surplus of CNAF’s principal insurance subsidiary, CCC.

The Series H 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 rating levels of the financial strength rating of CCC from its rating at the time of issuance by any of A.M. Best Company, Standard & Poor’s or Moody’s Investor Services 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 Series H Issue unless and until one of the two triggering events described above has occurred. Beginning with the quarter following an increase of one intermediate rating level in CCC’s financial strength rating, however, current (but not accrued cumulative) quarterly dividends can be paid. As of December 31, 2004, the Company has $127 million of undeclared (and therefore unrecorded) but accumulated dividends.

$13 million.

The Series H 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 Series H Issue have been paid. CNAF may not issue any equity securities ranking senior to or on par with the Series H Issue without the consent of a majority of its stockholders. The Series H 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.

189150


SCHEDULE III. SUPPLEMENTARY INSURANCE INFORMATION

                                                                   
 Gross Insurance Reserves
 Insurance Amortiz-     Gross Insurance Reserves Insurance Amortiz-     
 Claims and ation     Claim Claims and ation     
 Deferred Claim Future Policy- Net Policy- of Deferred Other Net Deferred And Claim Future Policy- Net Policy- of Deferred Other Net 
 Acquisition And Claim Policy Unearned holders Net Earned Investment holders’ Acquisition Operating Written Pre- Acquisition Adjustment Policy Unearned holders’ Net Earned Investment holders’ Acquisition Operating Written Pre- 
 Costs
 Expense
 Benefits
 Premium
 Funds
 Premiums
 Income (a)
 Benefits
 Costs
 Expenses
 miums (b)
 Costs Expense Benefits Premium Funds Premiums Income (a) Benefits Cost Expenses miums (b) 
(In millions)  
December 31, 2006 
Standard Lines $407 $14,934 $ $2,007 $35 $4,413 $991 $3,111 $981 $521 $4,433 
Specialty Lines 283 5,529  1,599  2,555 403 1,550 538 284 2,596 
Life and Group Non-Core 500 3,134 6,645 173 980 641 698 1,195 14 259 633 
Corporate and Other Non-Core  6,039  5   (1) 320 190 1 137  (2)
Eliminations       (5)  1   (56)  (5)
                       
 
Consolidated Operations $1,190 $29,636 $6,645 $3,784 $1,015 $7,603 $2,412 $6,047 $1,534 $1,145 $7,655 
                       
 
December 31, 2005 
Standard Lines $408 $15,084 $ $1,952 $30 $4,410 $767 $3,876 $986 $554 $4,382 
Specialty Lines 274 5,205  1,577  2,475 281 1,621 532 223 2,463 
Life and Group Non-Core 515 3,277 6,297 168 1,465 704 593 1,161 22 318 694 
Corporate and Other Non-Core  7,372  9   (8) 251 343 3 138  (19)
Eliminations       (12)   (2)   (75)  (12)
                       
 
Consolidated Operations $1,197 $30,938 $6,297 $3,706 $1,495 $7,569 $1,892 $6,999 $1,543 $1,158 $7,508 
                       
 
December 31, 2004  
Standard Lines $444 $14,302 $ $1,978 $43 $4,917 $495 $3,487 $1,109 $687 $4,582  $4,917 $496 $3,489 $1,109 $687 $4,582 
Specialty Lines 285 4,860  1,546  2,277 246 1,446 506 201 2,391  2,277 246 1,446 506 189 2,391 
Life and Group Non-Core 537 3,680 5,883 164 1,682 921 692 1,369 36 367 633  921 692 1,369 36 367 633 
Corporate and Other Non-Core 2 8,678  834  128 241 165 29 151 5  128 246 162 29 151 5 
Eliminations       (34)   (21)   (99)  (17)  (34)   (21)   (99)  (17)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
              
Consolidated Operations $1,268 $31,520 $5,883 $4,522 $1,725 $8,209 $1,674 $6,446 $1,680 $1,307 $7,594 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2003 
Standard Lines $499 $14,282 $ $2,267 $79 $4,530 $407 $4,542 $1,195 $938 $4,561 
Specialty Lines 257 4,200  1,480 3 1,840 201 1,651 408 201 2,038 
Life and Group Non-Core 1,745 3,576 8,161 153 522 2,376 821 2,394 224 596 538 
Corporate and Other Non-Core 32 9,672  1,100  (3) 582 218 1,815 138 199 496 
Eliminations       (114)   (115)   (118)  (16)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
Consolidated Operations $2,533 $31,730 $8,161 $5,000 $601 $9,214 $1,647 $10,287 $1,965 $1,816 $7,617  $8,209 $1,680 $6,445 $1,680 $1,295 $7,594 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
              
 
December 31, 2002 
Standard Lines $519 $12,779 $ $2,163 $47 $4,678 $475 $3,491 $1,125 $654 $4,755 
Specialty Lines 216 3,628  1,261 3 1,451 172 1,069 349 170 1,574 
Life and Group Non-Core 1,764 3,457 7,409 156 533 3,408 821 3,220 162 732 1,682 
Corporate and Other Non-Core 52 7,506  1,253  (3) 714 262 681 155 321 680 
Eliminations     (13)   (38)   (41)   (143)  (38)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Consolidated Operations $2,551 $27,370 $7,409 $4,820 $580 $10,213 $1,730 $8,420 $1,791 $1,734 $8,653 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

(a)Investment income is allocated based on each segment’s net carried insurance reserves as adjusted.
(b)Net written premiums relate to business in property and casualty companies only.

(a) Investment income is allocated based on each segment’s net carried insurance reserves as adjusted.

(b) Net written premiums relate to business in property and casualty companies only.

190151


SCHEDULE IV. REINSURANCE

Incorporated herein by reference from Note H of the Consolidated Financial Statements included under Item 8.

SCHEDULE V. VALUATION AND QUALIFYING ACCOUNTS

                                        
 Balance at Charged to Charged to   Balance at Charged to Charged to   
 Beginning Costs and Other Balance at Beginning Costs and Other Balance at 
 of Period
 Expenses
 Accounts (a)
 Deductions
 End of Period
 of Period Expenses Accounts (a) Deductions End of Period 
(In millions)  
Year ended December 31, 2006 
Deducted from assets: 
Allowance for doubtful accounts: 
Insurance and reinsurance receivables $964 $48 $3 $178 $837 
           
 
Valuation allowance: 
Deferred income taxes $30 $ $ $30 $ 
           
 
Year ended December 31, 2005 
Deducted from assets: 
Allowance for doubtful accounts: 
Insurance and reinsurance receivables $1,048 $111 $3 $198 $964 
           
Valuation allowance: 
Deferred income taxes $33 $(3) $ $ $30 
           
 
Year ended December 31, 2004  
Deducted from assets:  
Allowance for doubtful accounts:  
Insurance and reinsurance receivables $948 $87 $14 $1 $1,048  $948 $312 $5 $217 $1,048 
 
 
 
 
 
 
 
 
 
 
            
Year ended December 31, 2003 
Deducted from assets: 
Allowance for doubtful accounts: 
Insurance and reinsurance receivables $352 $602 $3 $9 $948 
 
 
 
 
 
 
 
 
 
 
  
Valuation allowance: 
Deferred income taxes $ $33 $ $ $33 
           

(a) Amount includes effects of foreign currency translation.

(a)Amount includes effects of foreign currency translation.
SCHEDULE VI. SUPPLEMENTAL INFORMATION CONCERNING PROPERTY AND CASUALTY INSURANCE OPERATIONS
                        
 Consolidated Property and Casualty Operations
 Consolidated Property and Casualty Operations
As of and for the years ended December 31 2004
 2003
 2002
 2006 2005 2004
 
(In millions)  
Deferred acquisition costs $1,267 $1,321 $1,257  $1,190 $1,197 
 
Reserves for unpaid claim and claim adjustment expenses 31,201 31,282 25,648  29,459 30,694 
 
Discount deducted from claim and claim adjustment expense reserves above (based on interest rates ranging from 3.5% to 7.5%) 1,827 2,280 2,440  1,648 1,739 
 
Unearned premiums 4,522 5,000 4,813  3,784 3,706 
 
Net written premiums 7,594 7,617 8,653  7,655 7,509 $7,594 
 
Net earned premiums 7,925 7,469 8,438  7,595 7,558 7,925 
 
Net investment income 1,260 1,532 1,422  2,035 1,595 1,266 
 
Incurred claim and claim adjustment expenses related to current year 5,118 4,747 6,722  4,837 5,054 5,118 
 
Incurred claim and claim adjustment expenses related to prior years 235 2,431 52  332 1,107 234 
 
Amortization of deferred acquisition costs 1,641 1,827 1,660  1,534 1,541 1,641 
 
Paid claim and claim adjustment expenses 5,359 5,075 8,218  4,165 3,541 5,401 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
     
  CNA Financial Corporation
     
Dated: February 25, 200522, 2007 By /s/ Stephen W. Lilienthal
   
 
   Stephen W. Lilienthal
   Chief Executive Officer
   (Principal Executive Officer)
     
 By /s/ D. Craig Mense
   
 
   D. Craig Mense
   Executive Vice President and
   Chief Financial Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
     
Dated: February 25, 200522, 2007 By /s/ Brenda J. Gaines
  
  (Brenda J. Gaines, Director)
     
    
Dated: February 25, 2005By/s/ Stephen W. Lilienthal
(Brenda J. Gaines, Director)  
  (Stephen W. Lilienthal, Chief Executive
Officer and Director)
     
Dated: February 25, 200522, 2007 By /s/ Paul J. LiskaStephen W. Lilienthal
   
 
   (Paul J. Liska,Stephen W. Lilienthal, Chief Executive Officer and Director)
     
Dated: February 25, 200522, 2007By/s/ Paul J. Liska
(Paul J. Liska, Director)
Dated: February 22, 2007By/s/ Jose Montemayor
(Jose Montemayor, Director)
Dated: February 22, 2007 By /s/ Don M. Randel
   
 
   (Don M. Randel, Director)

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Dated: February 25, 200522, 2007 By /s/ Joseph Rosenberg
   
 
   (Joseph Rosenberg, Director)
     
Dated: February 25, 200522, 2007 By /s/ James S.Andrew Tisch
   
 
   (James S.Andrew Tisch, Director)
     
Dated: February 25, 200522, 2007 By /s/ Preston R.James S. Tisch
   
 
   (Preston R.James S. Tisch, Director)
     
Dated: February 25, 200522, 2007 By /s/ Marvin Zonis
   
 
   (Marvin Zonis, Director)

195154