SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997 COMMISSION FILE NUMBER 1-5823
--------------------------
CNA FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 36-6169860
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
CNA PLAZA
Chicago, Illinois 60685
(Address of principal executive offices) (Zip Code)
(312) 822-5000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
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 periods that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes |X| No...
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
CLASS OUTSTANDING AT NOVEMBER 1, 1997
- ---------------------------------- -------------------------------
Common Stock, Par value $2.50 61,798,262
- --------------------------------------------------------------------------------
Page (1) of (30)
CNA FINANCIAL CORPORATION
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
- ------- --------------------- --------
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1997 (Unaudited) AND DECEMBER 31, 1996.............. 3
STATEMENT OF CONSOLIDATED OPERATIONS (Unaudited) FOR THE
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996........... 4
STATEMENT OF CONDENSED CONSOLIDATED STOCKHOLDERS'
EQUITY (Unaudited) FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND 1996....................................... 5
STATEMENT OF CONSOLIDATED CASH FLOWS (Unaudited)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996............. 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Unaudited) SEPTEMBER 30, 1997......................... 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS......................................... 15
PART II. OTHER INFORMATION
- -------- -----------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K........................... 26
SIGNATURES............................................................. 27
EXHIBIT 11 COMPUTATION OF NET INCOME PER COMMON SHARE............... 28
EXHIBIT 12.1 COMPUTATION OF RATIO OF EARNINGS
TO FIXED CHARGES.............................. 29
EXHIBIT 12.2 COMPUTATION OF RATIO OF NET INCOME, AS ADJUSTED,
TO FIXED CHARGES............................... 29
EXHIBIT 27 FINANCIAL DATA SCHEDULE.................................. 30
(2)
CNA FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEET
- -----------------------------------------------------------------------------------------------
SEPTEMBER 30 DECEMBER 31
1997 1996
(In millions of dollars) (Unaudited)
- -----------------------------------------------------------------------------------------------
ASSETS
Investments:
Fixed maturities available for sale (cost: $27,784 and $27,540)...$ 28,169 $ 27,721
Equity securities available for sale (cost: $704 and $702)........ 863 859
Mortgage loans and real estate
(less accumulated depreciation: $4 and $4)........................ 98 123
Policy loans...................................................... 177 174
Other invested assets............................................. 732 681
Short-term investments............................................ 6,844 5,854
---------- ------------
Total investments............................................... 36,883 35,412
Cash................................................................ 371 257
Insurance receivables:
Reinsurance receivables .......................................... 6,031 6,530
Other insurance receivables....................................... 6,501 5,943
Less allowance for doubtful accounts.............................. (294) (277)
Deferred acquisition costs.......................................... 2,223 1,854
Accrued investment income........................................... 410 508
Receivables for securities sold..................................... 704 264
Federal income taxes recoverable (includes $(15) and $151 due (to)
from Loews)......................................................... (31) 134
Deferred income taxes............................................... 1,091 1,347
Property and equipment at cost (less accumulated depreciation:
$563 and $436)...................................................... 698 645
Prepaid reinsurance premiums........................................ 372 295
Intangibles......................................................... 573 418
Other assets........................................................ 945 849
Separate Account business........................................... 6,012 6,121
- -----------------------------------------------------------------------------------------------
TOTAL ASSETS $ 62,489 $ 60,300
===============================================================================================
CNA FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEET - CONTINUED
- -----------------------------------------------------------------------------------------------
September 30 December 31
1997 1996
(In millions of dollars) (Unaudited)
- -----------------------------------------------------------------------------------------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Insurance reserves:
Claim and claim expense.........................................$ 30,150 $ 30,395
Unearned premiums............................................... 5,221 4,659
Future policy benefits.......................................... 4,508 4,181
Policyholders' funds............................................ 752 746
Securities sold under repurchase agreements........................ 1,176 100
Payables for securities purchased.................................. 1,088 405
Participating policyholders' equity................................ 126 119
Short-term debt.................................................... 150 -
Long-term debt..................................................... 2,721 2,765
Other liabilities.................................................. 2,668 3,749
Separate Account business.......................................... 6,012 6,121
----------- -------------
TOTAL LIABILITIES.............................................. 54,572 53,240
----------- -------------
Stockholders' equity:
Common stock ($2.50 par value; Authorized - 200,000,000 shares;
Issued - 61,841,969 shares)...................................... 155 155
Money market cumulative preferred stock............................ 150 150
Additional paid-in capital......................................... 435 435
Retained earnings.................................................. 6,706 6,024
Net unrealized investment gains.................................... 474 299
Treasury stock, at cost............................................ (3) (3)
------------ -------------
TOTAL STOCKHOLDERS' EQUITY..................................... 7,917 7,060
- -------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 62,489 $ 60,300
=================================================================================================
<FN>
See accompanying Notes to Condensed Consolidated Financial Statements
(Unaudited).
</FN>
(3)
CNA FINANCIAL CORPORATION
STATEMENT OF CONSOLIDATED OPERATIONS
(Unaudited)
- -------------------------------------------------------------------------------------------------------
THIRD QUARTER NINE MONTHS
- -------------------------------------------------------------------------------------------------------
PERIOD ENDED SEPTEMBER 30 1997 1996 1997 1996
(In millions of dollars, except per share data)
- -------------------------------------------------------------------------------------------------------
Revenues:
Premiums...................................... $ 3,336 $ 3,435 $10,031 $10,049
Net investment income......................... 530 540 1,641 1,676
Realized investment gains..................... 237 109 475 487
Other......................................... 206 172 537 454
--------- --------- -------- --------
4,309 4,256 12,684 12,666
--------- --------- -------- --------
Benefits and expenses:
Insurance claims and policyholders' benefits.. 2,854 2,839 8,607 8,401
Amortization of deferred acquisition costs.... 621 602 1,738 1,568
Other operating expenses...................... 384 464 1,223 1,470
Interest expense.............................. 57 51 153 155
--------- --------- -------- --------
3,916 3,956 11,721 11,594
--------- --------- -------- --------
Income before income tax...................... 393 300 963 1,072
Income tax expense.............................. 119 61 276 302
--------- --------- -------- --------
$ 274 $ 239 $ 687 $ 770
=======================================================================================================
EARNINGS PER SHARE
- ------------------
Net income ..................................... $ 4.41 $ 3.83 $ 11.04 $ 12.38
========= ========= ======== ========
Weighted average outstanding shares of
common stock (in millions of shares)............ 61.8 61.8 61.8 61.8
=======================================================================================================
<FN>
See accompanying Notes to Condensed Consolidated Financial Statements
(Unaudited).
</FN>
(4)
CNA FINANCIAL CORPORATION
STATEMENT OF CONSOLIDATED STOCKHOLDERS' EQUITY
(Unaudited)
- -------------------------------------------------------------------------------------------------------------
Nine months Ended September 30, 1997 and 1996
Net
Additional Unrealized
Capital Paid in Retained Investment Gains Total
Stock Capital Earnings (Losses)
(In millions of dollars)
- -------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 $ 302 $ 435 $ 5,066 $ 933 $ 6,736
Net income........................ - - 770 - 770
Change in net unrealized
investment losses................. - - - (790) (790)
Preferred dividends............... - - (5) - (5)
- -------------------------------------------------------------------------------------------------------------
Balance, September 30, 1996 $ 302 $ 435 $ 5,831 $ 143 $ 6,711
=============================================================================================================
Balance, December 31, 1996 $ 302 $ 435 $ 6,024 $ 299 $ 7,060
Net income........................ - - 687 - 687
Change in net unrealized
investment losses................. - - - 175 175
Preferred dividends............... - - (5) - (5)
- ------------------------------------------------------------------------------------------------------------
Balance, September 30, 1997 $ 302 $ 435 $ 6,706 $ 474 $ 7,917
============================================================================================================
<FN>
See accompanying Notes to Condensed Consolidated Financial Statements
(Unaudited).
</FN>
(5)
CNA FINANCIAL CORPORATION
STATEMENT OF CONSOLIDATED CASH FLOWS
(Unaudited)
- -----------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30 1997 1996
(In millions of dollars)
- -----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ................................................................... $ 687 $ 770
------------ --------------
Adjustments to reconcile net income to net cash flows from operating
activities:
Net realized investment gains, pre-tax ...................................... (475) (487)
Participating policyholders' interest........................................ 2 2
Amortization of intangibles.................................................. 20 19
Amortization of bond discount................................................ (81) (130)
Depreciation................................................................. 132 118
Changes in:
Insurance receivables, net.................................................. (42) (897)
Deferred acquisition costs.................................................. (369) (285)
Accrued investment income................................................... 98 52
Federal income taxes recoverable............................................ 165 99
Deferred income taxes....................................................... 156 139
Prepaid reinsurance premiums................................................ (77) 122
Insurance reserves.......................................................... 662 293
Reinsurance payables........................................................ (60) 235
Other liabilities........................................................... (991) 289
Other, net.................................................................. (186) (404)
------------ --------------
Total adjustments ...................................................... (1,046) (835)
------------ --------------
NET CASH FLOWS FROM OPERATING ACTIVITIES ............................... (359) (65)
------------ --------------
=================================================================================================================
CNA FINANCIAL CORPORATION
STATEMENT OF CONSOLIDATED CASH FLOWS - CONTINUED
(Unaudited)
- -----------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30 1997 1996
(In millions of dollars)
- -----------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed maturities.................................................. (28,756) (24,783)
Proceeds from fixed maturities:
Sales......................................................................... 27,545 25,758
Maturities, calls and redemptions............................................. 1,668 1,658
Purchases of equity securities................................................. (854) (513)
Proceeds from sale of equity securities........................................ 937 650
Change in short-term investments............................................... (993) (2,340)
Purchases of property and equipment ........................................... (195) (149)
Change in securities sold under repurchase agreements.......................... 1,075 (172)
Change in other investments.................................................... 173 256
Investment in affiliates....................................................... (65) --
Other, net..................................................................... (151) 21
------------ --------------
NET CASH FLOWS FROM INVESTING ACTIVITIES ............................... 384 386
------------ --------------
Cash flows from financing activities:
Dividends paid to preferred shareholders....................................... (5) (5)
Receipts from investment contracts credited to policyholder account balances... 7 12
Return of policyholder account balances on investment contracts................ (18) (34)
Change in short-term debt...................................................... -- (258)
Principal payments on long-term debt........................................... (4) (3)
Proceeds from issuance of long-term debt....................................... 109 10
------------ --------------
NET CASH FLOWS FROM FINANCING ACTIVITIES............................... 89 (278)
------------ --------------
Net cash flows..................................................... 114 43
Cash at beginning of period..................................................... 257 222
==================================================================================================================
CASH AT END OF PERIOD $ 371 $ 265
==================================================================================================================
Supplemental disclosures of cash flow information: Cash (paid) received:
Interest expense............................................................... $ (148) $ (166)
Federal income taxes........................................................... 50 (43)
===================================================================================================================
<FN>
See accompanying Notes to Condensed Consolidated Financial Statements
(Unaudited).
</FN>
(6)
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1997
(Unaudited)
NOTE A. Basis of Presentation:
The Condensed Consolidated Financial Statements (unaudited) include CNA
Financial Corporation and its operating subsidiaries (CNA or the Company) which
consist of property/casualty insurance companies (principally Continental
Casualty Company and The Continental Insurance Company) and life insurance
companies (principally Continental Assurance Company and Valley Forge Life
Insurance Company). Loews Corporation (Loews) owns approximately 84% of the
outstanding common stock of CNA.
CNA is a multiple-line insurer underwriting property and casualty
coverages; life, accident and health insurance; and pension and annuity
business. CNA serves a wide spectrum of insureds, including individuals; small,
medium and large businesses; associations; professionals and groups.
The operating results for the interim periods are not necessarily
indicative of the results to be expected for the full year. These statements
should be read in conjunction with the financial statements and notes thereto
included in CNA's Annual Report to Shareholders (incorporated by reference in
Form 10-K) for the year ended December 31, 1996, filed with the Securities and
Exchange Commission on March 31, 1997, and the information shown below.
The accompanying condensed consolidated financial statements have been
prepared in conformity with generally accepted accounting principles. Certain
amounts applicable to the prior year have been reclassified to conform to
classifications followed in 1997. All significant intercompany amounts have been
eliminated.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. In the
opinion of CNA's management, these statements include all adjustments,
consisting of normal recurring accruals, which are necessary for the fair
presentation of the financial position, results of operations and cash flows in
the accompanying condensed consolidated financial statements.
CNA, its subsidiaries and Separate Accounts, invest from time to time in
certain derivative financial instruments to increase investment returns and to
reduce the impact of changes in interest rates on certain corporate borrowings.
Financial instruments used for such purposes include interest rate swaps, put
and call options, commitments to purchase securities, futures and forwards.
Unrealized investment gains and losses on derivative securities, except for
the interest rate swaps associated with corporate borrowings, are reflected as
part of realized investment gains and losses. Unrealized gains or losses related
to changes in the value of the interest rate swaps associated with corporate
borrowings are not recognized.
(7)
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE B. Restricted Investments:
On December 30, 1993, CNA deposited $987 million in an escrow account,
pursuant to the Fibreboard Global Settlement Agreement, as discussed in Note C
below. At September 30, 1997, the escrow account amounted to $1.1 billion. The
funds are included in short-term investments and are invested substantially in
U. S. Treasury securities. The escrow account is the prefunding mechanism to the
trust fund for future claimants.
NOTE C. Legal Proceedings and Contingent Liabilities:
The following information updates legal proceedings and contingent
liabilities reported in Note F of the Notes to the Consolidated Financial
Statements in the 1996 Annual Report to Shareholders.
FIBREBOARD LITIGATION
CNA's primary property/casualty subsidiary, Continental Casualty Company
("Casualty"), has been party to litigation with Fibreboard Corporation
("Fibreboard") involving coverage for certain asbestos-related claims and
defense costs (San Francisco Superior Court, Judicial Council Coordination
Proceeding 1072). As described below, Casualty, Fibreboard, another insurer
(Pacific Indemnity, a subsidiary of the Chubb Corporation), and a negotiating
committee of asbestos claimant attorneys (collectively referred to as "Settling
Parties") have reached a Global Settlement (the "Global Settlement") which is
subject to court approval, to resolve all future asbestos-related bodily injury
claims involving Fibreboard.
Casualty, Fibreboard and Pacific Indemnity have also reached an agreement
(the "Trilateral Agreement"), on a settlement to resolve the coverage litigation
and provides funding for Fibreboard's asbestos claims in the event the Global
Settlement does not obtain final court approval.
On July 27, 1995, the United States District Court for the Eastern District
of Texas entered judgment approving the Global Settlement Agreement and the
Trilateral Agreement. As expected, appeals were filed as respects both of these
decisions. On July 25, 1996, a panel of the United States Fifth Circuit Court of
Appeals in New Orleans affirmed the judgment approving the Global Settlement
Agreement by a 2 to 1 vote and affirmed the judgment approving the Trilateral
Agreement by a 3 to 0 vote. Petitions for rehearing by the panel and Suggestions
for Rehearing by the entire Fifth Circuit Court of Appeals as respects the
decision on the Global Settlement Agreement were denied. Two petitions for
certiorari were filed in the Supreme Court as respects the Global Settlement
Agreement. On June 27, 1997, the Supreme Court granted these petitions, vacated
the Fifth Circuit's judgment as respects the Global Settlement Agreement, and
remanded to the Fifth Circuit for reconsideration in light of the Supreme
Court's decision in Amchem Products Co. v. Windsor. The Fifth Circuit has
---------------------------------
not yet rendered a decision on this remand.
No further appeal was filed with respect to the Trilateral Agreement;
therefore, court approval of the Trilateral Agreement has become final.
GLOBAL SETTLEMENT AGREEMENT
On April 9, 1993, Casualty and Fibreboard entered into an agreement
pursuant to which, among other things, the parties agreed to use their best
efforts to negotiate and finalize a global class action settlement with
asbestos-related bodily injury and death claimants.
(8)
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
On August 27, 1993, the Settling Parties reached an agreement in principle
for an omnibus settlement to resolve all future asbestos-related bodily injury
claims involving Fibreboard. The Global Settlement Agreement was executed on
December 23, 1993. The agreement calls for contribution by Casualty and Pacific
Indemnity of an aggregate of $1.53 billion to a trust fund for a class of all
future asbestos claimants, defined generally as those persons whose claims
against Fibreboard were neither filed nor settled before August 27, 1993. An
additional $10 million is to be contributed to the fund by Fibreboard. As
indicated above, the Global Settlement approval is presently before the Fifth
Circuit on remand by order of the Supreme Court vacating the Fifth Circuit's
previous decision approving the Global Settlement. There is limited precedent
with settlements which determine the rights of future personal injury claimants
to seek relief.
Through September 30, 1997, Casualty, Fibreboard and plaintiff attorneys
had reached settlements with respect to approximately 135,620 claims, for an
estimated settlement amount of approximately $1.62 billion plus any applicable
interest. Final court approval of the Trilateral Agreement obligates Casualty to
pay under these settlements. Approximately $1.59 billion including interest was
paid through September 30, 1997, including approximately $590 million paid in
the fourth quarter of 1996 and the first quarter of 1997 as a result of the
Trilateral Agreement becoming final. As described above, such payments have been
partially recovered from Pacific Indemnity. Casualty may negotiate other
agreements for unsettled claims.
Final court approval of the Trilateral Agreement and its implementation has
eliminated any further material exposure with respect to the Fibreboard matter,
and subsequent reserve adjustments, if any, will not materially affect the
results of operations or equity of CNA.
TOBACCO LITIGATION
CNA's primary property/casualty subsidiaries have been named as defendants
as part of a "direct action" lawsuit, Richard P. Ieyoub v. The
-------------------------------
American Tobacco Company, etal., filed by the Attorney General for the State of
- --------------------------------
Louisiana, in state court, Calcasieu Parish, Louisiana. In that suit, filed
against certain tobacco manufacturers and distributors (the "Tobacco
Defendants") and over 100 insurance companies, the State of Louisiana seeks to
recover medical expenses allegedly incurred by the State as a result of
tobacco-related illnesses.
The original suit was filed on March 13, 1996, against the Tobacco
Defendants only. The insurance companies were added to the suit in March 1997
under a "direct action" statute in Louisiana. Under the direct action statute,
the Louisiana Attorney General is pursuing liability claims against the Tobacco
Defendants and their insurers in the same suit, even though none of the Tobacco
Defendants has made a claim for insurance coverage.
Recently, the United States District Court for the Western District of
Louisiana, Lake Charles Division, granted a petition to remove this litigation
to the federal district court. The district court's decision is currently on
appeal to the United States Fifth Circuit Court of Appeals. During the pending
appeal, all proceedings in state court and in the federal district court are
stayed. Because of the uncertainties inherent in assessing the risk of liability
at this very early stage of the litigation, management is unable to make a
meaningful estimate of the amount or range of any loss that could result from an
unfavorable outcome of the pending litigation. However, management believes that
the ultimate outcome of the pending litigation should not materially affect the
results of operations or equity of CNA.
(9)
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
OTHER LITIGATION
CNA and its subsidiaries are also parties to other litigation arising in
the ordinary course of business. The outcome of this other litigation will not,
in the opinion of management, materially affect the results of operations or
equity of CNA.
ENVIRONMENTAL POLLUTION AND ASBESTOS-RELATED CLAIMS
The CNA property/casualty insurance companies have potential exposures
related to environmental pollution and asbestos-related claims.
Environmental pollution clean-up is the subject of both federal and state
regulation. By some estimates, there are thousands of potential waste sites
subject to clean-up. 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-Superfund") govern the
clean-up and restoration of abandoned toxic waste sites and formalize the
concept of legal liability for clean-up and restoration by "Potentially
Responsible Parties" ("PRP's"). Superfund and the mini-Superfunds (Environmental
Clean-up Laws or "ECLs") establish a mechanism to pay for clean-up of waste
sites if PRP's fail to do so, and to assign liability to PRP's. The extent of
liability to be allocated to a PRP is dependent on a variety of factors.
Further, the number of waste sites subject to clean-up is unknown. To date,
approximately 1,300 clean-up sites have been identified by the Environmental
Protection Agency on its National Priorities List. On the other hand, the
Congressional Budget Office is estimating that there will be 4,500 National
Priority List sites, and other estimates project as many as 30,000 sites that
will require clean-up under ECLs. Very few sites have been subject to clean-up
to date. The extent of clean-up necessary and the assignment of liability has
not been established.
CNA and the insurance industry are disputing coverage for many such claims.
Key coverage issues include whether Superfund response costs are considered
damages under the policies, trigger of coverage, applicability of pollution
exclusions, the potential for joint and several liability and definition of an
occurrence. Similar coverage issues exist for clean-up of waste sites not
covered under Superfund. To date, courts have been inconsistent in their rulings
on these issues.
A number of proposals to reform Superfund have been made by various
parties. Despite Superfund taxing authority expiring at the end of 1995, no
reforms have yet been enacted by Congress. While the current Congress may
address this issue, no predictions can be made as to what legislation, if any,
will result. If there is legislation, and in some circumstances even if there is
no legislation, the federal role in environmental clean-up may be materially
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
clean-up statutes and regulations. There can be no meaningful prediction of the
pattern of regulation that would result.
Due to the inherent uncertainties described above, including the
inconsistency of court decisions, the number of waste sites subject to clean-up,
and the standards for clean-up and liability, the ultimate exposure to CNA for
environmental pollution claims cannot be meaningfully quantified.
(10)
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
Claim and claim expense reserves represent management's estimates of
ultimate liabilities based on currently available facts and case law. However,
in addition to the uncertainties previously discussed, additional issues related
to, among other things, specific policy provisions, multiple insurers and
allocation of liability among insurers, consequences of conduct by the insured,
missing policies and proof of coverage make quantification of liabilities
exceptionally difficult and subject to adjustment based on new data. As of
September 30, 1997 and December 31, 1996, CNA carried approximately $824 million
and $908 million, respectively, of claim and claim expense reserves, net of
reinsurance recoverables, for reported and unreported environmental pollution
claims. The reserves relate to claims for accident years 1988 and prior, which
coincides with CNA's adoption of the Simplified Commercial General Liability
coverage form which included an absolute pollution exclusion. There was no
unfavorable reserve development for the nine months ended September 30, 1997 and
1996.
CNA has exposure to asbestos-related claims, including those attributable
to the Fibreboard Claim. A detailed discussion of CNA's litigation with
Fibreboard Corporation regarding asbestos-related bodily injury claims is
discussed at the beginning of this note. Estimation of asbestos-related claim
reserves encounter many of the same limitations discussed above for
environmental pollution claims such as inconsistency of court decisions,
specific policy provisions, multiple insurers and allocation of liability among
insurers, missing policies and proof of coverage. As of September 30, 1997 and
December 31, 1996, CNA carried approximately $1,415 million and $1,506 million,
respectively, of claim and claim expense reserves, net of reinsurance
recoverable, for reported and unreported asbestos-related claims. Unfavorable
reserve development for the nine months ended September 30, 1997 and 1996,
totaled $40 million and $38 million, respectively.
The following table provides additional data related to CNA's environmental
pollution and asbestos-related claims reserves.
|------------------------------------------------------------------------------|
| |
|Reserve Summary September 30, 1997 December 31, 1996 |
| -----------------------------------------------------|
| Environmental Asbestos Environmental Asbestos|
| Pollution Pollution |
|------------------------------------------------------------------------------|
|In millions of dollars) |
| |
|Gross reserves: |
| Reported claims $ 288 $1,431 $ 289 $1,551 |
| Unreported claims 577 101 714 94 |
| ------ ------ ------- ------- |
| 865 1,532 1,003 1,645 |
|Less reinsurance recoverable (41) (117) (95) (139) |
|------------------------------------------------------------------------------|
|Net reserves $ 824 $1,415 $ 908 $1,506 |
|==============================================================================|
The results of operations in future years may continue to be adversely
affected by environmental pollution and asbestos claims and claim expenses.
Management will continue to monitor potential liabilities and make further
adjustments as warranted.
(11)
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE D. Reinsurance:
CNA assumes and cedes insurance with other insurers and reinsurers and
members of various reinsurance pools and associations. CNA utilizes reinsurance
arrangements to limit its maximum loss to provide greater diversification of
risk and to minimize exposures on larger risks. The reinsurance coverages are
tailored to the specific risk characteristics of each product line with CNA's
retained amount varying by type of coverage. Generally, reinsurance coverage for
property risks is on an excess of loss, per risk basis. Liability coverages are
generally reinsured on a quota share basis in excess of CNA's retained risk.
The ceding of insurance does not discharge the primary liability of the
original insurer. CNA places reinsurance with other carriers only after careful
review of the nature of the contract and a thorough assessment of each
reinsurer's credit quality and claim settlement performance. Further, for
carriers that are not authorized reinsurers in its states of domicile, CNA
receives collateral, primarily in the form of bank letters of credit.
|-----------------------------------------------------------------------------|
|NINE MONTHS ENDED EARNED PREMIUMS ASSUMED/ |
|SEPTEMBER 30 |
| -------------------------------------- |
| NET |
|(In millions of dollars) DIRECT ASSUMED CEDED NET % |
|-----------------------------------------------------------------------------|
| |
|1997 |
| Life $ 649 $ 92 $ 90 $ 651 14.1% |
| Accident and health 2,806 73 115 2,764 2.6 |
| Property and casualty 6,087 1,078 549 6,616 16.3 |
|-----------------------------------------------------------------------------|
| TOTAL PREMIUMS $ 9,542 $ 1,243 $ 754 $10,031 12.4% |
|=============================================================================|
|1996 |
| Life $ 520 $ 87 $ 33 $ 574 15.2% |
| Accident and health 2,580 183 113 2,650 6.9 |
| Property and casualty 6,702 1,056 933 6,825 15.5 |
|-----------------------------------------------------------------------------|
| TOTAL PREMIUMS $ 9,802 $ 1,326 $ 1,079 $10,049 13.2% |
|=============================================================================|
In the table above, life premium revenue is from long duration contracts,
property/casualty earned premium is from short duration contracts, and
approximately three-quarters of accident and health earned premium is from short
duration contracts.
Insurance claims and policyholders' benefits are net of reinsurance
recoveries of $618 and $1,010 million for the nine months ended September 30,
1997 and September 30, 1996, respectively.
(12)
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
NOTE E. Debt:
Long-term and short-term borrowings consisted of the following:
|------------------------------------------------------------------------------|
|LONG-TERM AND SHORT-TERM DEBT SEPTEMBER 30 DECEMBER 31|
|(In millions of dollars) 1997 1996 |
- -------------------------------------------------------------------------------|
|Long-term: |
| Variable Rate Debt: |
| Credit Facility $ 400 $ 400 |
| Commercial Paper 675 675 |
| Credit Facility - CNA Surety 105 --- |
|Senior Notes: |
| 8 7/8%, due March 1, 1998* --- 150 |
| 8 1/4%, due April 15, 1999 101 102 |
| 7 1/4%, due March 1, 2003 146 146 |
| 6 1/4%, due November 15, 2003 249 248 |
| 6 3/4%, due November 15, 2006 248 248 |
| 8 3/8%, due August 15, 2012 98 98 |
| 7 1/4% Debenture, due November 15, 2023 247 247 |
| 11% Secured Mortgage Notes, due June 20, 2013 388 387 |
| 6.90% - 16.29% Secured Capital Leases, |
| due December 31, 2011 46 47 |
| Other 18 17 |
|------------------------------------------------------------------------------|
| TOTAL LONG-TERM DEBT $ 2,721 $ 2,765 |
| Short-term: |
| 8 7/8%, due March 1, 1998 150 --- |
|------------------------------------------------------------------------------|
| TOTAL DEBT $ 2,871 $ 2,765 |
|==============================================================================|
*Included in short-term in 1997.
To finance the acquisition of Continental (including the refinancing of
$205 million of Continental debt) CNA entered into a five-year $1.325 billion
revolving credit facility. In 1996, the Company renegotiated the facility,
extending the maturity to May 2001. The interest rate for the facility is based
on the London Interbank Offered Rate (LIBOR), plus 16 basis points.
Additionally, there is a facility fee of 9 basis points annually. The average
interest rate on the borrowings under the revolver at September 30, 1997 was
5.82%. Under the terms of the facility, CNA may prepay the debt without penalty.
On November 15, 1996, CNA issued $250 million of 6 3/4% senior notes, due
November 15, 2006. The net proceeds from this issuance of approximately $248
million were used to pay down a portion of the borrowings outstanding under the
revolving credit facility. As a result of this debt issuance, borrowing capacity
under the revolving credit facility was reduced by $250 million to $1.075
billion. Concurrent with the paydown of $250 million on the revolving credit
facility, CNA terminated interest rate swaps with a total notional amount of
$250 million.
CNA maintains a commercial paper program to take advantage of favorable
interest rate spreads. The commercial paper borrowings are classified as
long-term as $675 million of the committed bank facility will support the
commercial paper program. The weighted-average yield on commercial paper at
September 30, 1997 was 5.82%.
As of November 1, 1997, the outstanding loans under the revolving credit
facility were $400 million. There was no unused borrowing capacity under the
facility after the effects of the commercial paper program.
(13)
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONCLUDED
To offset the variable rate characteristics of the facility, CNA entered
into interest rate swap agreements with several banks having a total notional
principal amount of $950 million. These agreements terminate from May to
December 2000. These agreements provide that CNA pay interest at a fixed rate,
averaging 6.20% at September 30, 1997, in exchange for the receipt of interest
at the three month LIBOR rate. The effect of these interest rate swaps was to
increase interest expense by $3 million for the nine months ended September 30,
1997.
The weighted average interest rate (interest and facility fees) on the
variable rate acquisition debt, which includes the revolving credit facility and
commercial paper, was 6.28% at September 30, 1997. This rate reflects the effect
of the interest rate swaps.
In conjunction with the merger with Capsure Holdings Corp. (See Note F)
CNA's affiliate, CNA Surety entered into a $130 million, 5 year revolving credit
facility which closed and was funded on September 30, 1997. The interest rate
for the facility is based on LIBOR plus 20 basis points. Additionally there is a
facility fee of 10 basis points annually. At September 30, 1997 the interest
rate was 5.86%.
As of September 30, 1997, $250 million of securities remained available for
issuance under a shelf registration. On October 22, 1997, an additional $750
million shelf registration for senior and subordinated debt and preferred stock
became effective. A portion of the net proceeds is expected to be used to pay
down borrowings outstanding under the Company's revolving credit facility and/or
commercial paper program. The remaining proceeds will be added to the Company's
general funds and used for general corporate purposes, which may include, but
are not limited to, pre-payment of other debt, and/or capital contributions to
the Company's subsidiaries to strengthen such subsidiaries' continuing
operations.
NOTE F. Merger CNA Surety Corporation/Capsure Holdings Corp.
In the fourth quarter of 1996, CNA Surety Corporation, an affiliate of CNA,
entered into a merger agreement with Capsure Holdings Corp. (Capsure) to form a
new stock company, CNA Surety Corporation. The transaction closed on September
30, 1997. In conjunction with the closing of the surety transaction, CNA
recognized a realized investment gain of $89 million. The new company, in which
CNA owns approximately 62% of the outstanding shares on a fully diluted basis,
is the largest U.S. surety company with the broadest product line and most
extensive distribution system. The remaining shares are held by existing Capsure
shareholders and option holders. The transaction was accounted for as a purchase
and, accordingly, CNA Surety's results of operations will be included in CNA's
consolidated results of operations subsequent to the date of merger. At
September 30, 1997, total assets of CNA Surety Corporation were $686 million.
Capsure's revenues for the year ended December 31, 1996 were approximately $111
million. Total assets were approximately $313 million at December 31, 1996.
(14)
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction
with the condensed consolidated financial statements and notes thereto found on
pages 3 to 14, which contain additional information helpful in evaluating
operating results and financial condition.
CNA is one of the largest commercial insurers in the United States, the
third largest property-casualty company and the twenty-second largest life
insurance company in the country, based on 1996 net written premium. Based on
market share, CNA ranks first among United States insurers in commercial auto,
commercial affiliation marketing, commercial multiple peril, personal packages,
surety, and ocean marine; second in commercial lines, general liability, medical
malpractice, federal employees health benefit plans, multiple peril crop,
offshore energy, and accounts receivable credit; third in automobile warranty,
directors & officers, farmowners multiple peril, recreational watercraft, and
workers' compensation; and fifth in reinsurance in the United States. In
addition, CNA ranks first, second or third for various errors & omissions
coverages for architects and engineers, accountants, lawyers and other
professionals.
Results of Operations:
The following chart summarizes key components of operating results for
the nine months and quarters ended September 30, 1997 and 1996.
|----------------------------------------------------------------------------------------------------------|
|PERIOD ENDED SEPTEMBER 30 THIRD QUARTER NINE MONTHS |
|(In millions of dollars) 1997 1996 1997 1996 |
|----------------------------------------------------------------------------------------------------------|
|OPERATING SUMMARY (EXCLUDING REALIZED INVESTMENT |
| GAINS/LOSSES): |
|Revenues: |
| Premiums: |
| Property/Casualty $ 2,489 $ 2,593 $ 7,489 $ 7,579 |
| Life 847 842 2,542 2,470 |
| ------ ------ ------ ------ |
| 3,336 3,435 10,031 10,049 |
| Net investment income 530 540 1,641 1,676 |
| Other 206 171 537 454 |
| ------ ------ ------ ------ |
| 4,072 4,146 12,209 12,179 |
|Benefits and expenses 3,911 3,957 11,712 11,583 |
| ------ ------ ------ ------ |
| Operating income before income tax 161 189 497 596 |
|Income tax expense (40) (28) (114) (138) |
| ------ ------ ------ ------ |
| Net operating income $ 121 $ 161 $ 383 $ 458 |
| ====== ====== ====== ====== |
| |
|SUPPLEMENTAL FINANCIAL DATA: |
|Net operating income (loss) by group: |
| Property/Casualty $ 121 $ 165 $ 385 $ 463 |
| Life 24 23 71 78 |
| Other, primarily interest expense (24) (27) (73) (83) |
| ------ ----- ----- ----- |
| 121 161 383 458 |
| ------ ----- ----- ----- |
|Net realized investment gains (losses) by group: |
| Property/Casualty 126 52 221 232 |
| Life 29 22 73 79 |
| Other (2) 4 10 1 |
| ------ ---- ------ ---- |
| 153 78 304 312 |
| ------ ---- ------ ---- |
|Net income (loss) by group: |
| Property/Casualty 247 217 606 695 |
| Life 53 45 144 157 |
| Other, primarily interest expense (26) (23) (63) (82) |
| ------ ----- ------ ----- |
| $ 274 $ 239 $ 687 $ 770 |
|==========================================================================================================|
(15)
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Consolidated Results
- --------------------
Consolidated revenues for the first nine months of both 1997 and 1996
were approximately $12.7 billion. Consolidated revenues excluding net realized
investment gains, for the first nine months of both 1997 and 1996 were
approximately $12.2 billion. For the first nine months, revenues reflect a
decrease of $18 million (0.2%) in earned premiums, a decrease of $35 million
(2.1%) in investment income and an increase of $83 million (18.3%) in other
income.
Net operating income, which excludes net realized investment gains, for
the first nine months of 1997 was $383 million, or $6.12 per share, compared to
net operating income of $458 million, or $7.33 per share, for the first nine
months of 1996. Net operating income for the third quarter was $121 million, or
$1.93 per share, compared with $161 million, or $2.57 per share, for the same
quarter in 1996. CNA's income in the first nine months of 1997 is net of pretax
losses of $79 million related to catastrophe claims; pretax catastrophe losses
in the first nine months of 1996 were $280 million.
Realized investment gains, net of tax, for the first nine months of 1997
were $304 million, or $4.92 per share, compared to net realized investment gains
for the first nine months of 1996 of $312 million, or $5.05 per share. The
components of the net realized investment gains (losses) are as follows:
|-----------------------------------------------------------------------------|
|REALIZED INVESTMENT GAINS(LOSSES) |
|NINE MONTHS ENDED SEPTEMBER 30 1997 1996 |
|(In millions of dollars) |
|-----------------------------------------------------------------------------|
|Bonds: |
| U.S. Government $ 103 $ 102 |
| Tax-exempt 26 109 |
| Asset-backed 18 23 |
| Taxable 102 14 |
| ------- ------- |
| Total bonds 249 248 |
|Stocks 57 148 |
|Derivative securities 2 11 |
|Separate accounts and other 167 * 80 |
| ------ ------- |
| Realized investment gains reported in revenues 475 487 |
|Participating policyholders' interest (8) (11) |
|Income tax expense (163) (164) |
| ------- -------- |
| Net realized investment gains $ 304 $ 312 |
|=============================================================================|
*Includes a realized investment gain of $89 million on the merger of CNA Surety
Corporation and Capsure Holdings Corp. (See Note F).
Net income was $687 million, or $11.04 per share, compared to $770
million, or $12.38 per share, for the first nine months of 1996. Net income for
the third quarter was $274 million, or $4.41 per share, compared with a net
income of $239 million, or $3.83 per share, for the third quarter of 1996.
(16)
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Property/Casualty Operations
- ----------------------------
|------------------------------------------------------------------------------|
|PROPERTY/CASUALTY GROUP THIRD QUARTER NINE MONTHS |
|PERIOD ENDED SEPTEMBER 30 1997 1996 1997 1996 |
|(In millions of dollars) |
|----------------------------------------------------------------------------- |
|OPERATING SUMMARY (EXCLUDING NET |
| REALIZED INVESTMENT GAINS/LOSSES): |
|Revenues: |
| Premiums $ 2,489 $ 2,593 $ 7,489 $ 7,579 |
| Net investment income 432 445 1,343 1,384 |
| Other 173 137 448 379 |
| ------ ------ ------ ------ |
| 3,094 3,175 9,280 9,342 |
|Benefits and expenses 2,936 2,979 8,781 8,740 |
| ----- ----- ----- ----- |
| Income before income tax 158 196 499 602 |
|Income tax expense (37) (31) (114) (139)|
| ------- ------- ------ ------|
|Net operating income (excluding net |
| realized investment gains/losses) $ 121 $ 165 $ 385 $ 463 |
| |
|==============================================================================|
Property/casualty revenues, excluding net realized investment gains/losses,
decreased $62 million for the first nine months ended September 30, 1997, when
compared to the same period a year ago. Property/casualty earned premium
decreased $90 million from the prior years comparable period. The decrease in
earned premium is due primarily to a reduction in premium in the involuntary
risk business , primarily workers' compensation, of $285 million and $70 million
for the nine and three months ended September 30, 1997, compared to the same
periods a year ago. These reductions are as a result of improved loss experience
in the involuntary risk business.
Property/casualty pretax operating income before realized gains reflects a
decrease of $103 million for the first nine months of 1997 compared to the same
period in 1996. The decrease in operating income stems from an increase in
underwriting losses as well as a decline in investment income. This decrease was
offset in part by lower operating expenses and favorable catastrophe loss
experience. Pre-tax catastrophe losses of approximately $79 million for the nine
months ended September 30, 1997 compared to $280 million for the respective
period in 1996. Underwriting losses for the first nine and three months ended
September 30, 1997, were $844 million and $273 million, compared to $783 million
and $249 million for the same periods in 1996. The GAAP combined ratio for the
nine months ending September 30, 1997 was 108.9% as compared to 108.6% for the
comparable period in 1996. GAAP expense ratios were 29.9% and 31.0% for the nine
month periods ended September 30, 1997 and September 30, 1996, respectively.
There was profitability improvement in the personal insurance lines, both in the
private passenger and homeowner lines. However, continued competitive pressures
on virtually all other segments of the insurance market, particularly in the
commercial insurance market, resulted in continued deterioration of the loss
ratio.
CNA, consistent with sound insurance reserving practices, regularly
adjusts its reserve estimates in subsequent reporting periods as new facts and
circumstances emerge that indicate the previous estimates need to be modified.
These adjustments, referred to as "reserve development" are inevitable given
the complexities of the reserving process and are recorded in the statement of
operations in the period the need for the adjustments becomes apparent.
Loss & loss adjustment expense reserve development for the nine months
ended September 30, 1997 and 1996 was favorable and aggregated $297 million and
$142 million, respectively (including the effects of unfavorable reserve
development for asbestos related claims - see Note D). Favorable loss reserve
development was partially offset by unfavorable premium development, which
aggregated $165 million and $21 million for the nine months ended September 30,
1997 and 1996, respectively.
(17)
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Loss reserve development for the nine months ended September 30, 1997 reflects
continued favorable claim frequency (rate of claim occurrence) and severity
(average cost per claim) experience, principally in the workers' compensation
line of business as well as favorable experience in the surety line of business.
In addition, involuntary risk exposures have developed to be less than
previously anticipated, which reduced both premium and losses associated with
the residual market pool participation, principally for workers' compensation.
These trends reflect the positive effects of changes in workers' compensation
laws, moderate increases in medical costs and a generally strong economy in
which individuals return to the workplace more quickly.
Pretax operating income excluding net realized investment gains/losses, for
the property/casualty insurance subsidiaries was $499 million and $158 million
for the nine months and three months ended September 30, 1997, compared to $602
million and $196 million for the same periods a year ago. Investment income
decreased 3.0% and 2.9% for the nine and three months ended September 30, 1997,
to $1,343 million and $432 million, respectively, when compared with the
comparable periods a year ago of $1,384 million and $445 million, respectively.
The decrease reflects reduced operating cash flow and a movement to lower market
yields. The fixed maturities segment of the investment portfolio yielded 6.3% in
the nine months of 1997 as compared to 6.6% for the nine months of 1996.
The net income of CNA's property/casualty insurance subsidiaries,
excluding net realized investment gains/losses, was $385 and $121 million for
the nine and three months ended September 30, 1997, compared to $463 million and
$165 million for the same periods in 1996. Net realized investment gains for the
nine and three months ended September 30, 1997 were $221 million and $126
million, compared to $232 million and $52 million in the comparable periods of
1996.
Life Operations
- ---------------
|------------------------------------------------------------------------------|
|LIFE GROUP THIRD QUARTER NINE MONTHS |
|PERIOD ENDED SEPTEMBER 30 1997 1996 1997 1996 |
|(In millions of dollars) |
|------------------------------------------------------------------------------|
|OPERATING SUMMARY (EXCLUDING NET |
| REALIZED INVESTMENT GAINS/LOSSES): |
|Revenues: |
| Premiums $ 847 $ 849 $ 2,544 $ 2,488 |
| Net investment income 102 99 306 295 |
| Other 33 32 89 75 |
| ----- ----- ----- ----- |
| 982 980 2,939 2,858 |
|Benefits and expenses 943 945 2,827 2,737 |
| ----- ----- ----- ----- |
| Income before income tax 39 35 112 121 |
|Income tax expense (15) (12) (41) (43)|
| ------ ------ ------ ------ |
|Net operating income (excluding net |
| realized investment gains/losses) $ 24 $ 23 $ 71 $ 78 |
| |
|==============================================================================|
Life group revenues, excluding net realized investment gains, were
approximately $2.9 billion, up 2.8% for the nine months ended September 30, 1997
compared to the same period a year ago. Life premium revenues increased
approximately 2.3% for the nine months ended September 30, 1997 when compared to
the first nine months of 1996. Individual life operations increased
approximately $45 million due to the continued growth in sales and renewal
premiums in the Viaterm life product. Group life operations increased
approximately $80 million with increases in the Federal Employees Health Benefit
Program, group medical and specialty risks. The increase in premiums for these
products is primarily offset by a drop in group reinsurance premium. Investment
income for the nine months ended September 30, 1997 was $306 million as compared
to $295 million for the same period a year ago. This increase can be mainly
attributed to a larger asset base generated from increased operating cash flows.
(18)
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
The fixed maturities segment of the life investment portfolio, which is the
primary investment segment, yielded 6.3% in the nine months of 1997 compared
with 6.7% for the same period a year ago.
Life group premiums declined approximately $2 million for the third quarter
of 1997 when compared to the third quarter of 1996. The primary reasons for this
decline are a decrease in annuity business and group reinsurance business offset
in part by increases in Viaterm and Disability and Accident premium.
Pretax operating income for the life insurance subsidiaries, excluding
net realized investment gains/losses, was $112 million and $39 million for the
nine and three months ended September 30, 1997, compared to $121 million and $35
million for the same periods in 1996.
CNA's life insurance subsidiaries' net operating income, excluding net
realized investment gains/losses was $71 million and $24 million for the nine
and three months ended September 30, 1997 compared to $78 million and $23
million for the same periods in 1996. Net realized investment gains for the nine
and three months ended September 30, 1997 were $73 million and $29 million,
compared to $79 million and $22 million for the same periods of 1996.
INVESTMENTS:
|--------------------------------------------------------------------------|----------------------------------|
|SUMMARY OF GENERAL ACCOUNT INVESTMENTS AT MARKET VALUE | NINE MONTHS ENDED |
| | SEPTEMBER 30, 1997 |
| |-----------------|----------------|
| | CHANGE IN | |
| SEPTEMBER 30 DECEMBER 31| NET UNREALIZED | REALIZED |
|(In millions of dollars) 1997 1996 | GAINS(LOSSES) | GAINS(LOSSES) |
|--------------------------------------------------------------------------|-----------------|----------------|
| | | |
|FIXED MATURITY SECURITIES: | | |
|U. S. Treasury securities and | | |
| obligations of government agencies $ 12,046 $ 9,835 | $ 59 | $ 103 |
|Asset-backed securities 4,763 6,292 | 69 | 26 |
|Tax exempt securities 4,831 4,951 | 52 | 18 |
|Taxable securities 6,529 6,643 | 24 | 102 |
| -------- -------- | ---- | ---- |
| Total fixed maturity securities 28,169 27,721 | 204 | 249 |
|Stocks 863 859 | 1 | 57 |
|Short-term investments and other 7,848 6,830 | 40 | 120* |
|Derivative security investments 3 2 | -- | 2 |
| -------- -------- | ---- | ---- |
| TOTAL INVESTMENTS $ 36,883 $ 35,412 | 245 | 428 |
| ======== ======== | | |
|Separate accounts and discontinued operations | 35 | 47 |
|Participating policyholders' interest | -- | (8) |
|Income tax expense | (105) | (163) |
| | ----- | ----- |
| NET INVESTMENT GAINS | $ 175 | $ 304 |
| | | |
|--------------------------------------------------------------------------|-----------------|----------------|
|--------------------------------------------------------------------------|
|SHORT-TERM INVESTMENTS: |
|--------------------------------------------------------------------------|
|Security repurchase collateral $ 1,185 $ 101 |
|Escrow 1,099 1,062 |
|Commercial paper 2,446 3,207 |
|Money markets 1,528 746 |
|Other 586 738 |
|--------------------------------------------------------------------------|
| TOTAL SHORT-TERM INVESTMENTS $ 6,844 $ 5,854 |
|--------------------------------------------------------------------------|
<FN>
*Includes a realized investment gain of $89 million on the merger of CNA Surety
Corporation and Capsure Holdings Corp. (See Note F).
</FN>
CNA's general account investment portfolio is managed to maximize
after-tax investment return, while minimizing credit risks, with investments
concentrated in high quality securities to support its insurance operations.
CNA has the capacity to hold its fixed maturity portfolio to maturity.
However, securities may be sold as part of CNA's asset/liability strategies or
(19)
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
to take advantage of investment opportunities generated by changing interest
rates, prepayments, tax and credit considerations, or other similar factors.
Accordingly, the fixed maturity securities are classified as available for sale.
CNA has a securities lending program where securities are loaned to
third parties, primarily major brokerage firms. Borrowers of these securities
must deposit 100% of the fair value of the securities if the collateral is cash,
or 102% if the collateral is securities. Cash deposits from these transactions
are invested in short-term investments (primarily commercial paper). CNA
continues to receive the interest on loaned debt securities, as beneficial
owner, and accordingly, loaned debt securities are included within fixed
maturity securities. The liabilities for securities sold subject to repurchase
agreements are recorded at their contractual repurchase amounts.
On December 30, 1993, CNA deposited $987 million in an escrow account,
pursuant to the Fibreboard Global Settlement Agreement, as discussed in Note C.
The funds are included in short-term investments and are invested mainly in U.S.
Treasury securities. The escrow account at September 30, 1997 amounted to $1,100
million as compared to $1,071 million at year end 1996.
In addition to interest rate swaps used to convert CNA's debt to
acquire Continental from a variable rate to a fixed rate, CNA holds derivative
financial instruments for purposes of enhancing income and total return. The
derivative securities are marked-to-market with valuation changes reported as
realized investment gains and losses. CNA's investment in, and risk in relation
to, derivative securities are not significant.
The general account portfolio consists primarily of high quality (BBB
or higher) marketable fixed maturity securities, approximately 94% of which are
rated as investment grade at September 30, 1997. At September 30, 1997,
tax-exempt securities and short-term investments, excluding collateral for
securities sold under repurchase agreements, comprised approximately 13% and
15%, respectively, of the general account's total investment portfolio compared
to 14% and 16%, respectively, at December 31, 1996. Historically, CNA has
maintained short-term assets at a level that provided for liquidity to meet its
short-term obligations, as well as reasonable contingencies and anticipated
claim payout patterns. At September 30, 1997, the major components of the
short-term investment portfolio consist primarily of high-grade commercial paper
and U.S. Treasury bills. Collateral for securities sold under repurchase
agreements increased $1,084 million from December 31, 1996 to $1,185 million at
September 30, 1997.
As of September 30, 1997, the market value of CNA's general account
investments in fixed maturities was $28.2 billion and was greater than amortized
cost by approximately $385 million. This compares to a market value of $27.7
billion and $181 million of net unrealized investment gains at December 31,
1996. The gross unrealized investment gains and losses for the fixed maturity
securities portfolio at September 30, 1997, were $508 million and $123 million,
respectively, compared to $444 million and $263 million, respectively, at
December 31, 1996. The increase in unrealized investment gains is attributable,
in large part, to decreases in interest rates which have a positive effect on
bond values.
Net unrealized investment gains on general account fixed maturities at
September 30, 1997 include net unrealized losses on high yield securities of $25
million, compared to net unrealized gains of $41 million at December 31, 1996.
High yield securities are bonds rated as below investment grade by bond rating
agencies, plus private placements and other unrated securities which, in the
opinion of management, are below investment grade. Fair values of high yield
securities in the general account were $1.79 billion at September 30, 1997 as
compared to $2.02 billion at December 31, 1996.
(20)
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
At September 30, 1997, total Separate Account cash and investments
amounted to $5.9 billion with taxable fixed maturity securities representing
approximately 83% of the separate accounts' portfolio. Approximately 75% of
separate account investments are used to fund guaranteed investments for which
Continental Assurance Company guarantees principal and a specified return to the
contractholders. The duration of fixed maturity securities included in the
guaranteed investment portfolio are matched approximately with the corresponding
payout pattern of the guaranteed investment contracts. The fair value of all
fixed maturity securities in the guaranteed investment portfolio was $4.0
billion at September 30, 1997 compared to $3.8 billion at December 31, 1996. At
September 30, 1997, fair value was greater than the amortized cost by
approximately $43 million. This compares to an unrealized loss of $1 million at
December 31, 1996. The gross unrealized investment gains and losses for the
guaranteed investment fixed maturity securities portfolio at September 30, 1997
were $66 million and $23 million, respectively. The gross unrealized investment
gains and losses for the guaranteed investment fixed maturity securities
portfolio at December 31, 1996 were $55 million and $56 million, respectively.
Carrying values of high yield securities in the guaranteed investment
portfolio were $543 million and approximated market value at September 30, 1997
as compared to a carrying value of $472 million at December 31, 1996. Net
unrealized investment losses on such high yield securities were $6 million at
December 31, 1996.
High yield securities (below BBB) generally involve a greater degree of
risk than that of investment grade securities. Expected returns should, however,
compensate for the added risk. The risk is also considered in the interest rate
assumptions in the underlying insurance products. As of September 30, 1997,
CNA's investment in high yield bonds, including Separate Accounts, was
approximately 4% of total assets. In addition, CNA's investment in mortgage
loans and investment real estate are substantially below the industry average,
representing less than one quarter of one percent of its total assets.
Included in CNA's fixed maturity securities at September 30, 1997,
(general and guaranteed investment portfolios) are $7.3 billion of asset-backed
securities, consisting of approximately 54% in collateralized mortgage
obligations ("CMOs"), 9% in corporate asset-backed obligations, and 37% in U.S.
Government issued pass-through certificates. The majority of CMOs held are U.S.
Government agency issues, which are actively traded in liquid markets and are
priced monthly by broker-dealers. At September 30, 1997, the fair value of
asset-backed securities was more than amortized cost by approximately $91
million compared to net unrealized investment losses of $5 million at December
31, 1996. CNA limits the risks associated with interest rate fluctuations and
prepayment by concentrating its CMO investments in early planned amortization
classes with relatively short principal repayment windows.
Over the last few years, much concern has been raised regarding the
quality of insurance company invested assets. At September 30, 1997, 47% of the
general account's fixed maturity securities portfolio was invested in U.S.
Government securities, 30% in other AAA rated securities and 12% in AA and A
rated securities. CNA's guaranteed investment portfolio includes fixed maturity
securities which are comprised of 2% U.S. Government securities, 61% in other
AAA rated securities and 13% in AA and A rated securities. These ratings are
primarily from Standard & Poor's.
CNA, its subsidiaries and Separate Accounts, invest from time to time
in certain derivative financial instruments to increase investment returns and
to reduce the impact of changes in interest rates on certain corporate
borrowings. Financial instruments used for such purposes include interest rate
swaps, put and call options, commitments to purchase securities, futures and
forwards.
(21)
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
The fair values associated with these instruments are generally
affected by changes in interest rates and the stock market. The credit exposure
associated with these instruments is generally limited to the unrealized fair
value of the instruments and will vary based on changes in market prices. The
risk of default depends on the creditworthiness of the counterparty to the
instrument.
The fair value of derivatives generally reflects the estimated amounts
that CNA would receive or pay upon termination of the contracts at the reporting
date. Dealer quotes are available for substantially all of CNA's derivatives.
For securities not actively traded, fair values are estimated using values
obtained from independent pricing services, costs to settle or quoted market
prices of comparable instruments.
Unrealized investment gains and losses on derivative securities, except
for the interest rate swaps associated with corporate borrowings, are reflected
as part of realized investment gains and losses. Unrealized gains or losses
related to changes in the value of the interest rate swaps associated with
corporate borrowings are not recognized.
One Separate Account product is an indexed group annuity contract for
institutional investors which guarantees the S&P 500 rate of return plus 25
basis points. Deposits are taken for a 3 year period with no payout until the
end of the period. CNA hedges the contract liability by purchasing S&P 500
futures contracts in a notional amount equal to the original deposit and
investing the remaining cash in a variety of short term strategies. The futures
contracts are rolled quarterly, and the number of contracts is adjusted
periodically to approximate the future liability to the customer. As of
September 30, 1997, CNA held 1,303 S&P 500 futures contracts with a notional
value of $622 million. This position hedged a liability to depositors in a
nearly equal amount.
FINANCIAL CONDITION:
|------------------------------------------------------------------------------|
|FINANCIAL POSITION SEPTEMBER 30 DECEMBER 31|
|(In millions of dollars, except per share data) 1997 1996 |
|------------------------------------------------------------------------------|
|Assets $ 62,489 $ 60,300 |
|Stockholders' equity 7,917 7,060 |
|Unrealized net appreciation included in |
| stockholders' equity 474 299 |
|Book value per common share 125.69 111.81 |
|------------------------------------------------------------------------------|
CNA's assets increased approximately $2.2 billion from December 31, 1996 to
$62.5 billion at September 30, 1997. This change was primarily the result of an
increase in securities sold under repurchase agreements of approximately $1.1
billion and increases of approximately $450 million in both receivables for
securities sold and fixed maturities investments.
During the first nine months of 1997, CNA's stockholders' equity
increased by $857 million, or 12.1%, to $7.9 billion. The major components of
this change were net operating income of $383 million, net realized investment
gains of $304 million and an increase of $175 million in net unrealized
investment gains.
When compared to December 31, 1996, the statutory surplus of the
property/casualty subsidiaries increased $435 million to $6.8 billion. The
statutory surplus of the life insurance subsidiaries remained at approximately
$1.2 billion, when compared to year end 1996.
(22)
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
LIQUIDITY AND CAPITAL RESOURCES:
The liquidity requirements of CNA have been met primarily by funds
generated from operations. The principal operating cash flow sources of CNA's
property/casualty and life insurance subsidiaries are premiums and investment
income and sales and maturities of investments. The primary operating cash flow
uses are payments for claims, policy benefits and operating expenses.
CNA's operating activities generated net negative cash flows of
approximately $359 million and $65 million for the nine months ended September
30, 1997, and 1996, respectively. Negative cash flows in 1997 are primarily the
result of substantial claim payments resulting from the settlement of the
Fibreboard litigation. CNA believes that future liquidity needs will be met
primarily by cash generated from operations.
Net cash flows from operations are invested in marketable securities.
Investment strategies employed by CNA's insurance subsidiaries consider the cash
flow requirements of the insurance products sold and the tax attributes of the
various types of marketable investments.
CNA and the insurance industry are exposed to liability for
environmental pollution, primarily related to toxic waste site clean-up. Refer
to Note C to the Condensed Consolidated Financial Statements for further
discussion of environmental pollution exposures.
The chart below lists the current insurance ratings for CNA's
Continental Casualty Company Intercompany Pool, The Continental Insurance
Company Intercompany Pool and Continental Assurance Company (CAC) Intercompany
Pool. Also shown are the ratings on the senior debt of both CNA Financial
Corporation (CNA) and The Continental Corporation (Continental) and CNA's
commercial paper and preferred stock.
|------------------|-------------------------------------||--------------------------------------------------|
| | INSURANCE RATINGS || DEBT AND STOCK RATINGS |
| |-------------------------------------||-------------------------------------|------------|
| | FINANCIAL STRENGTH || | |
| |----------|-------------|------------|| | |
| | | | || CNA | Continental|
| | | | ||-------------------------------------|------------|
| | | | ||Senior Debt Commercial Preferred | Senior Debt|
| | CCC | CAC | CIC || Paper Stock | |
| |----------|-------------|------------|| | |
| | | | ||------------|-------------|----------|------------|
| | | | || | | | |
|A.M. Best | A | A | A- || - | - | - | - |
| | | | || | | | |
| | | | || | | | |
|Moody's | A1 | A1* | A2 || A3 | P2 | a3 | Baa1 |
| | | | || | | | |
| |----------|-------------|------------|| | | | |
| | CLAIMS PAYING ABILITY || | | | |
| |----------|-------------|------------|| | | | |
| | | | || | | | |
|Standard & Poor's | A+ | AA- | A- || A- | A2 | A- | BBB- |
| | | | || | | | |
| | | | || | | | |
|Duff & Phelps | AA- | AA | - || A- | - | A- | - |
|------------------|----------|-------------|------------||------------|-------------|----------|------------|
<FN>
*Applies to Continental Assurance Company only.
</FN>
(23)
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
ACCOUNTING STANDARDS:
In June 1996, the Financial Accounting Standards Board (FASB) issued
Statements on Financial Accounting Standards (SFAS) 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities."
This Statement provides standards for distinguishing transfers of financial
assets that are sales from transfers that are secured borrowings. This Statement
has been amended and is now effective for transfers and servicing of financial
assets and extinguishment of liabilities occurring after December 31, 1996 or
1997, depending on the type of transaction. This Statement will not have a
significant impact on CNA.
In January 1997, the Securities and Exchange Commission approved
amendments to Regulation S-X, Regulation S-K, Regulation S-B, and various forms
to clarify and expand existing disclosure requirements with respect to
derivative financial instruments and derivative commodity instruments. The new
rules require enhanced descriptions in the footnotes to the financial statements
of accounting policies for derivative financial instruments and derivative
commodity instruments. They also require disclosure outside the financial
statements of qualitative and quantitative information about market risk related
to derivative financial instruments, other financial instruments and derivative
commodity instruments. These amendments are effective for the year end 1997
financial statements and will not have a significant impact on CNA.
In February 1997, the FASB issued SFAS 128, "Earnings per Share." This
Statement establishes standards for computing and presenting earnings per share
(EPS), which simplifies the computations originally established in APB Opinion
No. 15, "Earnings per Share" and makes them comparable to international EPS
standards. It replaces the presentation of primary EPS with basic EPS, which
excludes dilution. It also requires dual presentation of basic and diluted EPS
on the face of the income statement for all entities with complex capital
structures and requires a reconciliation between the two computations. This
Statement is effective for financial statements issued for periods ending after
December 15, 1997. This Statement will not have a significant impact on CNA.
In February 1997, the FASB issued SFAS 129, "Disclosure of Information
about Capital Structure," which establishes standards for disclosing information
about an entity's capital structure. The Statement consolidates existing
disclosure requirements for ease of retrieval and greater visibility to
nonpublic entities. The new Statement contains no change in disclosure
requirements for companies previously subject to the requirements of APB Opinion
No. 10, "Omnibus Opinion--1966," APB Opinion No. 15, "Earnings per Share," and
FASB Statement 47, "Disclosure of Long-Term Obligations." It applies to all
entities and is effective for financial statements issued for periods ending
after December 15, 1997. This Statement has no impact on CNA.
In June 1997, the FASB issued SFAS 130, "Reporting Comprehensive
Income," which establishes accounting standards for reporting and display of
comprehensive income and its components (revenues, expenses, gains, and losses)
in a full set of general-purpose financial statements. This Statement requires
that an enterprise (a) classify items of other comprehensive income by their
nature in a financial statement and (b) display the accumulated balance of other
comprehensive income separately from retained earnings and additional paid-in
capital in the equity section of a statement of financial position. This
Statement is effective for fiscal years beginning after December 15, 1997. This
Statement is not expected to result in a significant change in CNA's
disclosures.
(24)
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONCLUDED
In June 1997, the FASB issued SFAS 131, "Disclosures about Segments of
an Enterprise and Related Information," which establishes standards for the way
that public business enterprises report information about operating segments in
interim and annual financial statements. It requires that those enterprises
report a measure of segment profit or loss, certain specific revenue and expense
items, and segment assets, and that the enterprises reconcile the total of those
amounts to the general-purpose financial statements. It also establishes
standards for related disclosures about products and services, geographic areas
and major customers. This Statement is effective for financial statements for
periods beginning after December 15, 1997. This Statement will redefine CNA's
business segment disclosure.
(25)
CNA FINANCIAL CORPORATION
PART II OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
Exhibit Page
Description of Exhibit Number Number
-------- ------
Computation of Net Income per Common Share 11 28
Computation of Ratio of Earnings to Fixed Charges 12.1 29
Computation of Ratio of Net Income
As Adjusted, to Fixed Charges 12.2 29
Financial Data Schedule 27 30
(b) REPORTS ON FORM 8-K:
On July 30, 1997, CNA Financial Corporation issued a press release
announcing that W. James MacGinnitie has been named chief financial officer and
senior vice president of CNA.
On July 24, 1997, CNA Financial Corporation issued a press release
announcing senior management changes in Commercial Operations.
(26)
CNA FINANCIAL CORPORATION
PART II OTHER INFORMATION - CONCLUDED
SIGNATURES
Pursuant to the requirements 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
Date: November 14, 1997 By: S\W. JAMES MACGINNITIE
----------------- ---------------------
W. James MacGinnitie
Senior Vice President and
Chief Financial Officer
(27)
EXHIBIT 11
CNA FINANCIAL CORPORATION
COMPUTATION OF NET INCOME PER COMMON SHARE
- --------------------------------------------------------------------------------
Period Ended September 30 Third Quarter Nine Months
(In millions, except per share data) 1997 1996 1997 1996
- --------------------------------------------------------------------------------
Earnings per share:
Net income ........................... $ 274 $ 239 687 $ 770
Less preferred stock dividends........ 2 2 5 5
------ ----- ------ ------
Net income available to
common stockholders................. $ 272 $ 237 $ 682 $ 765
====== ====== ====== ======
Weighted average shares outstanding... 61.8 61.8 61.8 61.8
====== ====== ====== ======
Net income per common share........... $ 4.41 $ 3.83 $11.04 $ 12.38
====== ====== ====== ======
================================================================================
(28)
EXHIBIT 12.1
CNA FINANCIAL CORPORATION
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
- --------------------------------------------------------------------------------
PERIOD ENDED SEPTEMBER 30 1997 1996
(In millions of dollars, except ratios)
- --------------------------------------------------------------------------------
Income before income tax and
cumulative effect of accounting changes.................... $ 963 $ 1,072
Adjustments:
Interest expense........................................... 153 155
Interest element of operating lease rental................. 25 26
----- --------
Income before income tax and cumulative effect of
accounting changes, as adjusted..........................$ 1,141 $ 1,253
====== ======
Fixed charges:
Interest expense...........................................$ 153 $ 155
Interest element of operating lease rental................. 25 26
------- -------
Fixed charges.................................................$ 178 $ 181
====== ======
Ratio of earnings to fixed charges (1)........................ 6.4 6.9
- --------------------------------------------------------------------------------
(1) For purposes of computing this ratio, earnings consist of income before
income taxes and cumulative effect of accounting changes plus fixed charges
of consolidated companies. Fixed charges consist of interest and that
portion of operating lease rental expense which is deemed to be an interest
factor for such rentals.
EXHIBIT 12.2
CNA FINANCIAL CORPORATION
COMPUTATION OF RATIO OF NET INCOME,
AS ADJUSTED, TO FIXED CHARGES
- --------------------------------------------------------------------------------
PERIOD ENDED SEPTEMBER 30 1997 1996
(In millions of dollars, except ratios)
- --------------------------------------------------------------------------------
Net income.................................................... $ 687 $ 770
Adjustments:
Interest expense, after tax................................ 100 101
Interest element of operating lease rental, after tax...... 16 17
-------- ------
Net income, as adjusted....................................... $ 803 $ 888
==== =====
Fixed charges:
Interest expense, after tax................................$ 100 $ 101
Interest element of operating lease rental, after tax...... 16 17
------- ------
Fixed charges.................................................$ 116 $ 118
====== ====
Ratio of net income, as adjusted, to fixed charges (1)........ 6.9 7.5
- --------------------------------------------------------------------------------
(1) For purposes of computing this ratio, net income has been adjusted to
include fixed charges of consolidated companies, after tax. Fixed charges
consist of interest and that portion of operating lease rental expense
which is deemed to be an interest factor for such rentals.
(29)