CNA FINANCIAL CORPORATION
1998 ANNUAL REPORT
CNA
PROFILE
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CNA Financial Corporation
is a holding company whose primary subsidiaries consist of
property/casualty and life insurance companies. Collectively these
subsidiaries are CNA. CNA is one of the largest writers of
commercial property/casualty insurance and one of the
ten largest insurance organizations in the United States.
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CNA serves businesses and individuals with a broad range of insurance and other
risk management products and services. Insurance products include property and
casualty coverages; life, accident and health insurance; and pension products
and annuities. CNA services include risk management, information services,
health care management and claims administration. CNA products and services are
marketed through agents, brokers, general agents and direct sales.
CNA Financial Corporation, with 1998 revenues of $17.1 billion, assets of $62.4
billion and stockholders' equity of $9.2 billion, is the holding company of
Continental Casualty Company, incorporated in 1897, Continental Assurance
Company, incorporated in 1911, and The Continental Corporation, which is the
holding company of The Continental Insurance Company, incorporated in 1853.
CNA Financial Corporation stock is traded primarily on the New York Stock
Exchange and, as of December 31, 1998, was approximately 85 percent owned by
Loews Corporation.
CNA FINANCIAL CORPORATION
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CNA
TABLE OF CONTENTS
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1998
2
FINANCIAL HIGHLIGHTS
4
LETTER FROM CNA FINANCIAL CORPORATION
CHAIRMAN EDWARD J. NOHA
6
LETTER FROM CNA CHAIRMAN
AND CEO BERNARD L. HENGESBAUGH
9
FINANCIAL SECTION CONTENTS
11
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
58
CONSOLIDATED FINANCIAL STATEMENTS
117
INDEPENDENT AUDITORS' REPORT
118
COMMON STOCK INFORMATION
119
CORPORATE DIRECTORY
CNA FINANCIAL CORPORATION
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FINANCIAL HIGHLIGHTS
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Results of Operations and Financial Condition
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As of and for the Year Ended December 31 1998 1997 1996 1995* 1994
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(In millions of dollars, except per share data and ratios)
RESULTS OF OPERATIONS
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Revenues $17,074 $17,072 $16,988 $14,700 $11,000
====================================================================================================
Net operating (loss) income (152) 488 578 463 187
Net realized investment gains (losses) 434 478 387 294 (151)
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NET INCOME $ 282 $ 966 $ 965 $ 757 $ 36
=================================================================================================================
EARNINGS PER SHARE
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Net operating (loss) income $ (0.86) $ 2.59 $ 3.08 $ 2.46 $ 0.98
Net realized investment gains (losses) 2.35 2.58 2.09 1.59 (0.81)
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NET INCOME $ 1.49 $ 5.17 $ 5.17 $ 4.05 $ 0.17
==================================================================================================================
FINANCIAL CONDITION
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Invested assets $37,177 $36,203 $35,412 $35,886 $29,943
Total assets 62,359 61,675 60,455 60,360 44,320
Reserves 40,438 39,829 39,981 40,803 28,938
Debt 3,160 2,897 2,765 3,026 914
Stockholders' equity 9,157 8,309 7,060 6,736 4,546
Book value per common share 47.89 44.01 37.27 35.52 23.71
Return on average stockholders' equity 3.2% 12.6% 14.0% 13.4% 0.7%
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STATUTORY SURPLUS
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Property/casualty companies** $ 7,593 $ 7,123 $ 6,349 $ 5,696 $ 3,367
Life companies 1,109 1,224 1,163 1,128 1,056
==================================================================================================================
* RESULTS OF OPERATIONS DATA INCLUDES THE CONTINENTAL CORPORATION SINCE ITS
ACQUISITION ON MAY 10, 1995.
** SURPLUS INCLUDES EQUITY OF PROPERTY/CASUALTY COMPANIES OWNERSHIP IN LIFE
INSURANCE SUBSIDIARIES.
CNA FINANCIAL CORPORATION
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2
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Financial Position
This page of CNA Financial Corporation's annual report has four bar graphs which
illustrate the trend in revenues, assets, stockholders' equity and book value
per common share from 1988 through 1998.
CNA FINANCIAL CORPORATION (1988-1998)
($ in billions except per share data)
|-----------------------|----------|---------|---------------|---------------|
|Measurement Period | | | Stockholders'| Book Value Per|
| (Fiscal Year Covered | Revenues | Assets | Equity | Common Share* |
|-----------------------|----------|---------|---------------|---------------|
|FYE 12/31/88...........| 8.3 | 25.9 | 3.6 | 18.29 |
|FYE 12/31/89...........| 9.1 | 30.9 | 4.2 | 21.58 |
|FYE 12/31/90...........| 9.9 | 34.7 | 4.5 | 23.41 |
|FYE 12/31/91...........| 11.1 | 39.2 | 5.1 | 26.75 |
|FYE 12/31/92...........| 10.8 | 39.7 | 4.8 | 25.02 |
|FYE 12/31/93...........| 11.0 | 41.9 | 5.4 | 28.22 |
|FYE 12/31/94...........| 11.0 | 44.3 | 4.5 | 23.71 |
|FYE 12/31/95...........| 14.7 | 60.4 | 6.7 | 35.52 |
|FYE 12/31/96...........| 17.0 | 60.5 | 7.1 | 37.27 |
|FYE 12/31/97...........| 17.1 | 61.7 | 8.3 | 44.01 |
|FYE 12/31/98...........| 17.1 | 62.4 | 9.2 | 47.89 |
|-----------------------|----------|---------|---------------|---------------|
*Previous years have been restated for 3 for 1 stock split that occured on 5/98.
CNA FINANCIAL CORPORATION
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3
A LETTER TO OUR SHAREHOLDERS
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1998
FROM CNA FINANCIAL CORPORATION
CHAIRMAN EDWARD J. NOAH
CNA Financial Corporation reported lower earnings in 1998. Net income for the
year was $282 million, or $1.49 per share, compared with net income of $966
million, or $5.17 per share, in 1997. Excluding after-tax restructuring and
other related charges of $169 million in 1998, net income was $451 million, or
$2.40 per share.
Net realized investment gains for 1998 were $434 million, or $2.35 per share,
compared with net realized gains of $478 million, or $2.58 per share, for 1997.
Consolidated revenues were approximately $17.1 billion in both 1998 and 1997.
Net operating income for 1998, excluding after-tax restructuring and other
related charges, was $17 million, or $0.05 per share, compared with $488
million, or $2.59 per share, for 1997.
Key factors that affected net income included intensely competitive marketplace
conditions, a change in estimate of prior year reserves of $270 million,
restructuring and related costs of $169 million after tax, increased catastrophe
costs of $140 million, and decreased investment income of $40 million. All these
factors underscore the importance of CNA's conservative financial strategies and
solid financial base.
At year-end 1998, CNA's total assets amounted to $62.4 billion. Stockholders'
equity was $9.2 billion, up 10% from the previous year. Book value per share
increased 9% to $47.89. In our investment portfolio, 93 percent of our fixed
maturity holdings were in investment-grade bonds. In addition, we began a
capital enhancement plan to place additional capital in one of the
property/casualty pools. During the fourth quarter, we began these efforts with
a $200 million public debt offering and $200 million of preferred stock
purchased by Loews, our majority shareholder.
Also of note, CNA implemented an officer stock ownership plan during the fourth
quarter. The senior officers purchasing the stock do so voluntarily and are
fully at risk for their holdings. Strong participation in the plan further
demonstrates management's confidence in the direction of CNA and its prospects
for the long term.
Along with its solid financial foundation, CNA continued to build on a strong
leadership team. In a succession plan announced in 1998 and completed earlier
this year, Bernard L. Hengesbaugh, former executive vice president and chief
operating officer, succeeded Dennis H. Chookaszian as chairman and chief
executive officer. Mr. Hengesbaugh has already demonstrated his leadership,
industry knowledge and
CNA FINANCIAL CORPORATION
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4
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1998
organizational capabilities as chief operating officer and in his previous
position as head of our successful Specialty Operations. We look forward to
working with him in his new role.
Mr. Chookaszian was elected chairman of the Executive Committee of the Board of
CNA Financial Corporation. Preston R. Tisch, who had served as chairman of the
Executive Committee for the past 25 years, will continue to serve as a committee
member. We appreciate Mr. Chookaszian's contributions during 23 years of service
to CNA, and we will benefit greatly from his continued counsel.
Looking to the future, we see an insurance environment being transformed by
consolidation, convergence of financial services, globalization and intense
competition. In this tumultuous arena, we are fully focused on improved earnings
and continued growth of shareholder value.
With its solid financial position and strong leadership, CNA is well positioned
to continue its record of integrity, growth of long-term value, and commitment
to customers, employees and business partners.
On behalf of the board of directors, I thank you for your commitment and ongoing
support.
Sincerely,
S/EDWARD J. NOHA
Edward J. Noha
Chairman of the Board
CNA Financial Corporation
CNA FINANCIAL CORPORATION
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5
A LETTER TO OUR SHAREHOLDERS
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1998
FROM CNA CHAIRMAN AND CHIEF EXECUTIVE OFFICER BERNARD L. HENGESBAUGH
The financial results you see in this report underscore two indisputable facts.
First, the conditions in the insurance marketplace have never been more
competitive. And second, our operating performance is unacceptable to CNA
management and our board.
CNA began implementing strategies this year to improve operating performance and
we will continue to concentrate our full management attention on improving the
Company's bottom line. These strategies include expense reduction and
restructuring, exiting non-core businesses, and working with key distribution
partners to achieve adequate rates in middle-market property/casualty business.
Together, these efforts are designed to build on CNA's strong franchise value by
focusing on core businesses and becoming a provider of choice in our selected
markets.
Early last year, we began a companywide drive to achieve best-in-class expense
levels. We stepped up our efforts at mid-year with the launch of an 18-month
restructuring plan, under which each of the business and support areas
accelerated their efforts to provide higher quality services on a more efficient
operating platform.
The restructuring activities resulted in charges of $246 million pre-tax during
the last half of the year, with an additional $100 million to $150 million
pre-tax in restructuring-related costs anticipated during 1999. When fully
implemented, the plan is expected to produce pre-tax annual savings in excess of
$300 million.
CNA continued a process of focusing all its resources on businesses with the
ability to sustain profitable, long-term growth. We no longer believe that
certain businesses have long-term profit potential for CNA. For this reason, we
exited the agriculture and certain employer health insurance businesses in 1998.
Early this year, we exited the entertainment insurance market.
Our third major strategy for improved operating performance relates to our book
of middle-market property/casualty insurance. In recent years, competitive
pressure has driven pricing in workers' compensation and other key lines to
unreasonable levels. During the last half of 1998, CNA reviewed its pricing and
underwriting standards. Now, in partnership with key agents and brokers, CNA is
working aggressively to improve price adequacy. We are addressing the issue on a
case by case basis, and are fully prepared to walk away from business if the
market continues to underprice.
While the strategies for improved operating performance are critical, they do
not tell the whole story of CNA's 1998 results. Several lines of business
continued to perform well, including surety, directors & officers liability,
nonmedical professional liability, warranty, individual life, long-term care and
others. CNA UniSource, our start-up Professional Employer Organization, ranks
among
CNA FINANCIAL CORPORATION
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6
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1998
the nation's fastest growing PEOs. In addition, we achieved our goal of
reaching Year 2000 computer readiness of all internal application systems by
December 1, 1998. While some work continues in 1999, the technology platform is
well prepared to support CNA operations as we move into the next century.
Looking to the rest of 1999, we anticipate another year of difficult market
conditions. Our efforts to improve operating performance will continue to focus
squarely on the fundamentals of our business.
In our businesses that are performing well, we will continue to improve earnings
through underwriting discipline, efficient operations and strong distribution
relationships.
We will complete our expense reduction and restructuring efforts, and we will
carry this approach forward by emphasizing continuous improvement.
We will continue our middle-market strategy at full speed. Although much of the
work will be done this year, we expect that the positive impact on our operating
results will not be fully realized until the year 2000. Many accounts do not
come up for renewal until later in 1999, and with some accounts, it will take
several renewal cycles of disciplined underwriting to achieve the right price
levels.
Finally, we will continue to challenge all our businesses on the basis of their
ability to sustain profitable, long-term growth. In that regard, we have
introduced a new approach to reporting CNA results. In this report, we are
providing financial data and discussion of each of our major business segments.
You will see this approach in the Management's Discussion and Analysis section.
We believe that segment reporting will provide a clearer picture of the way we
manage our businesses, as well as the progress that we are making in each
segment.
In summary, CNA is focused on improving profitability in the near term, while
continuing to manage for long-term value. In a difficult insurance environment,
we believe CNA is on the right track. We have the people, the strategies, the
business relationships and the financial strength to emerge as the most improved
player over the next few years.
Thank you for your continuing confidence in CNA, and I look forward to sharing
our progress with you in next year's report.
Sincerely,
S/BERNARD L. HENGESBAUGH
Bernard L. Hengesbaugh
Chairman and Chief Executive Officer
CNA
CNA FINANCIAL CORPORATION
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7
CNA
FINANCIAL SECTION CONTENTS
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1998
11
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
58
CONSOLIDATED BALANCE SHEETS
60
CONSOLIDATED STATEMENTS OF OPERATIONS
61
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
62
CONSOLIDATED STATEMENTS OF CASH FLOWS
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
117
INDEPENDENT AUDITORS' REPORT
118
COMMON STOCK INFORMATION
119
CORPORATE DIRECTORY
CNA FINANCIAL CORPORATION
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9
CNA
MANAGEMENT'S DISCUSSION AND ANALYSIS
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Consolidated Operations
INTRODUCTION
The following discussion highlights significant factors influencing the results
of operations and financial condition of CNA Financial Corporation (CNAF). CNAF
together with its subsidiaries is referred to as CNA or the Company. This
discussion should be read in conjunction with the consolidated financial
statements and the related notes, appearing on pages 58 through 116, and the
five-year summary of selected financial highlights appearing on page 2.
The discussion also includes an overview of each of the Company's seven
operating segments, the products offered, the customers served, the distribution
channels used and an analysis of operating results. Since distinct investment
portfolios are not maintained for each insurance segment, the discussion of
investment results, including investment income and realized investment gains,
is on a consolidated basis and begins on page 40. The 1998 provisions for
restructuring and other related charges are discussed along with consolidated
operations.
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CONSOLIDATED OPERATIONS
BUSINESS OVERVIEW
CNA is one of the largest insurance organizations in the United States and,
based on 1997 net written premium, is the third largest property/casualty
company and the thirty-second largest life insurance company.
CNA's overall goal is to create long-term enterprise value by pursuing a
strategy of profitable growth in the market segments in which it operates.
CNA conducts its operations through seven operating segments that are briefly
described below:
AGENCY MARKET OPERATIONS - provides small to mid-size businesses as well as
individuals a wide range of property/casualty products distributed through one
of the broadest independent agency networks in the U.S.
SPECIALTY OPERATIONS - provides a broad array of professional, financial and
specialty property/casualty products and services distributed through brokers,
managing general agencies and independent agencies.
CNA RE - serves as a property/casualty reinsurer, offering primarily traditional
treaty reinsurance, with developing positions in facultative and financial
reinsurance.
GLOBAL OPERATIONS - provides marine, property/casualty, surety, warranty and
specialty products to both domestic and international customers.
RISK MANAGEMENT - serves the property/casualty needs of large domestic
commercial businesses, offering customized, solution based strategies to address
risk management.
CNA FINANCIAL CORPORATION
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11
MANAGEMENT'S DISCUSSION AND ANALYSIS
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Consolidated Operations (cont.)
GROUP OPERATIONS - provides a broad array of group life and health insurance
products and services to employers, affinity groups and other entities that buy
as a group. Group operations also provides reinsurance for group and individual
life and health insurers.
LIFE OPERATIONS - provides financial protection to individuals through a full
product line of insurance, including term life, universal life and long term
care as well as annuities and viatical settlements. Life Operations also
provides retirement products and administration services to pension plans and
other institutional buyers.
These operating segments reflect the way in which CNA distributes its products
to the marketplace and the way in which it manages operations and makes business
decisions. A more detailed description of each segment is included later in this
discussion.
Corporate results consist of interest expense on corporate borrowings, certain
run-off insurance operations, asbestos claims related to Fibreboard Corporation,
financial guarantee insurance contracts, and certain non-insurance operations,
principally the operations of Agency Management Systems, Inc. (AMS), an
information technology and agency software development subsidiary.
CNA FINANCIAL CORPORATION
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12
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Consolidated Operations (cont.)
OPERATING RESULTS:
The following chart summarizes the consolidated operating results for each of
the last three years.
CONSOLIDATED OPERATIONS
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Year Ended December 31 1998 1997 1996
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(In millions of dollars)
OPERATING REVENUES
(EXCLUDING REALIZED INVESTMENT
GAINS/LOSSES):
Premiums $13,375 $13,482 $13,525
Net investment income 2,146 2,209 2,276
Other 858 628 568
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Total operating revenues (excluding realized
investment gains/losses) 16,379 16,319 16,369
Restructuring and other related charges 246 - -
Benefits and other expenses 16,465 15,689 15,619
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Operating (loss) income before income tax (332) 630 750
Income tax benefit (expense) 200 (132) (163)
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Net operating (loss) income (excluding realized
investment gains/losses) (132) 498 587
Realized investment gains, net of tax 434 478 387
Minority interest (20) (10) (9)
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NET INCOME $ 282 $ 966 $ 965
=============================================================================
REVENUES
Total operating revenues, which consist of premium, net investment income, and
other revenues, were $16.4 billion, $16.3 billion and $16.4 billion for the
years ended December 31, 1998, 1997 and 1996, respectively.
Premiums and other operating revenues, exclusive of net investment income and
net realized investment gains, are discussed and analyzed in the context of the
discussions of each of the business segments that follow. Benefits and other
operating expenses are also discussed at the segment level.
Premiums for 1998 declined by $107 million when compared with 1997. This
decrease is primarily due to intense price competition facing the commercial
lines insurance market.
Premiums for 1997 declined by $43 million when compared with 1996. This decrease
is primarily due to reductions in premiums from involuntary markets and
competitive conditions in the commercial lines insurance market.
NET INVESTMENT INCOME
Net investment income was $2.1 billion, $2.2 billion and $2.3 billion for 1998,
1997 and 1996, respectively. Net investment income for 1998 decreased by $63
million when compared with 1997. This decrease is primarily attributable to a
lower average level of assets invested in interest-bearing securities in 1998 as
compared with 1997. See discussion on investments on page 40.
CNA FINANCIAL CORPORATION
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13
MANAGEMENT'S DISCUSSION AND ANALYSIS
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Consolidated Operations (cont.)
Net investment income for 1997 decreased by $67 million when compared with 1996.
This decrease is primarily due to lower interest rates in 1997 as compared with
1996.
REALIZED INVESTMENT GAINS/LOSSES
The Company's investment portfolio is managed to maximize after-tax investment
return while minimizing credit risk with investments concentrated in high
quality securities to support its insurance underwriting results. As a result of
this investment philosophy, the Company may sell, and has sold, securities from
time to time to take advantage of market conditions. Investment gains realized
from these sales can be a significant component of the overall investment
portfolio performance and the Company's net income. In 1998, realized investment
gains, net of tax, amounted to $434 million in 1998 as compared with $478
million and $387 million in 1997 and 1996, respectively. See discussion of
investments on page 40.
RESTRUCTURING AND OTHER RELATED CHARGES
BACKGROUND
During 1998, the Company initiated a comprehensive review of several of its
business operations and corporate functions to identify opportunities to
restructure those operations and/or eliminate processes and employee positions.
The objectives of these reviews were to develop detailed plans to increase
operating efficiencies by better use of technology and streamlining of
decision-making, and to exit businesses that were not contributing to the
achievement of corporate financial objectives, the net results of which are
expected to be a better focus on the customer and the realization of cost
savings.
COMPANY PLAN
The Company finalized and approved a restructuring plan (the "Plan") in August
1998. In connection with the Plan, the Company incurred various expenses that
were recorded in the third and fourth quarters of 1998. These restructuring and
other related charges primarily related to the following activities: planned
reductions in the workforce; the consolidation of certain processing centers;
the exiting of certain businesses and facilities; the termination of related
lease obligations; and the writeoff of certain assets related to these
activities. The Plan contemplates a gross reduction in workforce of 4,500
employees, resulting in a planned net reduction of 2,400 employees. According to
the Plan, the various activities and workforce reductions should be completed by
the end of 1999. Once the Plan is fully executed, it is expected that there will
be cost savings of approximately $300 to $350 million on an annualized basis.
INCOME STATEMENT CHARGES
The pretax restructuring and other related charges were comprised of the
following costs and expenses: a) costs and benefits related to planned employee
terminations of $98 million, of which $53 million related to severance and
outplacement costs, $24 million related to other employee transition related
costs, principally parallel processing and $21 million related to benefit plan
curtailment losses; b) writedown of certain assets to their fair value of $74
million, of which $59 million related to a writedown of an intangible asset, and
$15 million related to adjustments for abandoned leasehold improvements and
other related fixed assets associated with leases that were terminated as part
of the restructuring plan; c) lease termination costs of $42 million; and d)
losses incurred on the exiting of certain businesses of $32 million.
CNA FINANCIAL CORPORATION
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14
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Consolidated Operations (cont.)
The Company recorded $220 million of these restructuring and other related
charges in the third quarter of 1998. Other charges such as parallel processing
costs, relocation costs, and retention bonuses, did not qualify for accrual at
the end of the third quarter under generally accepted accounting principles and
are being expensed as incurred. In the fourth quarter of 1998, $26 million of
these charges were recorded. Based on the Company's current estimates, it is
expected that the Company will record an additional $100 million to $150
million, pre-tax, of these costs over approximately the next twelve months. Such
costs are expected to be reported as uses of operating cash.
AGENCY MARKET OPERATIONS
The 1998 pre-tax restructuring and other related charges for Agency Market
Operations totaled approximately $96 million. The charges included employee
severance and outplacement costs of $34 million related to the planned net
reduction in the workforce of approximately 1,200 employees. Approximately $29
million of lease termination costs were also incurred in connection with the
consolidation of four regional offices into two zone offices and a reduction of
the number of claim processing offices from 24 to 8. The Agency Market
Operations charges also included benefit plan costs of $12 million, parallel
processing charges of $7 million, and $5 million of other fixed asset
writedowns. Other charges, including travel, relocation and other
transition-related activity, which were expensed as incurred, totaled
approximately $9 million.
Through December 31, 1998, approximately 364 Agency Market Operation employees,
the majority of whom were loss adjusters and office support staff, had been
released at a cost of $8 million.
RISK MANAGEMENT
The 1998 pre-tax restructuring and other related charges for Risk Management
totaled approximately $88 million. The charges included lease termination costs
associated with the consolidation of claim offices in 36 market territories that
totaled approximately $8 million. In addition, employee severance and
outplacement costs relating to the planned net reduction in workforce of
approximately 200 employees were approximately $10 million and the writedown of
fixed and intangible assets totaled approximately $64 million.
Parallel processing and other charges totaled approximately $6 million.
The charges related to fixed and intangible assets were primarily due to a
writedown of an intangible asset (goodwill) related to a business that had been
acquired several years earlier. As part of the Company's periodic reviews of
asset recoverability and as a result of several adverse events, the Company
concluded, based on its discounted cash flow analysis completed in the third
quarter of 1998, that a $59 million writeoff was necessary. The adverse events
contributing to this conclusion included operating losses from the business, the
loss of several significant customers whose business volume within this
operation contributed a large portion of the revenue base, and substantial
changes in the overall market demand for the services offered by this operation
which, in turn, had negative effects on the prospects for achieving the
profitability levels necessary to recover the intangible asset.
Through December 31, 1998, approximately 152 Risk Management employees had been
released at a cost of $2 million. The majority of the employees were adjusters
and office support staff.
CNA FINANCIAL CORPORATION
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15
MANAGEMENT'S DISCUSSION AND ANALYSIS
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Consolidated Operations (cont.)
GROUP OPERATIONS
The 1998 pre-tax restructuring and other related charges for Group Operations
totaled approximately $39 million. The charges included approximately $29
million of costs related to the Company's decision to exit the Employer Health
and Affinity lines of business. These costs represent the Company's estimate of
losses in connection with fulfilling the remaining obligations under contracts
related to these lines. Earned premiums for these lines of business approximated
$400 million in 1998. The 1998 charges also included employee severance and
outplacement costs of approximately $7 million related to the planned net
reduction in workforce of approximately 400 employees. Charges for lease
termination costs and fixed asset writedowns totaled $3 million.
Through December 31, 1998, approximately 56 Group Operations employees had been
released at a cost of $1 million. The majority of the employees were claims and
sales support staff.
OTHER SEGMENTS
For the other segments of the Company, pre-tax restructuring and other related
charges totaled approximately $23 million for 1998. Charges related primarily to
the closing of leased facilities ($3 million) and employee severance and
outplacement costs related to planned net reductions of 600 employees in the
current workforce and benefit costs associated with those reductions ($13
million). In addition, there were $4 million in charges related to the writedown
of certain assets and $3 million related to the exiting of certain businesses.
Through December 31, 1998, approximately 270 employees of these other segments,
most of whom were underwriters and office support staff, had been released at a
cost of $3 million.
CORPORATE
Corporate results consist of interest expense on corporate borrowings, certain
run-off insurance operations, asbestos claims related to Fibreboard Corporation,
financial guarantee insurance contracts, and certain non-insurance operations,
principally the operations of Agency Management Systems, Inc. (AMS), an
information technology and agency software development subsidiary.
Operating losses for 1998 increased by $124 million compared with 1997. This
increase is primarily attributed to a net unfavorable change in loss development
on asbestos claims related to Fibreboard Corporation of approximately $70
million, an increase in pre-tax operating losses attributable to AMS of $20
million and a decrease in investment income and an increase in interest expense
totaling $29 million.
Operating losses for 1997 increased by $94 million from 1996. This increase was
primarily attributable to a net unfavorable change in loss development on
run-off operations and financial guarantee insurance contracts of $77 million.
The remaining increase was due to increased operating losses from AMS of
approximately $12 million, and other items aggregating $5 million.
A discussion of consolidated investment results can be found on page 40.
CNA FINANCIAL CORPORATION
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16
CNA SEGMENT OVERVIEWS AND ANALYSIS
- - ---------------------------------------------------------------------------
1998
AGENCY MARKET OPERATIONS
18
SPECIALTY OPERATIONS
22
CNA RE
25
GLOBAL OPERATIONS
27
RISK MANAGEMENT
31
GROUP OPERATIONS
34
LIFE OPERATIONS
37
CNA FINANCIAL CORPORATION
--------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - ----------------------------------------------------------------------------
Agency Market Operations
BUSINESS OVERVIEW
Agency Market Operations builds on the Company's long and successful
relationship with the independent agency distribution system to market a broad
range of property/casualty insurance products and services to both businesses
and individuals. Business products include workers' compensation, commercial
packages, general liability and commercial auto, as well as a variety of
creative risk management services. Products for individuals are primarily
personal auto and homeowners insurance. In addition, Agency Market Operations
recently launched a professional employer organization, CNA UniSource, which
provides various employer-related services.
Agency Market Operations includes four groups.
COMMERCIAL INSURANCE
Commercial Insurance (CI) provides traditional property/casualty insurance
products such as workers' compensation, general and product liability, property,
commercial auto and umbrella coverage to businesses with less than $1 million in
annual premiums. The majority of CI customers are small and medium-sized
businesses. CI is among the market leaders in applying industry segmentation
techniques to design products and services tailored to the needs of its targeted
customer groups.
In early 1998, CI completed an extensive review of its business and developed a
new, more effective platform that positions CI as a world class competitor for
the next century. The basis for the platform is to move decision-making
authority and resources closer to our customers.
That platform consists of 40 branches, located throughout the U.S., providing
customer support in the areas of underwriting, loss control and sales. A new
processing center will be responsible for premium processing and accounting for
all 40 branches, and will incorporate a call center for increased customer
service. Eight claim service centers, located throughout the U.S., will provide
customers and claimants with improved service through more specialized claim
handling and easier claim reporting.
The improved efficiencies are expected to result in decreased expenses in
underwriting and claims through the implementation of new technology, process
redesign and centralization. In addition, CI recognizes that an even lower cost
platform is necessary to be successful in the small commercial marketplace. CI
has developed underwriting and sales tools that automate the underwriting
process, enabling agents to handle applications, verify eligibility, price
and issue policies at the point of sale.
PERSONAL INSURANCE
Personal Insurance (PI) sells primarily personal auto and homeowners coverages
and also offers excess liability, separate scheduled property, boat-owners and
other recreational vehicle insurance. These coverages are sold primarily as a
package product. In addition, PI is developing capabilities that support
employer group marketing through independent agencies.
E&S
E&S provides specialized insurance and other financial products for a wide array
of commercial and personal lines customers. Risks covered by E&S are generally
viewed as highly perilous and less predictable in exposure than those covered
CNA FINANCIAL CORPORATION
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18
- - ----------------------------------------------------------------------------
Agency Market Operations (cont.)
by the more traditional insurance markets. By combining superior insurance and
financial expertise with a detailed understanding of customer operations and
future direction, E&S is able to create and implement innovative business
solutions that are valued by the customer. In addition, E&S actively seeks
business partners who can supplement CNA resources and enhance value for the
customer.
CNA UNISOURCE
CNA UniSource is a professional employer organization that provides integrated
products and services to business owners and their employees. Products and
services include payroll processing, human resource services, and access to
workers' compensation and employee benefit insurance. The primary sales force is
comprised of independent insurance agencies that are also contracted with the CI
branches. Payroll processing and human resource services can also be provided on
an unbundled basis.
At December 31, 1998, CNA UniSource was licensed in 35 states and the District
of Columbia. It expects to be licensed in ten additional states by mid-1999.
Currently 325 clients, representing over 13,000 employees, receive
employer-related services from CNA UniSource's 25 service offices. Continued
growth of enrolled employees is anticipated over the next several years.
CNA FINANCIAL CORPORATION
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19
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - --------------------------------------------------------------------------
Agency Market Operations (cont.)
OPERATING RESULTS
- - ---------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - ---------------------------------------------------------------------------
(In millions of dollars)
Premiums $5,247 $ 5,092 $ 5,346
Other revenue 39 50 13
Restructuring and other related charges (96) - -
Benefits and expenses (6,070) (5,491) (6,020)
- - ---------------------------------------------------------------------------
Underwriting loss (880) (349) (661)
Investment income 744 787 828
Non-insurance revenues 68 - -
Non-insurance expenses (91) (6) -
- - ---------------------------------------------------------------------------
Operating (loss) income before income tax (159) 432 167
Income tax benefit (expense) 105 (106) (13)
- - ---------------------------------------------------------------------------
Net operating (loss) income (54) 326 154
Realized investment gains, net of tax 171 187 133
- - ---------------------------------------------------------------------------
NET INCOME $ 117 $ 513 $ 287
===========================================================================
SUMMARY:
Agency Market Operations' 1998 results were significantly impacted by
competitive pricing in commercial insurance lines, catastrophe losses and net
loss reserve strengthening. In addition, 1998 results also reflected significant
restructuring and other related charges.
PREMIUMS:
Premiums for 1998 increased by $155 million, or approximately 3%, as compared
with 1997. Premiums for CI increased $94 million and was primarily attributable
to premiums from involuntary risks. Excluding involuntary risks, premiums in CI
decreased by approximately $165 million due to the continued soft market
conditions throughout the commercial insurance industry. Agency Market
Operations' participation in involuntary risks is mandatory and generally a
function of its share of the voluntary market by line of insurance in each
state. The increase in involuntary risk premiums in 1998 as compared with 1997
was $259 million and is largely a function of the 1997 involuntary risk premiums
being reduced by a revision of prior years' estimated premiums. The decrease in
involuntary risk premiums in 1997 stemmed from a greater willingness on the part
of the voluntary market, including Agency Market Operations, to write these
types of coverages. This willingness was precipitated by improved loss
experience trends in the involuntary market.
Premiums for PI grew $61 million in 1998. Contributing to the growth was the
strong product identity of the Personal Package policy, a personal insurance
product providing a wide range of available coverage options and the convenience
of single policy delivery and combined billing.
The decrease in premiums of $254 million in 1997 as compared with 1996 was
primarily due to a decrease in premiums of approximately $425 million related to
CI involuntary risks, as previously discussed, offset by increases in workers'
compensation premiums.
CNA FINANCIAL CORPORATION
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20
- - ---------------------------------------------------------------------------
Agency Market Operations (cont.)
UNDERWRITING AND NON-INSURANCE RESULTS:
Underwriting results for 1998 declined by $531 million as compared with 1997.
Contributing to this decline were net changes in reserve development,
restructuring and other related charges and catastrophe losses.
The increase in underwriting losses for 1998 is due primarily to an increase in
benefits and expenses of $579 million in 1998 as compared with 1997, as well as
restructuring and other related charges of $96 million (discussed on page 15),
partially offset by the aforementioned increase in premiums in 1998 of $155
million. Benefits and expenses increased due to reserve development and
increased catastrophe losses in 1998. Net reserve development in 1998 was $168
million as compared with favorable reserve development of $276 million in 1997.
Management strengthened reserves in 1998 primarily in response to deteriorating
claim experience for asbestos and other mass tort exposures. Reserves were also
increased for construction defect claims and for workers' compensation
reinsurance bureaus. In 1997, actions were taken to mitigate further exposure
from construction defect liabilities that arose almost exclusively out of
exposures underwritten in California. In 1998, catastrophe losses were $131
million higher than the 1997 losses of $68 million.
Underwriting results for 1997 improved by $312 million compared with 1996. This
improvement was primarily due to a net favorable change in loss reserve
development of $258 million, lower catastrophe losses of $158 million when
compared to the prior year, and improved benefits and expenses of approximately
$113 million associated with the $254 million decrease in premiums for 1997
discussed above. The favorable change in loss reserve development was due
principally to favorable loss development in 1997 of $276 million, comprised of
$492 million in favorable development in involuntary risks, primarily workers'
compensation, and $80 million of favorable loss development in PI lines offset
in part by unfavorable development in CI lines of $296 million.
The favorable loss development in involuntary risks in 1997 was attributable to
better than expected results in workers' compensation and private passenger
automobile lines stemming from improved frequency and severity in these lines.
Non-insurance results are attributable to CNA UniSource. Non-insurance
operations experienced a loss of $23 million for 1998, an increase of $17
million when compared with 1997. This increase is due to the start-up nature of
CNA UniSource as it develops the volume necessary for generating profits.
A discussion of consolidated investment results can be found on page 40.
CNA FINANCIAL CORPORATION
-------------------------
21
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - -----------------------------------------------------------------------------
Specialty Operations
BUSINESS OVERVIEW
Specialty Operations provides a broad array of professional, financial and
specialty property/casualty products and services through a network of brokers,
managing general agencies and independent agencies. Specialty Operations
provides creative solutions for managing the risks of its clients, including
architects, engineers, lawyers, healthcare professionals, financial
intermediaries and corporate directors and officers.
Specialty Operations is composed of three principal groups.
CNA PRO
CNA Pro is the largest provider of professional liability insurance and risk
management services for non-medical professionals and service firms in the U.S.
CNA Pro's customers include four targeted professions: architects & engineers,
lawyers, accountants and real estate agents and brokers. In addition, CNA Pro is
focusing on a diversified group of growing professions including staffing
services and consultants. Product distribution is primarily through program
administrators, although large law firms and the diversified professions are
served through independent insurance brokers.
HEALTHPRO
HealthPro offers a comprehensive set of specialized insurance products and
clinical risk management consulting services designed to assist health care
providers in managing the quality-of-care risks associated with the delivery of
health care. Key customer segments include individual and small group purchasers
of malpractice insurance, as well as large corporate buyers of malpractice,
directors & officers, and errors & omissions coverages related to managed care.
Caronia Corporation, acquired during 1997, also provides third-party claims
administration for medical professional liability insureds.
FINANCIAL INSURANCE
Financial Insurance offers a comprehensive selection of governance liability,
fidelity, credit, residual value and other financial peril insurance products.
These products provide coverage for large and small corporate clients and
not-for-profit organizations. Governance liability (including directors &
officers, errors & omissions, and employment practices liability) and fidelity
products are distributed on a national basis through approximately 3,000
independent brokers and agents. Credit, residual value and other financial peril
products are distributed on a national basis through a variety of channels
including brokers, agents and direct sales.
OTHER OPERATIONS
A start-up venture, Hedge Financial Products, was formed in 1997 to focus on
securitization of insurance risk and the embedding of financial protections
within traditional insurance programs.
CNA FINANCIAL CORPORATION
-------------------------
22
- - ----------------------------------------------------------------------------
Specialty Operations (cont.)
OPERATING RESULTS
- - -----------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - -----------------------------------------------------------------------
(In millions of dollars)
Premiums $ 1,092 $ 1,251 $ 1,217
Other revenue 17 11 -
Retructuring and other related charges (5) - -
Benefits and expenses (1,277) (1,398) (1,403)
- - -----------------------------------------------------------------------
Underwriting loss (173) (136) (186)
Investment income 245 268 273
Non-insurance revenues 10 3 -
Non-insurance expenses (18) (9) -
- - -----------------------------------------------------------------------
Operating income before income tax 64 126 87
Income tax expense (6) (31) (15)
- - -----------------------------------------------------------------------
Net operating income 58 95 72
Realized investment gains, net of tax 57 63 44
- - -----------------------------------------------------------------------
NET INCOME $ 115 $ 158 $ 116
========================================================================
SUMMARY:
In 1998, Specialty Operations (Specialty) continued to produce strong overall
operating results. However, results trended downward as rate competition
stiffened and loss reserves for medical malpractice were strengthened.
Intense competition in Specialty's markets has resulted in lower premium rates,
despite expanded forms of coverage and higher coverage limits. Specialty remains
committed to conservative underwriting practices in this difficult environment.
This has resulted in little premium growth in the segment's core financial
insurance, medical malpractice and professional liability businesses. In
addition, Specialty has decided to exit the agricultural and entertainment
insurance businesses after determining that these markets did not offer
acceptable long-term profitability.
PREMIUMS:
Premiums in 1998 decreased by $159 million, or approximately 13%, compared with
1997. The decrease was largely attributable to an approximate $100 million
reduction in premiums caused by management's decision to exit the agricultural
insurance market. The remaining decline in premiums in 1998 was due to increased
price competition and management's resolve not to accept inadequately priced
business.
Premiums in 1997 were 2.8% higher than 1996, reflecting modest growth in the
period.
Specialty's commitment to prudent underwriting and responsible pricing are
expected to continue to limit premium growth until general market pricing
improves.
CNA FINANCIAL CORPORATION
-------------------------
23
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - ------------------------------------------------------------------------------
Speciality Operations (cont.)
UNDERWRITING AND NON-INSURANCE RESULTS:
Results for 1998 reflect an underwriting loss of $173 million compared with an
underwriting loss of $136 million in 1997. The increase in underwriting losses
in 1998 of $37 million was primarily attributable to the aforementioned decrease
in premiums of $159 million, offset in part by a decrease in benefits and
expenses of $121 million in 1998 as compared with 1997. The decrease in benefits
and expenses was comprised of reduced losses and operating expenses of
approximately $222 million relating primarily to the aforementioned exit of the
agricultural insurance lines of business, as well as decisions not to write
inadequately priced business. These decreases were partially offset by a net
unfavorable change in reserve development of $112 million. The increase in
unfavorable loss reserve development in 1998 was due principally to adverse
claim experience in the medical malpractice insurance line of business.
The improvement in underwriting results in 1997 of $50 million as compared with
1996 was primarily attributable to the increase in premiums of $34 million as
well as net favorable change in reserve development of $76 million, offset by
increases in losses and operating expenses related to premium growth.
The non-insurance operations incurred pre-tax operating losses of $8 million and
$6 million in 1998 and 1997, respectively. These losses were primarily
attributable to the start-up activities of Hedge Financial Products.
A discussion of consolidated investment results can be found on page 40.
CNA FINANCIAL CORPORATION
-------------------------
24
- - -----------------------------------------------------------------------------
CNA Re
BUSINESS OVERVIEW
CNA Re operates globally as a reinsurer in the broker market, offering both
treaty and facultative products through major offices in London and Chicago. CNA
Re's operations include the business of CNA Reinsurance Company, Limited (CNA Re
U.K.), a U.K. company, and U.S. operations based in Chicago. Major products are
traditional treaty reinsurance, with developing positions in facultative and
financial reinsurance. CNA Re also participates in Lloyd's of London through a
corporate syndicate, Syndicate 1229, as well as investments in several similar
syndicates.
Headquartered in London with offices in Amsterdam, Milan, Singapore and Zurich,
CNA Re U.K. writes both London market and other European business. As one of the
largest reinsurers in this market, CNA Re maintains an A+ (Good) rating from
Standard and Poor's and an A (Excellent) rating from A.M. Best. CNA Re writes
U.S. and international treaty and professional liability business, including
medical malpractice, errors & omissions and directors & officers coverages.
Based in Chicago, the U.S. operations of CNA Re provide products to the North
and South American markets. Treaty products include working layer property,
working layer casualty, property catastrophe, workers' compensation, products
liability, general liability, professional liability, specialty and excess and
surplus lines. In addition, financial reinsurance products are offered as well
as property and casualty facultative reinsurance.
OPERATING RESULTS
- - ------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - ------------------------------------------------------------------------
(In millions of dollars)
Premiums $ 944 $ 898 $ 944
Other revenue 3 - -
Restructuring and other related charges (1) - -
Benefits and expenses (1,012) (993) (983)
- - -------------------------------------------------------------------------
Underwriting loss (66) (95) (39)
Investment income 163 153 161
Non-insurance revenues 2 7 7
Non-insurance expenses (4) (3) (2)
- - -------------------------------------------------------------------------
Operating income before income tax 95 62 127
Income tax expense (27) (11) (38)
- - -------------------------------------------------------------------------
Net operating income 68 51 89
Realized investment gains, net of tax 27 34 21
- - -------------------------------------------------------------------------
NET INCOME $ 95 $ 85 $ 110
=========================================================================
CNA FINANCIAL CORPORATION
--------------------------
25
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - ------------------------------------------------------------------------------
CNA Re (cont.)
SUMMARY:
CNA Re experienced an increase in profitability in 1998 due principally to net
favorable reserve development partially offset by an increase in catastrophe
losses.
PREMIUMS:
Premiums in 1998 increased by $46 million, or approximately 5%, compared with
1997. The increase in 1998 premiums over 1997 is primarily a function of adverse
premium development of prior year estimates recorded in 1997.
Premiums decreased $46 million, or approximately 5%, in 1997 as compared with
1996. The decrease in premiums in 1997 included an unfavorable change in
estimates of prior year premiums of $88 million, offset in part by growth in
treaty reinsurance business. The prior year movement can be largely attributed
to the competitive insurance marketplace and its effect on CNA Re's clients, who
have not met their own estimated premium targets. These shortfalls have had an
effect upon CNA Re's proportional reinsurance book.
UNDERWRITING RESULTS:
The improvement in underwriting results of $29 million in 1998, as compared with
1997, is comprised of an $80 million net favorable change in estimates of prior
year premiums and related commissions, as well as an improvement in underwriting
expense of $10 million. These increases were partially offset by increased
catastrophe losses of $37 million due principally to hurricane activity in 1998,
and a $21 million net unfavorable change in loss reserve development. The
decrease in underwriting expenses in 1998 as compared with 1997 is principally
due to the start-up costs associated with expansion into facultative reinsurance
and the establishment of branch offices abroad during 1997.
Underwriting losses increased $56 million in 1997 as compared with 1996. This
increase is primarily due to the $46 million decrease in premiums discussed
above, an increase in current year loss experience, an increase in underwriting
expenses of $33 million and a decrease in catastrophe losses of $20 million. The
increase in underwriting expenses was primarily due to the start-up costs
discussed above.
A discussion of consolidated investment results can be found on page 40.
CNA FINANCIAL CORPORATION
-------------------------
26
- - ---------------------------------------------------------------------------
Global Operations
BUSINESS OVERVIEW
Global Operations provides products and services to U.S.-based customers,
customers expanding overseas and foreign customers. Product distribution is
primarily through brokers and independent agents. The major product lines
include marine, commercial and contract surety, warranty and specialty products,
as well as commercial property and casualty.
Global Operations is composed of five principal groups.
MARINE
Marine Office of America Corp. (MOAC), a leading provider of ocean marine
insurance in the U.S., offers hull, cargo, primary and excess marine liability,
offshore energy, marine claims and recovery products and services. Business is
sold through national brokers, regional marine specialty brokers and independent
agencies. These distributors work closely with MOAC's 10 branch offices located
throughout the U.S.
On June 30, 1998, CNA completed the acquisition of Maritime Insurance Co., Ltd.
in the U.K. and its Canadian subsidiary, Eastern Marine Underwriters (EMU),
strengthening CNA's position as a global marine insurer. Management expects
growth to come from leveraging the relationships with CNA's domestic producers
and providing customers with services and products throughout the world.
SURETY
On October 1, 1997, Global Operations completed the merger of CNA's surety
operations with Capsure Holdings Corp.'s subsidiaries, Western Surety Company
and Universal Surety of America to form CNA Surety Corporation (CNA Surety). CNA
owns approximately 61% of CNA Surety.
CNA Surety, traded on the New York Stock Exchange (SUR), is the largest publicly
traded provider of surety bonds, with approximately 9% of that market. Among its
U.S. competitors, CNA Surety has the most extensive distribution system and one
of the most diverse surety product lines, offering 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 approximately 37,000
independent agencies. Management expects growth to come from CNA Surety's broad
product line and distribution network and cross-selling opportunities.
WARRANTY
CNA Warranty, Inc. (Warranty), is the fourth largest warranty underwriter in the
U.S., providing extended service contracts, warranties and related insurance
products that protect the consumer or business from the financial burden
associated with the breakdown, under-performance or maintenance of a product.
Warranty's key market segments consist of vehicle, retail, home, commercial and
original equipment manufacturer. Each market segment distributes its product via
a sales force employed or contracted through a program administrator.
CNA FINANCIAL CORPORATION
-------------------------
27
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - -----------------------------------------------------------------------------
Global Operations (cont.)
In 1998, Warranty expanded into the home warranty segment with the acquisition
of a 90% interest in Home Security of America, Inc., one of the largest home
warranty administrators in the U.S.
Warranty expects growth from cross marketing efforts with other CNA businesses,
increasing product distribution via the CNA agency force and introducing several
warranty products in the international marketplace.
INTERNATIONAL
International is responsible for coordinating and managing the direct business
of the foreign operations of CNA. The business identifies and capitalizes on
strategic indigenous opportunities outside the U.S. by continuing to build its
own capabilities and by initiating acquisitions, strategic alliances and
start-up operations that allow for expansion into targeted markets. In addition,
International provides U.S.-based customers that are expanding their operations
overseas with a single source for their commercial insurance needs. To this end,
International has placed underwriters within Commercial Insurance branches.
International currently oversees foreign operations in Europe, Latin America,
Canada and Asia. In Europe, CNA formed CNA Insurance Company (Europe) Limited
(CIE) in 1996, which is based in London. CIE has since opened offices in France,
Germany, the Netherlands and Denmark. Through its network of offices,
International intends to build on the successes of several CNA specialty
products (including warranty, personal accident and financial lines insurance)
and introduce those products across Europe.
In Latin America, International acquired a 70% interest in Omega A.R.T. in 1997,
the third largest workers' compensation company in Argentina. International
plans to expand its presence within the region with additional insurance
products.
In Canada, CNA Canada, formed in 1998, sells a broad array of property/casualty
and specialty insurance products through brokers and managing general agents.
The short to mid-term growth opportunities for International are in the more
mature foreign insurance markets, such as Europe and Canada, and in the
marketing of specialty insurance products. In the longer term, emphasis will be
on the emerging insurance markets in Latin America and Asia.
FIRST INSURANCE COMPANY OF HAWAII
First Insurance Company of Hawaii, Ltd. (FICOH) is the oldest domestic insurer
in the state of Hawaii, dating back to 1911. FICOH is also the largest
commercial insurance company and the third largest property/casualty insurance
company in the state. FICOH offers commercial and personal lines solely in the
state of Hawaii. Distributed through independent agencies, the business mix is
approximately 65% commercial and 35% personal. CNA owns 60% of FICOH and
foresees growth opportunities through collaborative partnerships with other CNA
businesses.
CNA FINANCIAL CORPORATION
-------------------------
28
- - ------------------------------------------------------------------------------
Global Operations (cont.)
OPERATING RESULTS
- - --------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - --------------------------------------------------------------------------
(In millions of dollars)
Premiums $ 941 $ 854 $ 945
Other revenue 5 1 -
Restructuring and other related charges (1) - -
Benefits and expenses (1,007) (857) (929)
- - --------------------------------------------------------------------------
Underwriting (loss) income (62) (2) 16
Investment income 110 117 134
Non-insurance revenues 77 28 34
Non-insurance expenses (64) (27) (31)
- - --------------------------------------------------------------------------
Operating income before income tax 61 116 153
Income tax expense (18) (35) (44)
- - --------------------------------------------------------------------------
Net operating income 43 81 109
Realized investment gains, net of tax 17 20 21
Minority interest (25) (29) (9)
- - --------------------------------------------------------------------------
NET INCOME $ 35 $ 72 $ 121
==========================================================================
SUMMARY:
Global Operations' 1998 underwriting results were adversely impacted primarily
by unfavorable development in discontinued pools and associations and marine
asbestos reserves. Recent decisions made are intended to achieve, sustain, and
augment the established standard of underwriting profitability. Actions included
placing International underwriters in selected Commercial Insurance branches and
establishing indigenous overseas organizations. Establishment of these
organizations was accelerated as a result of the acquisitions of Maritime and
Omega A.R.T. Actions also included the strategic expansion of the successful
Surety and Warranty businesses and a decision to allow FICOH to reinvest its
earnings enabling it to grow over 70% since 1996. Lastly, MOAC exited non-core
lines and unprofitable domestic pools, and is now focused exclusively on the
ocean marine market.
PREMIUMS:
Premiums in 1998 increased by $87 million, or approximately 10%, compared with
1997. This increase was primarily attributable to the effects of the recent
acquisitions and mergers. Omega contributed $48 million, Maritime contributed
$37 million and Surety's business increased $80 million in 1998 reflecting the
first full year of Capsure premiums as well as leveraging the expanded product
line and distribution channels. Warranty had an increase in premiums in 1998 of
$27 million as compared with 1997. This increase was primarily due to growth in
Western National, an automobile warranty business, which has seen broad market
acceptance of its products and services. Additionally, International premiums
increased by $25 million primarily attributable to growth in Canadian
operations.
CNA FINANCIAL CORPORATION
-------------------------
29
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - ------------------------------------------------------------------------------
Global Operations (cont.)
Partially offsetting the growth through acquisitions was the sale of a $47
million book of business. In addition, premiums decreased $84 million in 1998
due to MOAC's strategic decision in 1997 to exit unprofitable non-core lines by
inland marine, commercial property, boiler and machinery and commercial auto
physical damage. Consequently, MOAC is now focused exclusively on its historic
core competencies of ocean marine business, upon which the franchise was
originally built.
Premiums decreased $91 million in 1997 when compared with 1996. The decision to
exit unprofitable pools and associations decreased voluntary pool premiums by
$180 million in 1997. In addition, an unwillingness to accept inadequate pricing
reduced MOAC's premiums by $62 million in 1997. Decisions to expand Global's
International franchise and growth in Surety, Warranty and FICOH helped offset
these declines by collectively generating growth of $151 million.
UNDERWRITING AND NON-INSURANCE RESULTS:
Global Operations' underwriting results declined in 1998 by $60 million as
compared with 1997. The decrease is attributable to the aforementioned growth in
premiums which was more than offset by increased benefits and expenses of $150
million. The increase in benefits and expenses is due to a net unfavorable
change in loss development of $64 million, increased expenses of $65 million and
higher catastrophe losses of $21 million.
The change in net unfavorable development of $64 million is comprised of
approximately $111 million of unfavorable year-over-year change related to
Surety, MOAC and discontinued pools, offset in part by favorable year-over-year
change of approximately $47 million related principally to the CNA International
and Warranty business. The increase in expenses is principally due to higher
costs associated with the growth in premiums.
The decline in underwriting income of $18 million in 1997 as compared with 1996
was attributable to the aforementioned decrease in premiums of $91 million,
offset in part in a decrease in benefits and expenses of approximately $72
million. The decrease in benefits and expenses in 1997 when compared with 1996
was principally the result of a net favorable change in loss reserve development
of approximately $55 million, of which approximately $43 million was
attributable to voluntary pools.
Included in the underwriting results above were net underwriting losses of $12
million related to the book of business which was sold by year-end 1997.
Additionally, MOAC's underwriting losses increased by $17 million in 1997 and
are reflected in the decrease noted above. This increase in underwriting losses
was a result of large losses in MOAC's property and inland marine book of
business. These underwriting losses precipitated management's decision to exit
these non-core lines of business.
Non-insurance income is primarily attributable to the Western National
automobile warranty business as well as results for Home Security of America, a
90% owned subsidiary purchased in 1998. Profit margins in these businesses are
improving as the current infrastructure is positioned to handle larger volumes
of business.
A discussion of consolidated investment results can be found on page 40.
CNA FINANCIAL CORPORATION
-------------------------
30
- - ----------------------------------------------------------------------------
Risk Management
BUSINESS OVERVIEW
Risk Management (RM) markets and sells insurance products and services to large
U.S.-based companies. These customers have a minimum of $1 million or more in
casualty claims each year. It is estimated that there are approximately 8,500
targeted companies within this market segment. RM is one of 11 significant
competitors and has a very strong reputation and presence, particularly as a
writer of casualty insurance lines.
RM includes two groups.
RISK TRANSFER
Risk Transfer writes casualty and property lines of insurance.
The casualty insurance business focuses on workers' compensation, commercial
auto liability, general liability through traditional and innovative financial
risk products, and excess coverage needs. The excess products provide umbrella,
excess workers' compensation and high excess coverages. Capacity has been
increased for the excess products to address the casualty needs of the global
customer.
Over the last two years, domestic and global property capabilities have been
increased, providing primary, inland marine and excess property facilities.
Global property includes a strategic alliance with Protection Mutual to address
the needs of the highly protected risk customer. Global property also includes
Northrock, a wholly owned subsidiary of CNA, offering property excess of loss
insurance coverages.
RSKCo SM
Formed in 1998, RSKCo SM provides total risk management services (integrated and
single component) related to claims, loss control, cost management and
information services to the commercial insurance marketplace.
The broad range of RSKCo's SM capabilities includes:
CLAIM SERVICES: Services that allow customers to select from a single source the
desired level of service-from an integrated claims package to any component
service.
LOSS CONTROL: Pre-loss prevention services include industrial hygiene,
laboratory, ergonomics, field consulting and training, property, environmental
and transportation loss control. Driver training is provided through Smith
System Driver Improvement Institute, Inc., a wholly owned subsidiary of CNA.
COST MANAGEMENT: Post-loss cost control services through case management,
medical bill review, preferred provider organizations and other unique
partnerships to reduce lost work days through rapid response, quality care and
effective coordination.
INFORMATION SERVICES: Data access, reporting tools, information and benchmarking
analysis, consulting and custom reporting services.
CNA FINANCIAL CORPORATION
-------------------------
31
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - ---------------------------------------------------------------------------
Risk Management (cont.)
OPERATING RESULTS
- - -------------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - -------------------------------------------------------------------------------
(In millions of dollars)
Premiums $ 823 $ 776 $ 572
Benefits and expenses (1,021) (976) (649)
- - -------------------------------------------------------------------------------
Underwriting loss (198) (200) (77)
Investment income 144 158 179
Non-insurance revenues 230 194 222
Non-insurance restructuring and other related charges (88) - -
Non-insurance other expenses (224) (214) (226)
- - -------------------------------------------------------------------------------
Operating (loss) income before income tax (136) (62) 98
Income tax benefit (expense) 48 25 (24)
- - -------------------------------------------------------------------------------
Net operating (loss) income (88) (37) 74
Realized investment gains, net of tax 31 37 29
- - -------------------------------------------------------------------------------
NET (LOSS) INCOME $ (57) $ - $ 103
===============================================================================
SUMMARY:
RM's 1998 net loss was $57 million, down from breakeven in 1997. The primary
reason for the decrease was an $88 million restructuring and other related
charges.
In 1998, RSKCo SM, a new total risk management services company, was created.
The new service organization will realize significant operating efficiencies
necessary to compete in a market place demanding comprehensive, efficient
service delivery.
PREMIUMS:
Premiums in 1998 increased by $47 million, or approximately 6%, as compared with
1997. The increase is due to growth of $30 million in the property facility
business, that was introduced in the latter part of 1997, underlying momentum in
Risk Management's core primary casualty business, and new business growth.
Premiums in 1997 increased $204 million as compared with 1996. This increase was
primarily due to RM's significant increase in market share among the Fortune
500-size companies, particularly in the casualty business that increased $85
million, growth of $20 million in the property facility business, $60 million of
incremental premium 1997 renewal accounts that moved from large deductible
insurance programs to guaranteed cost programs and $54 million of favorable
premium development.
UNDERWRITING RESULTS:
Underwriting losses remained consistent in 1998 with the aforementioned increase
in premiums of $47 million being offset by a like increase in benefits and
expenses as customers moved to guaranteed cost business.
CNA FINANCIAL CORPORATION
-------------------------
32
- - ----------------------------------------------------------------------------
Risk Management (cont.)
Restructuring and other related charges in 1998, as discussed on page 15,
totaled $88 million.
The 1997 underwriting loss deterioration of $123 million was primarily the
result of the aforementioned increase in premium of $204 million, offset by
increased benefits and expenses of $327 million. The increase in benefits and
expenses in 1997 when compared with 1996 was principally the result of a net
unfavorable change in reserve development of $253 million, increased losses on
premium growth of approximately $124 million, offset by favorable changes in
policyholders dividends of approximately $50 million.
Total expenses, excluding loss and loss adjustment expense, decreased by $10
million during the 3 year period ended December 31, 1998, while premiums grew by
44% for the same period.
A discussion of consolidated investment results can be found on page 40.
CNA FINANCIAL CORPORATION
-------------------------
33
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - ----------------------------------------------------------------------------
Group Operations
BUSINESS OVERVIEW
Group Operations provides a broad array of group life and health insurance
products and services to employers, affinity groups and other entities that
purchase insurance as a group. Its products and services are primarily
distributed through brokers. In addition, Group Operations provides health
insurance to postal and other federal employees, retirees and their families;
managed care and self-funded medical excess insurance; medical provider network
management and administration services; and reinsurance for life and health
insurers.
Group Operations includes five principal groups.
SPECIAL BENEFITS
Special Benefits provides group term life insurance, short and long term
disability, statutory disability, long term care and accident products. Products
are marketed through a nationwide operation of 31 sales offices, third party
administrators, managing general agents and insurance consultants.
PROVIDER MARKETS
Provider Markets is comprised of two major businesses and a third now under
development. CNA Health Partners provides comprehensive managed care services to
employers and healthcare provider networks including network development and
management, medical management, claims administration, consulting services and
management services. Currently under development is a Management Services
Organization that will provide a complete set of managed care services to health
care provider organizations that are managing capitated risks. Services will
include medical management, claims administration, consulting services and
management services. Group Reinsurance writes assumed reinsurance on health,
life and other related products written on a group basis, as well as excess risk
coverages related to health care.
LIFE REINSURANCE
Life Reinsurance reinsures individual life and health products marketed by other
life insurance companies throughout North America. Sales are through an internal
sales force.
FEDERAL MARKETS
Federal Markets is the second largest provider of health insurance benefits to
postal and other federal employees under the Federal Employees Health Benefit
Plan (FEHBP). In addition to insuring over one million members, Federal Markets
is responsible for all claim management activities under the plan, such as large
case management, hospital and provider bill negotiations, systems, fraud
detection activities, vendor contracts and federal government relations.
HEALTH BENEFITS
Health Benefits markets direct mail specialty products such as accidental death
and dismemberment, term life and dental insurance to bank customers and federal
employees.
CNA FINANCIAL CORPORATION
--------------------------
34
- - ----------------------------------------------------------------------------
Group Operations (cont.)
OPERATING RESULTS
- - --------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - --------------------------------------------------------------------------
(In millions of dollars)
Revenues:
Premiums $3,712 $ 3,903 $3,816
Investment income 133 117 118
Other 24 17 8
- - --------------------------------------------------------------------------
Total operating revenues 3,869 4,037 3,942
Restructuring and other related charges 39 - -
Claims and benefits and other operating expenses 3,913 4,055 3,922
- - --------------------------------------------------------------------------
Operating (loss) income before income tax (83) (18) 20
Income tax benefit (expense) 35 10 (3)
- - ---------------------------------------------------------------------------
Net operating (loss) income (48) (8) 17
Realized investment gains, net of tax 29 28 21
- - ---------------------------------------------------------------------------
NET (LOSS) INCOME $ (19) $ 20 $ 38
===========================================================================
SUMMARY:
In 1998, Group Operations experienced a reduction in profitability as a result
of restructuring and other related charges associated with exiting certain
businesses and the continued challenging market conditions in group health
lines.
PREMIUMS:
Premiums decreased by approximately 5% or $191 million, in 1998 as compared with
1997. The decrease was attributable, in part, to a $166 million decrease in the
medical lines of coverage in Health Benefits, resulting from the decision to
exit certain markets. Additionally, due to changes in coverage terms, FEHBP
premiums decreased by $90 million. These decreases were offset, in part, by
premium growth of $65 million across all other lines of business.
During 1997, premiums grew by $87 million as compared with 1996. Premium growth
was experienced in Special Benefits, driven by strong sales to employee benefit
plans, and in Health Benefits, attributable to sales of credit card accidental
death and dismemberment and other non-medical insurance products; other growth
was from sales and renewal increases on employer medical plans. Partially
offsetting these increases were decreases in the Group Reinsurance premiums,
resulting from the termination of some small group medical quota share treaties.
CNA FINANCIAL CORPORATION
-------------------------
35
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - ------------------------------------------------------------------------------
Group Operations (cont.)
OPERATING RESULTS:
Pre-tax operating income in 1998 deteriorated by $65 million as compared with
1997. The decrease is primarily due to restructuring and other related charges
of $39 million for Group Operations, as discussed on page 16. In addition,
increased losses of $30 million on accident coverages contributed to the
operating loss. The increased losses resulted from both adverse claim
developments and unusually high claim activity in the traditional accident
insurance line. During 1998, CNA decided to exit the insured comprehensive
medical portion of the employer and affinity markets and a majority of this
inforce business was sold effective January 1, 1999.
Earned premiums for these lines of business approximated $400 million in 1998.
The $38 million decline in pre-tax operating results from 1996 to 1997 was
driven primarily by deteriorating group medical claim experience, including
increased losses of about $40 million in Health Benefits (employer and affinity
health), and $10 million of increased losses on medical stop loss and reinsured
group medical in Provider Markets. Offsetting these declines, Special Benefits'
results improved by about $20 million due to improved experience under both
long-term care and life coverages.
A discussion of consolidated investment results can be found on page 40.
CNA FINANCIAL CORPORATION
-------------------------
36
- - ----------------------------------------------------------------------------
Life Operations
BUSINESS OVERVIEW
Life Operations provides financial protection to individuals through a full
product line of term life insurance, universal life insurance, long term care
insurance, annuities and other products. Life Operations also provides
retirement services to institutions in the form of various investment products
and administration services. Life Operations has several distribution
relationships and partnerships including managing general agencies, other
independent agencies working with CNA life sales offices, a network of brokers
and dealers and various other independent insurance consultants.
Life Operations has three principal groups.
INDIVIDUAL LIFE
Individual Life offers primarily level premium term life insurance, universal
life insurance and related products. New sales of term life have placed CNA as
either first or second in the market in each of the last three years.
RETIREMENT SERVICES
Retirement Services markets investment and annuity products to both the retail
and institutional markets.
LONG TERM CARE
Long Term Care products provide reimbursement for covered nursing home and home
health care expenses incurred due to physical or mental disability.
OTHER OPERATIONS
Other Life Operations businesses include pre-need insurance, viatical
settlements and a developing business in the international arena.
CNA FINANCIAL CORPORATION
-------------------------
37
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - --------------------------------------------------------------------------
Life Operations (cont.)
OPERATING RESULTS
- - ---------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - ---------------------------------------------------------------------------
(In millions of dollars)
Revenues:
Premiums $ 684 $ 688 $ 654
Investment income 525 501 485
Other 115 105 106
- - ---------------------------------------------------------------------------
Total operating revenues 1,324 1,294 1,245
Restructuring and other related charges 7 - -
Claims and benefits and other operating expenses 1,153 1,107 1,028
- - ---------------------------------------------------------------------------
Operating income before income tax 164 187 217
Income tax expense (58) (66) (74)
- - ---------------------------------------------------------------------------
Net operating income 106 121 143
Realized investment gains, net of tax 82 124 102
- - ---------------------------------------------------------------------------
NET INCOME $ 188 $ 245 $ 245
===========================================================================
SUMMARY:
Life Operations continued to experience good profitability in 1998, although
results were lower than 1997 and 1996. The primary reasons for the reduction
were lower realized gains, less favorable mortality experience in 1998, reduced
income from decreased pension deposits and lower available margins on those
sales.
PREMIUMS:
Direct premiums have continued to show strong growth over the last three years.
Premium revenues, however, decreased slightly in 1998 to $684 million from $688
million in 1997, principally due to the increased use of reinsurance for
individual term life insurance products. Premium revenues increased $34 million
in 1997 as compared with 1996 premium revenues of $654 million, primarily due to
an increase in individual term life premiums.
Individual Life premium revenues were $321 million in 1998, as compared with
$373 million in 1997. The reason for this decrease in premiums was the increased
use of reinsurance. The current program includes a 90% coinsurance treaty
covering policies issued from mid-1994 to mid-1996 and 75% coinsurance on
policies issued after September, 1997. Individual Life premium revenues
increased from $313 million in 1996 to $373 million in 1997, primarily as a
result of growth in individual term life premiums.
Individual Life insurance premiums, on a direct basis, were $754 million in
1998, an increase of $111 million from 1997 premiums of $643 million. Premiums
increased $148 million in 1997 from 1996 premiums of $495 million. This trend
reflects CNA's strong market presence in term insurance.
CNA FINANCIAL CORPORATION
--------------------------
38
- - ------------------------------------------------------------------------------
Life Operations (cont.)
Retirement Services premium revenues increased slightly in 1998 to $177 million
as compared with $174 million in 1997. Premium revenues increased $24 million in
1997 from $150 million in 1996. Total sales volume for Retirement Services,
which reflects deposits and other income which are not included in the premiums
above, declined from $1,410 million in 1996 to $1,042 million in 1997 to $998
million in 1998. The decreased sales volume is primarily due to the
discontinuation of fixed individual annuities and the lower volume of guaranteed
investment contracts sold in institutional markets.
Long Term Care premium revenues increased $27 million to $137 million over the
two year period ended December 31, 1998. Long Term Care sales volume increased
$102 million to $299 million over the two year period ended December 31, 1998.
A discussion of consolidated investment results can be found on page 40.
CNA FINANCIAL CORPORATION
-------------------------
39
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - -----------------------------------------------------------------------------
Investments
Investments:
- - ------------
Net investment income, in the table below, was approximately $2.1 billion, $2.2
billion and $2.3 billion for the years ended December 31, 1998, 1997 and 1996
respectively. Lower net investment income can be attributed to a lower average
level of assets invested in interest-bearing securities in 1998 as compared with
1997. The decrease in 1997 as compared with 1996 is primarily due to a decline
in investment yields in the bond market. The bond segment of the investment
portfolio yielded 6.4% in 1998 compared with 6.4% and 6.6% in 1997 and 1996,
respectively.
Net realized investment gains, in the table below, were $434 million, $478
million and $387 million for the years ended December 31, 1998, 1997 and 1996,
respectively.
NET INVESTMENT INCOME
- - ------------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - ------------------------------------------------------------------------------
(In millions of dollars)
Fixed maturities:
Bonds:
Taxable $1,490 $1,522 $1,716
Tax-exempt 340 288 273
Redeemable preferred stocks 2 7 2
Equity securities 33 37 25
Mortgage loans and real estate 5 10 11
Policy loans 11 6 12
Short-term investments 241 321 231
Security repurchase transactions-net 10 9 4
Other 67 56 45
- - -------------------------------------------------------------------------------
2,199 2,256 2,319
Investment expense (53) (47) (43)
- - -------------------------------------------------------------------------------
NET INVESTMENT INCOME $2,146 $2,209 $2,276
===============================================================================
ANALYSIS OF INVESTMENT GAINS (LOSSES)
- - -------------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - -------------------------------------------------------------------------------
(In millions of dollars)
Realized investment gains and (losses):
Fixed maturities $ 467 $ 452 $ 293
Equity securities 38 103 216
Derivative securities 12 (7) 18
Other, including guaranteed Separate Account business 178 205* 92
- - -------------------------------------------------------------------------------
695 753 619
Allocated to participating policyholders (14) (15) (14)
Income tax expense (247) (260) (218)
- - -------------------------------------------------------------------------------
NET REALIZED INVESTMENT GAINS $ 434 $ 478 $ 387
===============================================================================
* INCLUDES $95 MILLION RELATED TO CNA SURETY TRANSACTION.
CNA FINANCIAL CORPORATION
-------------------------
40
The following table summarizes CNA's general account investments at cost or
amortized cost for each of the last five years.
DISTRIBUTION OF INVESTMENTS - GENERAL ACCOUNT
- - -----------------------------------------------------------------------------------------------------
December 31 1998 % 1997 % 1996 % 1995 % 1994 %
- - -----------------------------------------------------------------------------------------------------
(In millions of dollars)
Fixed maturities:
Bonds:
Taxable $23,348 66% $24,419 69% $22,631 65% $25,832 75% $17,484 63%
Tax-exempt 6,127 17 4,534 13 4,860 14 3,453 10 3,717 13
Redeemable
preferred stocks 36 -- 67 -- 49 -- 100 -- 423 2
Equity securities:
Common stocks 734 2 567 2 478 1 734 2 729 3
Non-redeemable
preferred stocks 321 1 128 -- 224 1 3 -- 8 --
Mortgage loans and
real estate 62 -- 85 -- 123 -- 122 -- 47 --
Policy loans 177 -- 177 -- 174 -- 177 1 176 1
Other invested assets 806 2 544 2 617 2 483 1 103 --
Short-term investments 4,037 12 4,884 14 5,854 17 3,725 11 5,036 18
- - -----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS $35,648 100% $35,405 100% $35,010 100% $34,629 100% $27,723 100%
=====================================================================================================
INVESTMENTS AT
CARRYING VALUE* $37,177 $36,203 $35,412 $35,886 $26,943
=====================================================================================================
*AS REPORTED IN THE CONSOLIDATED BALANCE SHEET
The Company's general account investment portfolio consists primarily of
publicly traded government bonds, asset-backed securities, mortgage-backed
securities, municipal bonds, and corporate bonds.
The Company's investment policies for both the general and separate accounts
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.
CNA FINANCIAL CORPORATION
-------------------------
41
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - -----------------------------------------------------------------------------
Investments (cont.)
The following table summarizes CNA's Separate Account investments at cost or
amortized cost for each of the last five years.
DISTRIBUTION OF INVESTMENTS - SEPARATE ACCOUNT
- - ---------------------------------------------------------------------------------------------------
December 31 1998 % 1997 % 1996 % 1995 % 1994 %
- - ---------------------------------------------------------------------------------------------------
(In millions of dollars)
Fixed maturities:
Taxable bonds $4,061 82% $4,667 84% $4,590 82% $5,385 95% $5,451 88%
Redeemable
preferred stocks -- -- -- -- 4 -- 10 -- 18 --
Equity securities:
Common stocks 171 3 115 2 101 2 167 3 117 2
Non-redeemable
preferred stocks 31 1 22 1 10 -- -- -- -- --
Other invested assets 189 4 94 2 -- -- 46 1 38 1
Short-term investments 473 10 629 11 916 16 85 1 533 9
- - -----------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS $4,925 100% $5,527 100% 5,621 100% $5,693 100% $6,157 100%
=====================================================================================================
INVESTMENTS AT
CARRYING VALUE $5,143 $5,722 $5,698 $5,872 $5,960
=====================================================================================================
Total Separate Account investments at fair value amounted to approximately $5.1
billion and $5.7 billion at December 31, 1998 and 1997, respectively, with
taxable fixed maturities representing approximately 80.8% and 83.3% of the
total, at December 31, 1998 and 1997, respectively. Approximately 64.3% and
73.8% of Separate Account investments at December 31, 1998 and 1997,
respectively, are used to fund guaranteed investment contracts 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 contract portfolio are matched approximately with the
corresponding payout pattern of the liabilities of the guaranteed investment
contracts.
One Separate Account product is an indexed group annuity contract for
institutional investors which guarantees the Standard and Poor's (S&P) 500 rate
of return plus 25 basis points annually. Deposits are taken from the customer
for a three year period with no payout until the end of the period. CNA
mitigates the risk associated with the contract liability by a combination of
purchasing S&P 500 futures contracts in a notional amount equal initially to the
original customer deposit and investing the remaining cash primarily in high
quality investments. The number of futures contracts is adjusted regularly to
approximate the liability to the contractholder.
CNA believes it has the capacity to hold its fixed maturity portfolio to
maturity. However, fixed maturity securities may be sold as part of CNA's
asset/liability strategies or to take advantage of investment opportunities
generated by changing interest rates, tax and credit considerations, or other
similar factors. Accordingly, the fixed maturity securities are classified as
available-for-sale.
CNA FINANCIAL CORPORATION
-------------------------
42
- - ----------------------------------------------------------------------------
Investments (cont.)
The general account portfolio consists primarily of high quality (rated BBB or
higher) marketable fixed maturities, 93.3% and 95.0% of which are rated as
investment grade at December 31, 1998 and 1997, respectively.
The following table summarizes the ratings of CNA's general account fixed
maturity bond portfolio at carrying value (fair value):
- - ------------------------------------------------------------------------------------------
December 31 1998 % 1997 % 1996 %
- - ------------------------------------------------------------------------------------------
(In millions of dollars)
U.S. government and affiliated securities $ 9,443 31.5% $13,679 46.4% $11,623 42.0%
Other AAA rated 11,595 38.7 8,801 29.9 9,277 33.5
AA and A rated 4,884 16.3 3,796 12.9 3,786 13.7
BBB rated 2,061 6.8 1,695 5.8 1,387 5.0
Below investment grade 1,996 6.7 1,480 5.0 1,582 5.8
- - ------------------------------------------------------------------------------------------
TOTAL $29,979 100% $29,451 100% $27,655 100%
==========================================================================================
The following table summarizes the ratings of CNA's guaranteed investment
contract separate account fixed maturity bond portfolio at carrying value (fair
value):
- - ------------------------------------------------------------------------------------------
December 31 1998 % 1997 % 1996 %
- - ------------------------------------------------------------------------------------------
(In millions of dollars)
U.S. government and affiliated securities $ 167 5.2% $ 148 3.9% $ 192 5.0%
Other AAA rated 1,977 61.2 2,401 62.6 2,279 59.0
AA and A rated 476 14.8 569 14.8 723 18.7
BBB rated 339 10.5 406 10.6 345 8.9
Below investment grade 269 8.3 310 8.1 324 8.4
- - ------------------------------------------------------------------------------------------
TOTAL $ 3,228 100% $ 3,834 100% $ 3,863 100%
==========================================================================================
At year end 1998, 1997 and 1996, respectively, 83.1%, 89.8% and 92.0% of the
general account portfolio and 76.8%, 82.1% and 85.7% of the guaranteed
investment contract portfolio, in the tables above, were rated by major
independent rating agencies.
High yield securities are bonds rated as below investment grade by bond rating
agencies and other unrated securities which, in the opinion of management, are
below investment grade (below BBB). High yield securities generally involve a
greater degree of risk than investment grade securities. However, expected
returns should compensate for the added risk. The risk is also considered in the
interest rate assumptions in the underlying insurance products. CNA's
concentration in high yield bonds including Separate Account business was
approximately 4.0% and 3.2% of total assets as of December 31, 1998 and 1997,
respectively.
Included in CNA's fixed maturity securities at December 31, 1998 (general and
guaranteed investment contract portfolios) are $10.3 billion of asset-backed
securities, at fair value, consisting of approximately 15.9% in U.S. government
agency issued pass-through certificates, 51.8% in collater-
CNA FINANCIAL CORPORATION
-------------------------
43
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - -----------------------------------------------------------------------------
Investments (cont.)
alized mortgage obligations (CMOs), 15.0% in corporate asset-backed obligations
and 17.3% in corporate mortgage-backed pass-through certificates. The majority
of CMOs held are actively traded in liquid markets and are priced by
broker-dealers.
CMOs are subject to prepayment risks that tend to vary with changes in interest
rates. During periods of declining interest rates, CMOs generally prepay faster
as the underlying mortgages are prepaid and refinanced by the borrowers in order
to take advantage of the lower rates. Conversely, during periods of rising
interest rates, prepayments generally slow which may result in a decrease in
yield or a loss as a result of the slower prepayments. CNA limits the risks
associated with interest rate fluctuations and prepayments by concentrating its
CMO investments in planned amortization classes with relatively short principal
repayment windows. CNA avoids investments in complex mortgage derivatives
without readily ascertainable market prices. At December 31, 1998, the fair
value of asset-backed securities was greater than the amortized cost by
approximately $163 million compared with net unrealized gains of approximately
$114 million at December 31, 1997.
At December 31, 1998 and 1997, short-term investments primarily consisted of
U.S. Treasury bills and commercial paper. The components of the short-term
investment portfolio were as follows:
SHORT-TERM INVESTMENTS
- - ---------------------------------------------
December 31 1998 1997
- - ---------------------------------------------
(In millions of dollars)
Commercial paper $1,398 $1,850
U.S. treasuries in escrow* 1,011 1,065
U.S. treasuries 506 558
Money markets 401 624
Security repurchase
collateral 132 154
Other 589 633
- - ---------------------------------------------
TOTAL SHORT-TERM
INVESTMENTS $4,037 $4,884
=============================================
*SEE NOTE A TO THE CONSOLIDATED FINANCIAL STATEMENTS.
CNA invests in certain derivative financial instruments primarily to reduce its
exposure to market risk (principally interest rate, equity price and foreign
currency risk).
CNA considers its derivatives as being held for purposes other than trading.
Derivative securities, except for interest rate swaps associated with certain
corporate borrowings, are recorded at fair value at the reporting date, with
changes in market value reflected in realized gains and losses. The interest
rate swaps on corporate borrowings are accounted for using accrual accounting
with the related income or expense recorded as an adjustment to interest
expense; the changes in fair value are not recorded. The Company also uses
derivatives to mitigate the risk associated with its indexed group annuity
contracts by purchasing S&P 500 futures contracts in a notional amount equal to
the contract liability relating to S&P 500 exposure.
CNA FINANCIAL CORPORATION
-------------------------
44
- - ------------------------------------------------------------------------------
Investments (cont.)
CNA's general account investments in bonds and redeemable preferred stocks,
carried at their fair value, were $30.1 billion at December 31, 1998, compared
with $29.5 billion at December 31, 1997. At December 31, 1998 and 1997, net
unrealized gains on fixed maturity securities amounted to approximately $562
million and $528 million, respectively. The gross unrealized gains and losses
for the fixed maturity securities portfolio at December 31, 1998, were $818
million and $256 million, respectively, compared to $644 million and $116
million, respectively, at December 31, 1997.
Net unrealized gains on general account bonds include net unrealized losses on
high yield securities of $101 million and $2 million, at December 31, 1998 and
1997, respectively. Carrying values of high yield securities in the general
account were approximately $2.0 billion and $1.5 billion at December 31, 1998
and 1997, respectively.
The Company's largest equity holding in a single issuer is Global Crossing, Ltd.
(Global Crossing) common stock. As of December 31, 1998, the Company owned
20,037,584 shares, or 9.8% of the outstanding common stock of Global Crossing
which was valued at $904 million at December 31, 1998. Net unrealized gains
associated with this security approximated $841 million at December 31, 1998.
Without registration or an exemption from registration, sales to the public of
the Company's holdings of Global Crossing are governed by Rule 144 of the
Securities Act of 1933 (the Act) and may not commence until August 13, 1999. The
Company has the right, after August 13, 1999 to require Global Crossing to
register under the Act up to 25% of the Company's holdings prior to December 31,
1999.
At December 31, 1998 and 1997, fixed maturity securities in the guaranteed
investment Separate Account contract portfolio, carried at fair value, amounted
to $3.2 billion and $3.8 billion. Net unrealized gains on fixed maturity
securities in these Separate Accounts amounted to approximately $64 million and
$71 million at December 31, 1998 and 1997, respectively. The gross unrealized
gains and losses for the fixed maturity securities portfolio at December 31,
1998, were $84 million and $20 million, respectively, compared to $87 million
and $16 million, respectively, at December 31, 1997.
At December 31, 1998, high yield securities in the guaranteed investment
Separate Account contract portfolio, were carried at fair value, amounted to
$269 million, compared to $310 million at December 31, 1997. Net unrealized
losses on high yield securities held in such Separate Accounts were $9 million
and $1 million at December 31, 1998 and 1997, respectively.
CNA FINANCIAL CORPORATION
-------------------------
45
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - ----------------------------------------------------------------------------
Market Risk
Market Risk:
- - ------------
Market risk is a broad term related to economic losses due to adverse changes in
the fair value of a financial instrument. Market risk is inherent to all
financial instruments, and accordingly, the Company's risk management policies
and procedures include all market risk sensitive financial instruments.
According to the Securities and Exchange Commission (SEC) disclosure rules,
discussions regarding market risk focus on only one element of market risk-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's primary market risk exposures are due to changes in
interest rates, although the Company has certain exposures to changes in equity
prices and foreign currency exchange rates.
Active management of market risk is integral to the Company's operations. The
Company may use the following tools to manage its 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 its existing asset and liability portfolios.
For purposes of this disclosure, market risk sensitive instruments are divided
into two categories: instruments entered into for trading purposes and
instruments entered into for purposes other than trading. The Company's market
risk sensitive instruments presented in the tables on pages 49-50, are
classified as held for purposes other than trading. The Company does not
generally hold or issue derivatives for trading purposes.
INTEREST RATE RISK
The Company has exposure to economic losses due to interest rate risk arising
from changes in the level or volatility of interest rates. The Company attempts
to mitigate its exposure to interest rate risk through active portfolio
management. The Company may also reduce this risk by utilizing instruments such
as interest rate swaps, interest rate caps, commitments to purchase securities,
options, futures and forwards. This exposure is also mitigated by the Company's
asset/liability matching strategy.
EQUITY PRICE RISK
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 which derive their value from such securities or
indexes. CNA attempts to mitigate its exposure to such risks by limiting its
investment in any one security or index.
FOREIGN EXCHANGE RISK
Foreign exchange rate risk arises from the possibility that changes in foreign
currency exchange rates will impact the value of financial instruments. The
Company has foreign exchange exposure when it buys or sells foreign currencies
or financial instruments denominated in a foreign currency. The Company's
foreign transactions are primarily denominated in Canadian Dollars, British
Pounds, German Deutsche Marks, Chilean
CNA FINANCIAL CORPORATION
-------------------------
46
- - ------------------------------------------------------------------------------
Market Risk (cont.)
Pesos, Argentinean Pesos and Japanese Yen. This exposure is mitigated by the
Company's asset/liability matching strategy and through the use of forwards for
those instruments which are not matched.
SENSITIVITY ANALYSIS
CNA monitors its sensitivity to interest rate risk by evaluating the change in
its financial assets and liabilities relative to fluctuations in interest rates.
The evaluation is made using 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's market value at risk and the
resulting effect on stockholders' equity. The analysis presents the sensitivity
of the market value of the Company's financial instruments to selected changes
in market rates and prices. The range of changes chosen reflects the Company's
view of changes which 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's prediction of future market events, but
rather an illustration of the impact of such events.
The sensitivity analysis estimates the change in the market value of the
Company's interest-sensitive assets and liabilities that were held on December
31, 1998 and 1997 due to instantaneous parallel changes in the year-end yield
curve. Also the interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market interest rates, while interest rates
on other types may lag behind changes in market rates. Accordingly, the analysis
may not be indicative of, is not intended to provide, and does not provide a
precise forecast of the effect of changes of market interest rates on the
Company's income or stockholders' equity. Further, the computations do not
contemplate any actions CNA would undertake in response to changes in interest
rates.
The sensitivity analysis assumes an instantaneous shift in market interest
rates, with scenarios of interest rates increasing and decreasing 100 and 150
basis points from their levels at December 31, 1998 and 1997 with all other
variables held constant. A 100 and 150 basis point increase in market interest
rates would result in a pre-tax decrease in the financial instrument position of
$1.7 billion and $2.6 billion, respectively, at December 31, 1998, compared to
$1.6 billion and $2.4 billion, respectively, at December 31, 1997. Similarly, a
100 and 150 basis point decrease in market interest rates would result in a
pre-tax increase in the net financial instrument position of $1.6 billion and
$2.4 billion, respectively, for both periods under comparison.
The Company's debt, including certain related interest rate swap agreements, as
of December 31, 1998 and 1997, is denominated in U.S. dollars. At December 31,
1998 and 1997, approximately 93% and 91%, respectively, of the Company's
long-term debt has been issued at or effectively converted to fixed rates, and
as such, interest expense would not be impacted by interest rate shifts. The
impact of a 100 and 150 basis point increase in interest rates on the fixed rate
debt would result in a decrease in the market value of the debt by $157 million
and $229 million, respectively, at December 31, 1998, compared to $117 million
and $176 million, respectively, at December 31, 1997. The impact of a 100 and
150 basis point decrease in the interest rates would result in an increase in
the market value of fixed rate debt by $174 million and $268 million,
respectively, at current year end, compared to $117 million and $176 million,
respectively, at December 31, 1997. The impact of a 100 and 150 basis point
increase in interest rates on the
CNA FINANCIAL CORPORATION
-------------------------
47
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - -----------------------------------------------------------------------------
Market Risk (cont.)
variable rate debt at December 31, 1998 would result in an
additional $2 million and $3 million, respectively, in interest expense per
year, compared to $3 million and $4 million, respectively, in interest expense
per year at December 31, 1997. Similarly, a 100 and 150 basis point decrease in
interest rates would result in like decreases in interest expense per year.
Equity price risk was measured assuming an instantaneous 10% and 25% change in
the Standard & Poor's 500 Index (the Index) from its level of December 31, 1998
and 1997, with all other variables held constant. The Company's equity holdings
were assumed to be positively correlated with the Index. At December 31, 1998, a
10% and 25% decrease in the Index would result in a $320 million and $795
million decrease, respectively, compared to $177 million and $441 million
decrease, respectively, at December 31, 1997, in the market rate of the
Company's equity investments. Of these amounts, $92 million and $229 million,
respectively, in the current year, and $66 million and $166 million,
respectively, in the prior year would be offset by decreases in liabilities to
customers under variable annuity contracts. Similarly, increases in the Index
would result in like increases in the market value of the Company's equity
investments and increases in liabilities to customers under variable annuity
contracts.
The sensitivity analysis also assumes an instantaneous 10% and 20% change in the
foreign currency exchange rates versus the U.S. dollar from their levels at
December 31, 1998 and 1997, with all other variables held constant. At December
31, 1998, a 10% and 20% strengthening of the U.S. dollar versus other currencies
would result in decreases of $220 million and $441 million, respectively, in the
market value of certain financial instruments that are denominated in foreign
currencies, compared to $47 million and $94 million, respectively, at December
31, 1997. Weakening of the U.S. dollar versus all other currencies would result
in like increases in the market value of certain financial instruments that are
denominated in foreign currencies.
CNA FINANCIAL CORPORATION
-------------------------
48
- - ----------------------------------------------------------------------------
Market Risk (cont.)
The following tables reflect the estimated effects on the market value of the
Company's financial instruments at December 31, 1998 and 1997, due to an
increase in interest rates of 100 basis points, a 10% decline in the S&P 500
index, and a decline of 10% in foreign currency exchange rates.
HELD FOR OTHER THAN TRADING PURPOSES
- - -----------------------------------------------------------------------------
December 31, 1998 Market Interest Currency Equity
Value Rate Risk Risk Risk
- - -----------------------------------------------------------------------------
(In millions of dollars)
General Account:
Fixed maturity securities $30,073 $(1,549) $(156) $ -
Equity securities 1,970 - (21) (197)
Short term investments 4,037 (21) (43) -
Interest rate swaps (20) 9 - -
Interest rate caps 1 1 - -
Other derivative securities 5 9 21 2
- - -----------------------------------------------------------------------------
TOTAL GENERAL ACCOUNT 36,066 (1,551) (199) (195)
- - -----------------------------------------------------------------------------
Separate Account Business:
Fixed maturity securities 4,155 (176) (20) (3)
Equity securities 297 - - (30)
Short term investments 473 - (1) -
Equity index futures 2 4 - (92)
Other derivative securities 2 (1) - -
- - -----------------------------------------------------------------------------
TOTAL SEPARATE ACCOUNT BUSINESS 4,929 (173) (21) (125)
- - -----------------------------------------------------------------------------
TOTAL ALL SECURITIES $40,995 $(1,724) $(220) $(320)
=============================================================================
DEBT $(3,160) $ 157 $ - $ -
=============================================================================
HELD FOR OTHER THAN TRADING PURPOSES
- - -----------------------------------------------------------------------------
December 31, 1997 Market Interest Currency Equity
Value Rate Risk Risk Risk
- - -----------------------------------------------------------------------------
(In millions of dollars)
General Account:
Fixed maturity securities $29,548 $(1,409) $ (20) $ (10)
Equity securities 814 - (7) (82)
Short term investments 4,884 (11) (21) -
Interest rate swaps (12) 20 - -
Interest rate caps 4 4 - -
Other derivative securities 2 1 1 3
- - -----------------------------------------------------------------------------
TOTAL GENERAL ACCOUNT 35,240 (1,395) (47) (89)
- - -----------------------------------------------------------------------------
Separate Account Business:
Fixed maturity securities 4,769 (190) - (1)
Equity securities 206 - - (21)
Short term investments 629 (1) - -
Equity index futures - 1 - (66)
Other derivative securities - (3) - -
- - -----------------------------------------------------------------------------
TOTAL SEPARATE ACCOUNT BUSINESS 5,604 (193) - (88)
- - -----------------------------------------------------------------------------
TOTAL ALL SECURITIES $40,844 $(1,588) $ (47) $(177)
=============================================================================
DEBT $(2,897) $ 117 $ - $ -
=============================================================================
CNA FINANCIAL CORPORATION
-------------------------
49
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - ------------------------------------------------------------------------------
Market Risk (cont.)
The following tables reflect the estimated effects on the market value of the
Company's financial instruments at December 31, 1998 and 1997, due to an
increase in interest rates of 150 basis points, a 25% decline in the S&P 500
index, and a decline of 20% in foreign currency exchange rates.
HELD FOR OTHER THAN TRADING PURPOSES
- - ------------------------------------------------------------------------------
December 31, 1998 Market Interest Currency Equity
Value Rate Risk Risk Risk
- - ------------------------------------------------------------------------------
(In millions of dollars)
General Account:
Fixed maturity securities $30,073 $(2,347) $(313) $ -
Equity securities 1,970 - (42) (493)
Short term investments 4,037 (31) (85) -
Interest rate swaps (20) 14 - -
Interest rate caps 1 1 - -
Other derivative securities 5 14 42 10
- - ------------------------------------------------------------------------------
TOTAL GENERAL ACCOUNT 36,066 (2,349) (398) (483)
- - ------------------------------------------------------------------------------
Separate Account Business:
Fixed maturity securities 4,155 (272) (41) (9)
Equity securities 297 - - (74)
Short term investments 473 (1) (2) -
Equity index futures 2 6 - (229)
Other derivative securities 2 (1) - -
- - ------------------------------------------------------------------------------
TOTAL SEPARATE ACCOUNT BUSINESS 4,929 (268) (43) (312)
- - ------------------------------------------------------------------------------
TOTAL ALL SECURITIES $40,995 $(2,617) $(441) $(795)
==============================================================================
DEBT $(3,160) $ 229 $ - $ -
==============================================================================
December 31, 1997 Market Interest Currency Equity
Value Rate Risk Risk Risk
- - ------------------------------------------------------------------------------
(In millions of dollars)
General Account:
Fixed maturity securities $29,548 $(2,113) $ (39) $ (24)
Equity securities 814 - (14) (204)
Short term investments 4,884 (17) (43) -
Interest rate swaps (12) 30 - -
Interest rate caps 4 7 - -
Other derivative securities 2 1 2 7
- - -----------------------------------------------------------------------------
TOTAL GENERAL ACCOUNT 35,240 (2,092) (94) (221)
- - -----------------------------------------------------------------------------
Separate Account Business:
Fixed maturity securities 4,769 (285) - (3)
Equity securities 206 - - (51)
Short term investments 629 (1) - -
Equity index futures - 2 - (166)
Other derivative securities - (5) - -
- - -----------------------------------------------------------------------------
TOTAL SEPARATE ACCOUNT BUSINESS 5,604 (289) - (220)
- - -----------------------------------------------------------------------------
TOTAL ALL SECURITIES $40,844 $(2,381) $ (94) $(441)
=============================================================================
DEBT $(2,897) $ 176 $ - $ -
=============================================================================
CNA FINANCIAL CORPORATION
-------------------------
50
- - ------------------------------------------------------------------------------
Year 2000
Year 2000:
- - ----------
IMPACT OF YEAR 2000 ON THE COMPANY
The widespread use of computer programs, both in the United States and
internationally, that rely on two digit date fields to perform computations and
decision-making functions may cause computer systems to malfunction when
processing information involving dates beginning in 1999. Such malfunctions
could lead to business delays and disruptions. The Company renovated or replaced
many of its legacy systems and upgraded its systems to accommodate business for
the Year 2000 and beyond. In addition, the Company is checking embedded systems
in computer hardware and other infrastructure such as elevators, heating and
ventilating systems, and security systems.
Based upon its current assessment, CNA estimates that the total cost to replace
and upgrade its systems to accommodate Year 2000 processing is expected to be
approximately $60 to $70 million. As of December 31, 1998, the Company has spent
approximately $59 million on Year 2000 readiness matters. However, prior to
1997, the Company did not specifically separate technology charges for Year 2000
from other information technology charges. In addition, while some hardware
charges are included in the budget figures, the Company's hardware costs
typically are included as part of ongoing technology updates and not
specifically as part of the Year 2000 project. All funds spent and to be spent
have been or will be financed from current operating funds. The Company believes
that it will be able to resolve the Year 2000 issue in a timely manner. As of
December 31, 1998, CNA has internally certified all of its internal applications
and systems as being ready for the year 2000. However, due to the interdependent
nature of computer systems, there may be an adverse impact on the Company if
banks, independent agents, vendors, insurance agents, third party
administrators, various governmental agencies and other business partners fail
to successfully address the Year 2000 issue. In addition, certain non-insurance
affiliates are not yet Year 2000 ready, but they are expected to be ready on a
timely basis. In the event that they are not, it is unclear at this time whether
the impact on the Company would be material. To mitigate this impact, the
Company is communicating with these various entities to coordinate Year 2000
conversion. The Company already has sent Year 2000 information packages to more
than 12,000 independent agents to encourage them to become Year 2000 ready on a
timely basis. The Company also has sent Year 2000 information to almost 300,000
business policyholders to increase their awareness of the Year 2000 issue.
Similar information packages have been sent to healthcare providers, lawyers and
others with whom the Company has business relationships. Because of the
interdependent nature of the issue, the Company cannot be sure that there will
not be a disruption in its business.
The Company also has developed business resumption plans to ensure that the
Company is able to continue critical processes through other means in the event
that it becomes necessary to do so. Formal strategies have been developed within
each business unit and support organization to include appropriate recovery
processes and use of alternative vendors. More than 200 strategies have been
developed to address all the recovery plans for approximately 400 processes.
These plans are being updated quarterly.
CNA FINANCIAL CORPORATION
-------------------------
51
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - ----------------------------------------------------------------------------
Year 2000 (cont.)
In addition, property/casualty insurance companies may have an underwriting
exposure related to the Year 2000 issue. There can be no assurance that
policyholders will not suffer losses resulting from Year 2000 issues and seek
indemnification under insurance policies underwritten by the Company. Coverage,
if any, will depend on the facts and circumstances of the claim and the
provisions of the policy. It is impossible to estimate with any degree of
accuracy the extent to which various types of policies issued by the Company may
afford coverage for losses or claims. At this time, the Company is unable to
forecast the nature and range of the losses, the availability of coverage for
the losses, or the likelihood of significant claims. As a result, the Company is
unable to determine whether the adverse impact, if any, in connection with the
foregoing circumstances would be material to the Company.
CNA FINANCIAL CORPORATION
-------------------------
52
- - -----------------------------------------------------------------------------
Liquidity and Capital Resources
Liquidity and Capital Resources:
- - --------------------------------
The principal operating cash flow sources of CNA's property/casualty and life
insurance subsidiaries are premiums and investment income. The primary operating
cash flow uses are payments for claims, policy benefits and operating expenses.
Net cash flows from operations are primarily 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.
For the year ended December 31, 1998, net cash used in operating activities was
$949 million, compared with net cash used of $193 million in 1997 and net cash
provided of $620 million in 1996.
The Company had substantially lower operating cash flows in 1998 and 1997,
primarily due to increases in insurance receivables.
On December 24, 1998, CNAF filed a Registration Statement on Form S-3 with the
Securities and Exchange Commission relating to $600 million in senior and
subordinated debt, junior debt, common stock, preferred stock and warrants. As
of December 31, 1998, this registration was not effective.
CNAF has a $795 million revolving credit facility that expires in May 2001. The
amount available is reduced by CNAF's outstanding commercial paper. As of
December 31, 1998, outstanding loans under the credit facility were $235 million
and outstanding commercial paper was $500 million. There was $60 million of
unused borrowing capacity under the facility at year end 1998. The interest rate
on the bank loans 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 bank loans under the credit facility at
December 31, 1998, 1997 and 1996, respectively was 5.49%, 6.16% and 5.72%.
On December 23, 1998, CNAF sold $200 million of preferred stock to its majority
shareholder, Loews Corporation.
In 1998, CNAF issued $1 billion of senior notes under a $1 billion Registration
Statement on Form S-3 filed with the Securities and Exchange Commission on
August 18, 1997. This shelf registration incorporated $250 million of securities
remaining available for issuance from a prior shelf registration. Since filing
this shelf registration, CNAF has issued in four separate offerings senior notes
with an aggregate principal amount of $1 billion. Proceeds from these debt
issues were used to repay or refinance existing debt, provide funds for
acquisitions, and increase the capital of Continental Casualty Company.
On November 15, 1996, CNAF issued $250 million, 6.75% Senior Notes, due
November 15, 2006. On March 1, 1996, CNAF paid, at the due date, $250 million of
8.625% senior notes.
To offset the variable rate characteristics of the credit facility, CNAF entered
into interest rate swap agreements with several banks. These agreements convert
variable debt into fixed debt resulting in fixed rates on notional amounts of
$650 million as of December 31, 1998. The effect of these interest rate swaps
was to increase interest expense by approximately $2 million, $4 million and $7
million for the years ended December 31, 1998, 1997 and 1996, respectively.
CNA FINANCIAL CORPORATION
-------------------------
53
MANAGEMENTS'S DISCUSSION AND ANALYSIS
- - ----------------------------------------------------------------------------
Liquidity and Capital Resources (cont.)
CNAF has a commercial paper program in place, in which it borrows from investors
and replaces a like amount of bank financing. As of December 31, 1998, the
commercial paper program totaled $500 million as compared with $675 million as
of December 31, 1997. The weighted-average interest rate on commercial paper was
5.89%, 6.05% and 5.67% at December 31, 1998, 1997 and 1996 respectively. The
commercial paper borrowings are classified as long-term, as borrowing capacity
under the revolving credit facility will support the commercial paper program
(at an undrawn cost of 9 basis points). The weighted-average interest rate
(interest and facility fees) on the revolving credit facility, commercial paper
and the effect of the interest rate swaps, was 6.36%, 6.35% and 6.28% at
December 31, 1998, 1997 and 1996 respectively.
The table below reflects ratings issued by A.M. Best, Standard and Poor's,
Moody's and Duff & Phelps for CNA's Continental Casualty Company (CCC)
Intercompany Pool, Continental Insurance Company (CIC) Intercompany Pool and
Continental Assurance Company (CAC) Intercompany Pool. Also rated were CNAF's
senior debt, commercial paper and preferred stock and The Continental
Corporation's (Continental) senior debt.
|-----------------|---------------------|------------------------------------|
| | INSURANCE RATINGS | DEBT AND STOCK RATINGS |
| |---------------------|------------------------------------|
| | Financial Strength | |
| |---------------------| |
| | | | | CNA Continental|
| | | | |-----------------|---------|--------|
| | CCC | CAC | CIC |Senior|Commercial|Prefered | Senior |
| | | | |Debt | Paper | Stock | Debt |
| |-----|-----|---------|------|----------|---------|--------|
|A.M. Best | A | A | A- | - | - | - | - |
|Moody's | A1 | A1*| A2 | A3 | P2 | a3 | Baa1 |
|Standard & Poor's| A+ | AA-| A- | A- | A2 | BBB | BBB- |
| |-----|-----|---------| | | | |
| |Claims Paying Ability| | | | |
| |-----|---------------| | | | |
|Duff & Phelps | AA-| AA | - | A- | - | BBB+ | - |
|-----------------|-----|-----|---------|------|----------|---------|--------|
*APPLIES TO CONTINENTAL ASSURANCE COMPANY ONLY.
CNA FINANCIAL CORPORATION
-------------------------
54
- - ----------------------------------------------------------------------------
Accounting Standards
Accounting Standards:
- - ---------------------
ACCOUNTING BY INSURANCE AND OTHER ENTERPRISES FOR INSURANCE-RELATED ASSESSMENTS
In December 1997, the American Institute of Certified Public Accountants'
Accounting Standards Executive Committee issued Statement of Position (SOP)
97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments." SOP 97-3 requires that entities recognize liabilities for
insurance-related assessments when all of the following criteria have been met:
an assessment has been imposed or it is probable that an assessment will be
imposed; the event obligating an entity to pay an imposed or probable assessment
has occurred on or before the date of the financial statements; and the amount
of the assessment can be reasonably estimated. This SOP is effective for
financial statements for fiscal years beginning after December 15, 1998. The
effects of this SOP will result in CNA recording an after-tax charge in the
first quarter of 1999 between $145 million and $175 million as a cumulative
effect of a change in accounting principle.
ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL
USE
In March 1998, the American Institute of Certified Public Accountants'
Accounting Standards Executive Committee issued SOP 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." For purposes
of this SOP, internal-use software is software acquired, internally developed or
modified solely to meet the entity's internal needs for which no substantive
plan exists or is being developed to market the software externally during the
software's development or modification. Accounting treatment for costs
associated with software developed or obtained for internal use, as defined by
this SOP, is based upon a number of factors, including the point in time during
the project that costs are incurred as well as the types of costs incurred. This
SOP is effective for financial statements for fiscal years beginning after
December 15, 1998 and will be adopted in the first quarter of 1999. CNA is
currently evaluating the effects of this SOP.
ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard 133, "Accounting for Derivative Instruments and
Hedging Activities." This statement requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. If certain conditions are
met, a derivative may be specifically designated as (a) a hedge of the exposure
to changes in the fair value of a recognized asset or liability or an
unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows
of a forecasted transaction, or (c) a hedge of the foreign currency exposure of
a net investment in a foreign operation, an unrecognized firm commitment, an
available-for-sale security, or a foreign-currency-denominated forecasted
transaction. The accounting for changes in the fair value of a derivative
depends on the intended use of the derivative and the resulting designation.
This Statement is effective for all fiscal quarters of fiscal years beginning
after June 15, 1999. CNA is currently evaluating the effects of this Statement
on its accounting and reporting for derivative securities and hedging
activities.
CNA FINANCIAL CORPORATION
-------------------------
55
MANAGEMENT'S DISCUSSION AND ANALYSIS
- - --------------------------------------------------------------------------
Accounting Standards (cont.)
REPORTING ON THE COSTS OF START-UP ACTIVITIES
In April 1998, the American Institute of Certified Public Accountants'
Accounting Standards Executive Committee issued SOP 98-5, "Reporting on the
Costs of Start-Up Activities." This SOP requires costs of start-up activities
and organization costs, as defined, to be expensed as incurred. SOP 98-5 is
effective for financial statements in 1999. Initial application of this SOP
should be reported as a change in accounting principle, and will, accordingly,
involve a cumulative adjustment. CNA does not expect the adoption of the SOP to
have a significant impact on the results of operations or equity of CNA.
ACCOUNTING FOR INSURANCE AND REINSURANCE CONTRACTS THAT DO NOT TRANSFER
INSURANCE RISK
In October 1998, the American Institute of Certified Public Accountants'
Accounting Standards Executive Committee issued SOP 98-7, "Accounting for
Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." This
guidance excludes long-duration life and health insurance contracts from its
scope. This SOP is effective for financial statements in the year 2000, with
early adoption encouraged. CNA is currently evaluating the effects of this SOP.
CNA FINANCIAL CORPORATION
-------------------------
56
- - -----------------------------------------------------------------------------
Forward-Looking Statements
Forward-Looking Statements:
- - ---------------------------
The statements contained in this management's discussion and analysis that are
not historical facts are forward-looking statements. When included in this
management's discussion and analysis, the words "believe," "expects," "intends,"
"anticipates," "estimates," and analogous expressions are intended to identify
forward-looking statements. Such statements inherently are subject to a variety
of risks and uncertainties that could cause actual results to differ materially
from those projected. Such risks and uncertainties include, among others, the
impact of competitive products, policies and pricing; product and policy demand
and market responses; development of claims and the effect on loss reserves; the
performance of reinsurance companies under reinsurance contracts with the
Company; general economic and business conditions; changes in financial markets
(interest rate, credit, currency, commodities and stocks) or in the value of
specific investments held by the Company; changes in foreign, political, social
and economic conditions; regulatory initiatives and compliance with governmental
regulations; judicial decisions and rulings; rating agency policies and
practices; the results of financing efforts; the actual closing of contemplated
transactions and agreements and various other matters and risks (many of which
are beyond the Company's control) detailed in the CNAF's Securities and Exchange
Commission filings. These forward-looking statements speak only as of the date
of this report. The Company expressly disclaims any obligation or undertaking to
release publicly any updates or revisions to any forward-looking statement
contained herein to reflect any change in the Company's expectations with regard
thereto or any change in events, conditions or circumstances on which any
statement is based.
CNA FINANCIAL CORPORATION
-------------------------
57
CONSOLIDATED FINANCIAL STATEMENTS
- - -----------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
ASSETS
- - -----------------------------------------------------------------------------------------------
December 31 1998 1997
- - -----------------------------------------------------------------------------------------------
(In millions of dollars,
Investments:
Fixed maturities available for sale
(cost: $29,511 and $29,020).............................................$30,073 $29,548
Equity securities available for sale
(cost: $1,055 and $695)................................................. 1,970 814
Mortgage loans and real estate (less accumulated
depreciation: $1 and $1)................................................ 62 85
Policy loans............................................................... 177 177
Other invested assets...................................................... 858 695
Short-term investments .................................................... 4,037 4,884
- - -----------------------------------------------------------------------------------------------
TOTAL INVESTMENTS 37,177 36,203
- - -----------------------------------------------------------------------------------------------
Cash......................................................................... 217 383
Receivables:
Reinsurance................................................................ 6,365 6,057
Insurance ................................................................. 6,504 6,224
Other ..................................................................... 300 208
Less allowance for doubtful accounts....................................... (328) (303)
Deferred acquisition costs................................................... 2,422 2,142
Prepaid reinsurance premiums................................................. 331 202
Accrued investment income.................................................... 392 389
Receivables for securities sold.............................................. 255 744
Federal income taxes recoverable (includes $234
and $26 due from Loews).................................................... 251 18
Deferred income taxes........................................................ 995 1,070
Property and equipment at cost
(less accumulated depreciation: $695 and $553)............................. 824 747
Intangibles, net of accumulated amortization................................. 368 620
Other assets................................................................. 1,083 1,159
Separate Account business.................................................... 5,203 5,812
- - -----------------------------------------------------------------------------------------------
TOTAL ASSETS $62,359 $61,675
===============================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
CNA FINANCIAL CORPORATION
-------------------------
58
- - -----------------------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS (CONT.)
LIABILITIES AND STOCKHOLDERS' EQUITY
- - -----------------------------------------------------------------------------------------------
December 31 1998 1997
- - -----------------------------------------------------------------------------------------------
(In millions of dollars)
Liabilities:
Insurance reserves:
Claim and claim adjustment expense ....................................$29,192 $29,558
Unearned premiums...................................................... 5,039 4,700
Future policy benefits................................................. 5,418 4,829
Policyholders' funds................................................... 789 742
Collateral on loaned securities........................................... 130 153
Payables for securities purchased......................................... 316 648
Participating policyholders' equity....................................... 140 132
Debt...................................................................... 3,160 2,897
Other liabilities......................................................... 3,611 3,723
Separate Account business................................................. 5,203 5,812
- - -----------------------------------------------------------------------------------------------
TOTAL LIABILITIES 52,998 53,194
- - -----------------------------------------------------------------------------------------------
Commitments and contingent liabilities - Notes A, B, C, E, F, and G
Minority Interest............................................................ 204 172
Stockholders' equity:
Common stock, $2.50 par value;
Authorized - 200,000,000 shares;
Issued - 185,525,907 shares;
Outstanding as of December 31, 1998 -183,889,569 shares
Outstanding as of December 31, 1997 -185,394,786 shares................. 464 464
Preferred stock........................................................... 350 150
Additional paid-in capital................................................ 126 126
Retained earnings......................................................... 7,258 6,983
Accumulated other comprehensive income.................................... 1,064 589
Treasury stock, at cost................................................... (61) (3)
- - -----------------------------------------------------------------------------------------------
9,201 8,309
Notes receivable from officer stockholders............................... (44) -
- - -----------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 9,157 8,309
- - -----------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $62,359 $61,675
===============================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
CNA FINANCIAL CORPORATION
-------------------------
59
CONSOLIDATED FINANCIAL STATEMENTS
- - -----------------------------------------------------------------------------
CONSOLIDATED STATEMENT OF OPERATIONS
- - -----------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 1998 1997 1996
- - -----------------------------------------------------------------------------
(In millions of dollars, except per share data)
- - -----------------------------------------------------------------------------
Revenues:
Premiums.....................................$13,375 $13,482 $13,525
Net investment income........................ 2,146 2,209 2,276
Realized investment gains.................... 695 753 619
Other........................................ 858 628 568
- - -----------------------------------------------------------------------------
17,074 17,072 16,988
- - -----------------------------------------------------------------------------
Claims, benefits and expenses:
Insurance claims and
policyholders' benefits.................. 11,717 11,268 11,371
Amortization of deferred acquisition costs... 2,180 2,138 1,856
Restructuring and other related charges ..... 246 - -
Other operating expenses..................... 2,363 2,100 2,207
Interest expense............................. 219 198 200
- - -----------------------------------------------------------------------------
16,725 15,704 15,634
- - -----------------------------------------------------------------------------
Income before income tax................. 349 1,368 1,354
Income tax expense............................. 47 392 380
Minority interest.............................. 20 10 9
=============================================================================
NET INCOME $ 282 $ 966 $ 965
- - -----------------------------------------------------------------------------
EARNINGS PER SHARE $ 1.49 $ 5.17 $ 5.17
=============================================================================
WEIGHTED AVERAGE OUTSTANDING SHARES
OF COMMON STOCK (IN MILLIONS OF SHARES) 184.9 185.4 185.4
=============================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
CNA FINANCIAL CORPORATION
-------------------------
60
- - ------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Notes
Accumulated Receivable
Additional Other From Total
Common Preferred Paid in Comprehensive Retained Comprehensive Treasury Officer Stockholders'
Stock Stock Capital Income Earnings Income Stock Stockholders Equity
- - --------------------------------------------------------------------------------------------------------------------
(In millions of dollars)
Balance, January 1, 1996 $464 $150 $126 $5,066 $ 933 $ (3) $ - $6,736
Comprehensive income:
Net income.............. - - - $ 965 965 - - - 965
Other comprehensive
loss.................... - - - (634) - (634) - - (634)
-------
Total comprehensive
income............ $ 331
=======
Preferred dividends..... - - - (7) - - - (7)
- - --------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 464 150 126 6,024 299 (3) - 7,060
Comprehensive income:
Net income.............. - - - $ 966 966 - - - 966
Other comprehensive
income.................. - - - 290 - 290 - - 290
--------
Total comprehensive
income............ $1,256
========
Preferred dividends..... - - - (7) - - - (7)
- - --------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 464 150 126 6,983 589 (3) - 8,309
Comprehensive income:
Net income.............. - - - $ 282 282 - - - 282
Other comprehensive
income.................. - - - 475 - 475 - - 475
--------
Total comprehensive
income............ $ 757
========
Issuance of preferred
stock................... - 200 - - - - - 200
Purchase of treasury
stock................... - - - - - (102) - (102)
Sale of treasury stock
and issuance of notes
receivable
from officer
stockholders......... - - - - - 44 (44) -
Preferred dividends..... - - - (7) - - - (7)
- - --------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 $464 $350 $126 $7,258 $1,064 $(61) $(44) $9,157
====================================================================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
CNA FINANCIAL CORPORATION
-------------------------
61
CONSOLIDATED FINANCIAL STATEMENTS
- - ---------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
- - ---------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - ---------------------------------------------------------------------------
(In millions of dollars)
CASH FLOWS FROM OPERATING ACTIVITIES:
- - -------------------------------------
Net income .............................. $ 282 $ 966 $ 965
--------------------------------
Adjustments to reconcile net income
to net cash flows from operating
activities:
Minority Interest ..................... 20 10 9
Deferred income tax provision.......... 47 144 352
Participating policyholders' interest.. 14 8 (5)
Net realized investment gains, pre-tax. (695) (753) (619)
Amortization of intangibles............ 93 30 25
Amortization of bond discount.......... (208) (100) (178)
Depreciation........................... 166 158 138
Changes in:
Receivables, net..................... (655) 147 84
Deferred acquisition costs........... (280) (288) (361)
Accrued investment income............ (3) 119 38
Federal income taxes recoverable..... (233) 116 (1)
Prepaid reinsurance premiums......... (129) 93 200
Insurance reserves................... 624 (133) (358)
Other liabilities.................... 1 (641) 790
Other, net........................... 7 (69) (459)
- - ---------------------------------------------------------------------------
Total adjustments .................. (1,231) (1,159) (345)
- - ---------------------------------------------------------------------------
NET CASH FLOWS FROM
OPERATING ACTIVITIES ............. $ (949) $ (193) $ 620
- - ---------------------------------------------------------------------------
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
CNA FINANCIAL CORPORATION
-------------------------
62
- - ---------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS (cont.)
- - ---------------------------------------------------------------------------
Year Ended December 31 1998 1997 1998
- - ---------------------------------------------------------------------------
(In millions of dollars)
CASH FLOWS FROM INVESTING ACTIVITIES:
- - -------------------------------------
Purchases of fixed maturities............ $(39,039) $(42,492) $(34,312)
Proceeds from fixed maturities:
Sales................................. 35,480 38,429 34,864
Maturities, calls and redemptions..... 3,564 2,997 1,796
Purchases of equity securities........... (1,071) (1,323) (972)
Proceeds from sale of equity securities.. 848 1,406 1,077
Change in short-term investments......... 823 1,112 (2,029)
Purchases of property and equipment ..... (261) (280) (205)
Change in securities sold under
repurchase agreements.................... (23) 53 (674)
Change in other investments.............. 62 421 146
Acquisitions, (net of cash of $1 and $4). (120) (104) -
Other, net............................... 180 (7) 21
NET CASH FLOWS FROM INVESTING ACTIVITIES 443 212 (288)
- - ---------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
- - -------------------------------------
Dividends paid to preferred shareholders.. (7) (6) (6)
Purchase of treasury stock................ (102) - -
Receipts from investment contracts credited
to policyholder account balances......... (20) 7 11
Return of policyholder account
balances on investment contracts.......... 6 (26) (41)
Change in short-term debt................... - - (257)
Principal payments on long-term debt........ (730) (5) (254)
Proceeds from issuance of long-term debt.... 993 137 250
Issuance of preferred stock ................ 200 - -
- - ---------------------------------------------------------------------------
NET CASH FLOWS FROM FINANCING ACTIVITIES 340 107 (297)
- - ---------------------------------------------------------------------------
NET CASH FLOWS........................... (166) 126 35
Cash at beginning of period................. 383 257 222
- - ---------------------------------------------------------------------------
CASH AT END OF PERIOD $ 217 $ 383 $ 257
===========================================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
- - --------------------------------------------------
Cash (paid) received:
Interest expense......................... $ (210) $ (201) $(211)
Federal income taxes..................... (143) (95) 16
Non-cash transactions:
Notes receivable from officer stockholders
for sale of treasury stock.............. (44) - -
===========================================================================
SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
CNA FINANCIAL CORPORATION
-------------------------
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------------------------------------------
Note A -- Significant Accounting Policies
Note A - Significant Accounting Policies:
- - -----------------------------------------
BASIS OF PRESENTATION
- - ---------------------
The Consolidated Financial Statements include CNA Financial Corporation (CNAF)
and its subsidiaries which include 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), collectively CNA, or the Company. Loews
Corporation (Loews) owns approximately 85% of the outstanding common stock of
CNAF.
The accompanying Consolidated Financial Statements have been prepared in
conformity with generally accepted accounting principles. Certain amounts
applicable to prior years have been reclassified to conform to classifications
followed in 1998. All material 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.
BUSINESS
- - ----------------------
CNA serves a wide spectrum of customers, including small, medium and large
businesses; associations; professionals; groups and individuals with a broad
range of insurance and risk management products and services.
Insurance products include property and casualty coverages; life, accident and
health insurance; and pension products and annuities. CNA services include risk
management, information services, health care management and claims
administration. CNA products and services are marketed through agents, brokers,
general agents and direct sales.
INSURANCE
- - -----------------------
PREMIUM REVENUES
Insurance premiums on property/casualty and accident and health insurance
contracts are earned ratably over the terms of the policies after provision for
estimated adjustments on retrospectively rated policies and deductions for ceded
insurance. Revenues on universal life-type contracts are comprised of contract
charges and fees which are recognized over the coverage period. Other life
insurance premiums and annuities are recognized as revenue when due after
deductions for ceded insurance premiums.
CLAIM AND CLAIM ADJUSTMENT EXPENSE RESERVES
Claim and claim expense reserves, except reserves for structured settlements,
workers' compensation lifetime claims and accident and health disability claims,
are not discounted and are based on (a) case basis estimates for losses reported
on direct business, adjusted in the aggregate for ultimate loss expectations,
(b) estimates of unreported
CNA FINANCIAL CORPORATION
--------------------------
64
- - -------------------------------------------------------------------------------
Note A - Significant Accounting Policies (cont.)
losses, (c) estimates of losses on assumed insurance, and (d) estimates of
future expenses to be incurred in settlement of claims. In establishing these
estimates, consideration is given to current conditions and trends as well as
past Company and industry experience. The effects of inflation, which can be
significant, are implicitly considered in the reserving process and are part of
the recorded reserve balance.
Claim and claim adjustment expense reserves represent management's estimates of
ultimate liabilities based on currently available facts and case law and the
ultimate liability may vary significantly from such estimates. CNA regularly
reviews its reserves and any adjustments to the previously established reserves
are reflected in operating income in the period the need for such adjustments
becomes apparent.
Structured settlements have been negotiated for claims on certain
property/casualty insurance policies. Structured settlements are agreements to
provide periodic payments to claimants, which are fixed and determinable as to
the amount and time of payment. Certain structured settlements are funded by
annuities purchased from Continental Assurance Company for which the related
annuity obligations are reflected as part of future policy benefits reserves.
Obligations for structured settlements not funded by annuities are included in
claim and expense reserves and carried at the present values determined using
interest rates ranging from 6.0% to 7.5%. At December 31, 1998 and 1997 the
discounted reserves for unfunded structured settlements were $893 million and
$913 million, respectively (reflecting a discount of $1,511 million and $1,527
million, respectively).
Workers' compensation lifetime claim reserves and accident and health disability
claim reserves are discounted at interest rates allowed by insurance regulators
that range from 3.5% to 6.0% with mortality and morbidity assumptions reflecting
the Company's and current industry experience. At December 31, 1998 and 1997,
such discounted reserves totaled $2,277 million and $2,196 million, respectively
(reflecting a discount of $869 million and $882 million, respectively).
FUTURE POLICY BENEFITS RESERVES
Reserves for traditional life insurance products (whole and term life products)
are computed based upon the net level premium method using actuarial assumptions
as to interest rates, mortality, morbidity, withdrawals and expenses. Actuarial
assumptions include a margin for adverse deviation and generally vary by plan,
age at issue and policy duration. Interest rates range from 3% to 9% and
mortality, morbidity and withdrawal assumptions reflect CNA and industry
experience prevailing at the time of issue. Expense assumptions include the
estimated effects of inflation and expenses beyond the premium paying period.
Reserves for universal life-type contracts are equal to the account balances
that accrue to the benefit of the policyholders. Interest crediting rates ranged
from 4.30% to 7.25% for the three years ended December 31, 1998.
INVOLUNTARY RISKS
CNA's share of involuntary risks is mandatory and generally a function of its
share of the voluntary market by line of insurance in each state. CNA records
the estimated effects of its mandatory participation on an accrual basis, using
either claim payments or premiums written in the current year depending on the
assessment basis. CNA currently records assessments for insolvencies as they are
paid. In 1999, CNA will account for these assessments in compliance with
Statement of Position (SOP) 97-3. SOP-97-3
CNA FINANCIAL CORPORATION
-------------------------
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - -------------------------------------------------------------------------------
Note A - Significant Accounting Policies (cont.)
requires that insurance companies recognize liabilities for insurance-related
assessments when an assessment is probable and will be imposed, when it can be
reasonably estimated, and when the event obligating the entity to pay an imposed
or probable assessment has occurred on or before the date of the financials. In
the first quarter of 1999, CNA will record an after-tax charge between $145
million and $175 million as a cumulative effect of a change in accounting
principle.
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, provide greater diversification of risk
and 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. CNA's life
reinsurance includes coinsurance, yearly renewable term and facultative
programs. Amounts recoverable from reinsurers are estimated in a manner
consistent with the claim or policy reserve liability and shown as a recoverable
in the balance sheet.
DEFERRED ACQUISITION COSTS
Costs of acquiring property/casualty insurance business which vary with and are
primarily related to the production of such business are deferred and amortized
ratably over the period the related premiums are recognized. Such costs include
commissions, premium taxes and certain underwriting and policy issuance costs.
Anticipated investment income is considered in the determination of the
recoverability of deferred acquisition costs.
Life acquisition costs are capitalized and amortized based on assumptions
consistent with those used for computing policy benefit reserves. Acquisition
costs on traditional life business are amortized over the assumed premium paying
periods. Universal life and annuity acquisition costs are amortized in
proportion to the present value of estimated gross profits over the products'
assumed durations. To the extent that unrealized gains or losses on
available-for sale securities would result in an adjustment of deferred policy
acquisition costs had those gains or losses actually been realized, the related
unamortized deferred policy acquisition costs are recorded as an adjustment of
the unrealized gains or losses included in stockholders' equity.
PARTICIPATING BUSINESS
Participating business represented 0.5%, 0.7% and 0.5% of gross life insurance
in force and 0.7%, 0.7% and 0.7% of life insurance premium income for 1998,
1997, and 1996, respectively. Participating policyholders' equity is determined
by allocating 90% of the net income or loss and unrealized investment gains or
losses related to such business as allowed by applicable laws, less dividends
determined by the Board of Directors. Revenues and benefits and expenses include
amounts related to participating policies; the net income or loss allocated to
participating policyholders' equity is a component of insurance claims and
policyholders' benefits.
CNA FINANCIAL CORPORATION
--------------------------
66
- - -------------------------------------------------------------------------------
Note A - Significant Accounting Policies (cont.)
INVESTMENTS
- - -------------------------------------
VALUATION OF INVESTMENTS
CNA classifies its fixed maturities (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 maturities is adjusted for amortization
of premiums and accretion of discounts to maturity. The amortization and
accretion are included in investment income.
CNA accounts for its derivative securities under the fair value method and
includes them in other invested assets, except for interest rate swaps
associated with certain corporate borrowings. Under this method, the derivative
securities are recorded in the balance sheet at fair value at the reporting date
with changes in fair value reflected in realized investment gains and losses.
For interest rate swaps associated with certain corporate borrowings, amounts
due or payable under these swaps are recorded as an adjustment to interest
expense and changes in the fair value of the swaps are not reflected in the
Company's financial statements.
Mortgage loans are carried at unpaid principal balances, including unamortized
premium or discount. Real estate is carried at depreciated cost. Policy loans
are carried at unpaid balances. Short-term investments are carried at amortized
cost, which approximates fair value.
Other invested assets include joint ventures, limited partnerships, certain
derivative securities and other investments. The joint ventures and limited
partnerships are carried at cost plus CNA's equity interest in changes in the
investee's net assets. CNA's equity interest in such changes is reflected in
investment income, realized investment gains/losses and unrealized investment
gains/losses, as appropriate.
The Company may from time to time invest in securities which have a limited
market or the sale of which may be restricted in whole or in part. The Company
carries these securities at fair value, with unrealized investment gains and
losses reflected as a separate component of accumulated other comprehensive
income.
INVESTMENT GAINS AND LOSSES
All securities transactions are recorded on the trade date. Realized investment
gains and losses are determined on the basis of the amortized cost of the
specific securities sold. Investments are written down to estimated fair values,
and losses are charged to income when a decline in value is considered to be
other than temporary.
Unrealized investment gains and losses on fixed maturity securities and equity
securities are reflected as part of stockholders' equity (accumulated other
comprehensive income), net of minority interest, applicable deferred income
taxes and participating policyholders' interest.
EQUITY IN AFFILIATES
CNA uses the equity method of accounting for investments in companies in which
its ownership interest is at least twenty percent but not greater than fifty
percent. Equity in operating income of these affiliates is reflected in other
income. Equity in investment gains/losses is included in realized investment
gains/losses or unrealized investment gains/losses as appropriate.
CNA FINANCIAL CORPORATION
-------------------------
67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - -------------------------------------------------------------------------------
Note A - Significant Accounting Policies (cont.)
SECURITIES LENDING ACTIVITIES
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.
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 F. The
majority of the funds are included in short-term investments and are invested
primarily in U.S. Treasury securities. The escrow account amounted to $1,130
million and $1,098 million at December 31, 1998 and 1997, respectively.
SEPARATE ACCOUNT BUSINESS
- - --------------------------------
Continental Assurance Company and Valley Forge Life Insurance Company write
certain investment and annuity contracts. The supporting assets and liabilities
of these contracts are legally segregated and reflected as assets and
liabilities of Separate Account business. Continental Assurance Company
guarantees principal and a specified return to the contractholders on
approximately 64% and 74% of the Separate Account business at December 31, 1998
and 1997, respectively. Substantially all assets of the Separate Account
business are carried at fair value. Separate Account liabilities are carried at
contract values.
INCOME TAXES ---------------------------------- The provision for income taxes
includes deferred taxes, resulting from temporary differences between the
financial statement and tax return bases of assets and liabilities under the
liability method. Temporary differences primarily relate to insurance reserves
(principally claim reserve discounting and unearned premium reserves), net
unrealized investment gains/losses and deferred acquisition costs.
PROPERTY AND EQUIPMENT
- - -------------------------------------
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 determined principally on accelerated methods. The
cost of maintenance and repairs is charged to income as incurred; major
improvements are capitalized.
MANAGEMENT SERVICES
- - --------------------------------------
CNA reimburses Loews or pays directly for management services, travel and
similar expenses, and expenses of investment facilities and services provided to
CNA. Such reimbursements amounted to approximately $13 million, $11 million and
$15 million in 1998, 1997 and 1996, respectively.
CNA FINANCIAL CORPORATION
-------------------------
68
- - -------------------------------------------------------------------------------
Note A - Significant Accounting Policies (cont.)
EARNINGS PER SHARE
- - ----------------------------------------
Earnings per share applicable to common stock are based on weighted average
outstanding shares, retroactively adjusted to reflect all stock splits. CNAF has
no stock options or warrants; therefore, basic and fully diluted earnings per
share are the same.
The computation of earnings per share for December 31, 1998, 1997 and 1996 was
as follows:
- - ----------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - ----------------------------------------------------------------
(In millions, except per share amounts)
Net income $ 282 $ 966 $ 965
Less: Preferred dividend (7) (7) (7)
- - ----------------------------------------------------------------
Net income applicable
to common stock $ 275 $ 959 $ 958
Weighted average
outstanding
common shares 184.9 185.4 185.4
- - ----------------------------------------------------------------
EARNINGS PER SHARE $1.49 $5.17 $5.17
================================================================
CNA FINANCIAL CORPORATION
-------------------------
69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - -----------------------------------------------------------------------------
Note B -- Investments
Note B - Investments:
- - ---------------------
NET INVESTMENT INCOME
- - -----------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - -----------------------------------------------------------------------------
(In millions of dollars)
Fixed maturities:
Bonds:
Taxable $1,490 $1,522 $1,716
Tax-exempt 340 288 273
Redeemable preferred stocks 2 7 2
Equity securities 33 37 25
Mortgage loans and real estate 5 10 11
Policy loans 11 6 12
Short-term investments 241 321 231
Security repurchase transactions-net 10 9 4
Other 67 56 45
- - -----------------------------------------------------------------------------
2,199 2,256 2,319
Investment expense (53) (47) (43)
- - -----------------------------------------------------------------------------
NET INVESTMENT INCOME $2,146 $2,209 $2,276
=============================================================================
CNA FINANCIAL CORPORATION
-------------------------
70
- - ----------------------------------------------------------------------------
Note B -- Investments (cont.)
ANALYSIS OF INVESTMENT GAINS (LOSSES)
- - ----------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - ----------------------------------------------------------------------------
(In millions of dollars)
Realized investment gains and (losses):
Fixed maturities $467 $452 $293
Equity securities 38 103 216
Derivative securities 12 (7) 18
Other, including guaranteed Separate Account business 178 205* 92
--------------------
695 753 619
Allocated to participating policyholders (14) (15) (14)
Income tax expense (247) (260) (218)
- - ----------------------------------------------------------------------------
Net realized investment gains 434 478 387
- - ----------------------------------------------------------------------------
Change in net unrealized investment gains and (losses):
Fixed maturities 34 347 (878)
Equity securities 796 (38) (24)
Other, including guaranteed Separate Account business (107) 72 (122)
--------------------
723 381 (1,024)
Minority interest (6) (5) 5
Allocated to participating policyholders - (4) 18
Income tax (expense) benefit (249) (101) 357
- - ----------------------------------------------------------------------------
Change in net unrealized investment gains (losses) 468 271 (644)
- - ----------------------------------------------------------------------------
NET REALIZED AND UNREALIZED
INVESTMENT GAINS (LOSSES) $902 $749 $(257)
============================================================================
*INCLUDES $95 MILLION RELATED TO THE CNA SURETY TRANSACTION.
SUMMARY OF PROCEEDS FROM SALES AND GROSS REALIZED INVESTMENT GAINS (LOSSES)
FOR FIXED MATURITIES AND EQUITY SECURITIES
- - ----------------------------------------------------------------------------
1998 1997 1996
--------------------- ----------------------- -----------------------
Fixed Equity Fixed Equity Fixed Equity
Year Ended December 31 Maturities Securities Maturities Securities Maturities Securities
- - -----------------------------------------------------------------------------------------------
(In millions of dollars)
Proceeds from sales $35,480 $848 $38,429 $1,406 $34,864 $1,077
===============================================================================================
Gross realized gains $ 621 $119 $ 651 $ 137 $ 412 $ 241
Gross realized losses (154) (81) (199) (34) (119) (25)
- - -----------------------------------------------------------------------------------------------
NET REALIZED GAINS
ON SALES $ 467 $ 38 $ 452 $ 103 $ 293 $ 216
===============================================================================================
CNA FINANCIAL CORPORATION
-------------------------
71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ----------------------------------------------------------------------------
Note B - Investments (cont.)
ANALYSIS OF NET UNREALIZED INVESTMENT GAINS (LOSSES)
INCLUDED IN STOCKHOLDERS' EQUITY
- - -----------------------------------------------------------------------------------------
1998 1997
------------------------------- ---------------------------
December 31 Gains Losses Net Gains Losses Net
- - -----------------------------------------------------------------------------------------
(In millions of dollars)
Fixed maturities $ 818 $ (256) $ 562 $ 644 $ (116) $ 528
Equity securities 1,051 (136) 915 190 (71) 119
Other, including guaranteed
Separate Account business 217 (166) 51 268 (110) 158
--------------------------------------------------------------
$2,086 $ (558) 1,528 $1,102 $ (297) 805
==================== ================
Minority Interest (6) -
Allocated to participating
policyholders (4) (4)
Deferred income taxes (527) (278)
- - --------------------------------------------------------------------------------------------
NET UNREALIZED
INVESTMENT GAINS $ 991 $ 523
============================================================================================
SUMMARY OF INVESTMENTS IN FIXED MATURITIES
AND EQUITY SECURITIES AVAILABLE FOR SALE
- - ------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
December 31, 1998 Cost Gains Losses Value
- - ------------------------------------------------------------------------------
(In millions of dollars)
United States Treasury securities and
obligations of government agencies $ 7,568 $ 183 $ 17 $ 7,734
Asset-backed securities 8,096 130 12 8,214
States, municipalities and political
subdivisions - tax-exempt $ 6,127 206 12 6,321
Corporate securities 5,074 135 143 5,066
Other debt securities 2,610 104 70 2,644
Redeemable preferred stocks 36 60 2 94
- - -----------------------------------------------------------------------------
Total fixed maturities 29,511 818 256 30,073
Equity securities 1,055 1,051 136 1,970
- - ------------------------------------------------------------------------------
TOTAL $30,566 $1,869 $392 $32,043
==============================================================================
CNA FINANCIAL CORPORATION
-------------------------
72
- - -----------------------------------------------------------------------------
Note B - Investments (cont.)
SUMMARY OF INVESTMENTS IN FIXED MATURITIES
AND EQUITY SECURITIES AVAILABLE FOR SALE
- - ------------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Market
December 31, 1997 Cost Gains Losses Value
- - ------------------------------------------------------------------------------
(In millions of dollars)
United States Treasury securities and
obligations of government agencies $12,883 $119 $ 22 $12,980
Asset-backed securities 4,716 98 10 4,804
States, municipalities and political
subdivisions - tax-exempt 4,534 194 4 4,724
Corporate securities 5,253 142 49 5,346
Other debt securities 1,567 61 31 1,597
Redeemable preferred stocks 67 30 - 97
- - ------------------------------------------------------------------------------
Total fixed maturities 29,020 644 116 29,548
Equity securities 695 190 71 814
- - ------------------------------------------------------------------------------
TOTAL $29,715 $834 $187 $30,362
==============================================================================
SUMMARY OF INVESTMENTS IN FIXED MATURITIES
BY CONTRACTUAL MATURITY
- - -----------------------------------------------------------------------------
1998 1997
------------------- ------------------
Amortized Market Amortized Market
December 31 Cost Value Cost Value
- - -----------------------------------------------------------------------------
(In millions of dollars)
Due in one year or less $ 3,167 $ 3,273 $ 2,058 $ 2,077
Due after one year through five years 5,419 5,437 11,520 11,525
Due after five years through ten years 5,380 5,353 3,323 3,373
Due after ten years 7,449 7,796 7,403 7,769
Asset-backed securities not due
at a single maturity date 8,096 8,214 4,716 4,804
- - -----------------------------------------------------------------------------
TOTAL $29,511 $30,073 $29,020 $29,548
=============================================================================
Actual maturities may differ from contractual maturities because securities may
be called or prepaid with or without call or prepayment penalties.
The carrying value of investments (other than equity securities) that have not
produced income for the last twelve months is $23 million at December 31, 1998.
At December 31, 1998, there were no investments in a single issuer, other than
the U.S. government, that, when aggregated exceeded 10% of stockholders' equity.
The Company's largest equity holding in a single issuer is Global Crossing, Ltd.
(Global Crossing) common stock. On December 31, 1998, the
CNA FINANCIAL CORPORATION
-------------------------
73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------------------------------------------
Note B - Investments (cont.)
Company owned 20,037,584 shares, or 9.8% of the outstanding common stock of
Global Crossing which was valued at $904 million. Net unrealized gains
associated with this security approximated $841 million at December 31, 1998.
Without registration or an exemption from registration, sales to the public of
the Company's holdings of Global Crossing are governed by Rule 144 of the
Securities Act of 1933 (the Act) and may not commence until August 13, 1999. The
Company has the right after August 13, 1999 to require Global Crossing to
register under the Act up to 25% of the Company's holdings prior to December 31,
1999.
STATUTORY DEPOSITS
- - -----------------------------------
Cash and securities with carrying values of $1.7 billion and $2.1 billion were
deposited by CNAF's subsidiaries under requirements of regulatory authorities as
of December 31, 1998 and 1997, respectively.
CNA FINANCIAL CORPORATION
-------------------------
74
- - -----------------------------------------------------------------------------
Note C - Financial Instruments
NOTE C - Financial Instruments:
- - ------------------------------
In the normal course of business, CNA invests in various financial assets,
incurs various financial liabilities, and enters into agreements involving
derivative securities, including off-balance sheet financial instruments.
Fair values are required to be disclosed for all financial instruments, whether
or not recognized in the consolidated balance sheet, for which it is practicable
to estimate that value. In cases where quoted market prices are not available,
fair values may be based on estimates using present value or other valuation
techniques. These techniques are significantly affected by the assumptions used,
including the discount rates and estimates of future cash flows. Potential taxes
and other transaction costs have not been considered in estimating fair value.
The estimates presented herein are subjective in nature and are not necessarily
indicative of the amounts that CNA could realize in a current market exchange.
Non-financial instruments such as real estate, deferred acquisition costs,
property and equipment, deferred income taxes, intangibles and insurance
reserves are excluded from fair value disclosure. Thus, the total fair value
amounts cannot be aggregated to determine the underlying economic value of CNA.
The carrying amounts reported in the consolidated balance sheet approximates
fair value for cash, short-term investments, accrued investment income,
receivables for securities sold, federal income taxes recoverable, securities
sold under repurchase agreements, payables for securities purchased and certain
other assets and other liabilities because of their short-term nature.
Accordingly, these assets and liabilities are not listed in the following
tables.
The carrying amounts and estimated fair values of CNA's other financial
instrument assets and liabilities are listed in the following tables. Derivative
instruments are shown in a separate table.
CNA FINANICIAL CORPORATION
--------------------------
75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - -------------------------------------------------------------------------------
Note C -- Financial Instruments (cont.)
FINANCIAL ASSETS
- - -------------------------------------------------------------------------------------
1998 1997
--------------------- --------------------
Carrying Estimated Carrying Estimated
December 31 Amount Fair Value Amount Fair Value
- - -------------------------------------------------------------------------------------
(In millions of dollars)
Investments:
Fixed maturities $ 30,073 $ 30,073 $ 29,548 $ 29,548
Equity securities 1,970 1,970 814 814
Mortgage loans 57 61 80 83
Policy loans 177 173 177 168
Other invested assets 858 858 695 695
Separate Account business:
Fixed maturities 4,155 4,155 4,769 4,769
Equity securities 297 297 206 206
Other 216 216 117 117
Notes receivable from officer shareholders 44 39 - -
- - -------------------------------------------------------------------------------------
The following methods and assumptions were used by CNA in estimating the fair
value for the above financial assets.
Fixed maturity securities 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, costs to
settle or quoted market prices of comparable instruments.
The fair values for mortgage loans and policy loans were estimated using
discounted cash flow analyses at interest rates currently offered for similar
loans to borrowers with comparable credit ratings. Loans with similar
characteristics were aggregated for purposes of the calculations.
Valuation techniques to determine fair value of other invested assets and other
Separate Account business assets consisted of discounted cash flows and quoted
market prices of the investments, comparable instruments or underlying assets of
the investments.
CNA FINANCIAL CORPORATION
-------------------------
76
- - -------------------------------------------------------------------------------
Note C - Financial Instruments (cont.)
FINANCIAL LIABILITIES
- - -------------------------------------------------------------------------------
1998 1997
-------------------- -------------------
Carrying Estimated Carrying Estimated
December 31 Amount Fair Value Amount Fair Value
- - -------------------------------------------------------------------------------
(In millions of dollars)
Premium deposits and annuity contracts $ 1,259 $ 1,205 $ 1,194 $ 1,145
Debt 3,160 3,179 2,897 2,928
Financial guarantee contracts 240 231 382 373
Separate Account business:
Guaranteed investment contracts 2,423 2,478 3,414 3,448
Variable separate accounts 1,268 1,268 997 997
Deferred annuities 85 102 73 90
Other 600 600 614 614
- - ------------------------------------------------------------------------------
Premium deposits and annuity contracts were valued based on cash surrender
values and the outstanding fund balances.
CNA's Senior Notes and debentures were valued based on quoted market prices. The
fair value for other long-term debt was estimated using discounted cash flow
analyses, based on current incremental borrowing rates for similar types of
borrowing arrangements.
The fair value of the liability for financial guarantee contracts was based on
discounted cash flows utilizing interest rates currently being offered for
similar contracts.
The fair values of guaranteed investment contracts and deferred annuities of the
Separate Account business were estimated using discounted cash flow
calculations, based on interest rates currently being offered for similar
contracts with similar maturities. The fair values of the liabilities for
variable Separate Account business are based on the quoted market values of the
underlying assets of each variable Separate Account. The fair value of other
Separate Account business liabilities approximated their carrying value.
CNA FINANCIAL CORPORATION
-------------------------
77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------------------------------------------
Note C - Financial Instruments (cont.)
DERIVATIVE FINANCIAL INSTRUMENTS
- - --------------------------------------------
CNA invests in derivative financial instruments in the normal course of business
primarily to reduce its exposure to market risk (principally interest rate,
equity stock price and foreign currency risk). Financial instruments used for
such purposes include interest rate swaps, interest rate caps, put and call
options, commitments to purchase securities, futures and forwards. The Company
generally does not hold or issue these instruments for trading purposes. CNA
also uses derivatives to mitigate the risk associated with its indexed group
annuity contracts by purchasing S&P 500 futures contracts in a notional amount
equal to the portion of the customer liability related to S&P 500 exposure.
The gross notional principal or contractual amounts of derivative financial
instruments in the general account at December 31, 1998 and 1997 totaled $1,667
million and $1,609 million, respectively. The gross notional principal or
contractual amounts of derivative financial instruments in the Separate Accounts
totaled $1,193 million and $956 million at December 31, 1998 and 1997,
respectively. The contractual or notional amounts 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 agreements.
The fair values associated with derivative financial instruments are generally
affected by interest rates, equity prices and foreign currency exchange rates.
The credit exposure associated with these instruments is generally limited to
the unrealized fair value of the instruments and will vary based on the
creditworthiness of the counterparties. Although the Company is exposed to the
aforementioned credit risk, it does not expect any counterparty to fail to
perform as contracted based on the creditworthiness of the counterparties. Due
to the nature of the derivative securities, the Company does not require
collateral.
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.
CNA FINANCIAL CORPORATION
-------------------------
78
- - -------------------------------------------------------------------------------
Note C - Financial Instruments (cont.)
A summary of the aggregate contractual or notional amounts, estimated fair
values and gains or losses related to derivative financial instruments as of and
for the year ended December 31, 1998 and 1997 are presented below.
- - ---------------------------------------------------------------------------------------------
CONTRACTUAL/ ASSET/(LIABILITY) RECOGNIZED
DECEMBER 31, 1998 NOTIONAL AMOUNT FAIR VALUE GAIN (LOSS)
- - ---------------------------------------------------------------------------------------------
(In millions of dollars)
General Account
Interest rate swaps - corporate borrowings $ 650 $(10) $ --
Interest rate swaps - other 78 (10) (30)
Interest rate caps 500 1 (2)
Futures - short 158 -- (3)
Forwards 211 (1) (6)
Options purchased 70 3 51
Options written -- -- 2
- - ---------------------------------------------------------------------------------------------
TOTAL $1,667 $(17) $ 12
=============================================================================================
Separate Accounts
Futures - long $ 928 $ 2 $ 156*
Futures - short 51 -- (1)
Forwards 2 -- --
Commitments to purchase government
and municipal securities 69 1 4
Options purchased 77 1 (1)
Options written 66 -- 2
- - ---------------------------------------------------------------------------------------------
TOTAL $1,193 $ 4 $ 160
=============================================================================================
*AMOUNT IS OFFSET BY AN INCREASE IN THE LIABILITY TO PARTICIPANTS.
CNA FINANCIAL CORPORATION
-------------------------
79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - -----------------------------------------------------------------------------
Note C - Financial Instruments (cont.)
- - -----------------------------------------------------------------------------------------------
CONTRACTUAL/ ASSET/(LIABILITY) RECOGNIZED
DECEMBER 31, 1997 NOTIONAL AMOUNT FAIR VALUE GAIN (LOSS)
- - -----------------------------------------------------------------------------------------------
(In millions of dollars)
General Account
Interest rate swaps - corporate borrowings $ 950 $ (4) $ --
Interest rate swaps - other 59 (8) (8)
Interest rate caps 500 4 (1)
Futures - short 21 -- (1)
Forwards 11 -- 7
Commitments to purchase government
and municipal securities -- -- 1
Options purchased 67 2 (5)
Options written 1 -- --
- - -------------------------------------------------------------------------------------------------
TOTAL $1,609 $ (6) $ (7)
=================================================================================================
Separate Accounts
Futures - long $ 663 $ -- $ 112*
Futures - short 48 -- --
Forwards 1 -- --
Commitments to purchase government
and municipal securities 80 -- 1
Options purchased 91 -- (1)
Options written 73 -- 2
- - --------------------------------------------------------------------------------------------------
TOTAL $ 956 $ -- $ 114
==================================================================================================
*AMOUNT IS OFFSET BY AN INCREASE IN THE LIABILITY TO PARTICIPANTS.
An interest rate swap is an agreement in which two parties agree to exchange, at
specified intervals, interest payment streams calculated on an agreed-upon
notional principal amount with at least one stream based upon a specified
floating rate index. CNAF has entered into interest rate swap agreements to
convert the variable rate of the borrowing under the revolving credit facility
and the commercial paper program to a fixed rate. At December 31, 1998 and 1997,
CNAF had outstanding interest rate swap agreements with several banks having a
total notional principal amount of $650 million and $950 million, respectively.
Those agreements, which terminate from May 2000 to December 2000, effectively
fixed CNAF's interest rate exposure on $650 million and $950 million of variable
rate debt, respectively.
CNA FINANCIAL CORPORATION
-------------------------
80
- - -----------------------------------------------------------------------------
Note C - Financial Instruments (cont.)
CNA also has outstanding trading interest rate swaps which primarily represent
an exchange of the 90-day treasury bill rate for the change in the Goldman Sachs
Commodities Index.
Futures are contracts to buy or sell a standard quantity and quality of a
commodity, financial instrument or index at a specified future date and price.
Forwards are contracts between two parties to purchase and sell a specific
quantity of a commodity, government security, foreign currency, or other
financial instrument at a price specified at contract inception, with delivery
and settlement at a specified future date.
Commitments to purchase government and municipal securities are agreements to
purchase securities in the future at a predetermined price.
Options are contracts that grant the purchaser, for a premium payment, the
right, but not the obligation, to either purchase or sell a financial instrument
at a specified price within a specified period of time.
An interest rate cap consists of a guarantee given by the issuer to the
purchaser in exchange for the payment of a premium. This guarantee states that
if interest rates rise above a specified rate the issuer will pay to the
purchaser the difference between the then current market rate and the specified
rate on the notional principal amount.
CNA FINANCIAL CORPORATION
-------------------------
81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - -----------------------------------------------------------------------------
Note D -- Income Taxes
Note D - Income Taxes:
- - ----------------------
CNAF and its eligible subsidiaries (CNA Tax Group) are included in the
consolidated Federal income tax return of Loews and its eligible subsidiaries.
Loews and CNAF have agreed that for each taxable year, CNA will (i) be paid by
Loews the amount, if any, by which the Loews consolidated Federal income tax
liability is reduced by virtue of the inclusion of the CNA Tax Group in the
Loews consolidated Federal income tax return, or (ii) pay to Loews an amount, if
any, equal to the Federal income tax which 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, CNAF may be required
to repay tax recoveries previously received from Loews. This agreement between
Loews and CNAF may be canceled by either party upon thirty days written notice.
For 1998, the inclusion of the CNA Tax Group in the consolidated Federal income
tax return of Loews has resulted in a decreased Federal income tax liability for
Loews. Accordingly, Loews has paid or will pay to CNAF approximately $83 million
for 1998. In 1997 and 1996, the inclusion of the CNA Tax Group increased the
Federal income tax liability for Loews. Accordingly, CNAF has paid Loews
approximately $210 million for 1997 and $99 million for 1996.
CNA FINANCIAL CORPORATION
-------------------------
82
- - -------------------------------------------------------------------------------
Note D -- Income Taxes (cont.)
A reconciliation between the statutory Federal income tax rate and CNA's
effective income tax rate as a percentage of income before income taxes, after
giving effect to minority interest, is as follows:
- - ---------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - ---------------------------------------------------------------------------
Income taxes at statutory rates 35.0% 35.0% 35.0%
Tax exempt interest and dividends received deduction (31.3) (6.7) (6.4)
State income taxes 8.3 1.5 0.7
Other 2.3 (0.9) (1.0)
- - ---------------------------------------------------------------------------
EFFECTIVE INCOME TAX RATE 14.3% 28.9% 28.3%
===========================================================================
The composition of CNA's total income tax expense allocated between operating
income and realized investment gains and losses is as follows:
- - ---------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - ---------------------------------------------------------------------------
(In millions of dollars)
Income tax (benefit) expense on operating income $(200) $132 $162
Income tax expense on realized investment gains 247 260 218
- - ---------------------------------------------------------------------------
TOTAL INCOME TAX EXPENSE $ 47 $392 $380
===========================================================================
The current and deferred components of CNA's income tax expense are as follows:
- - ---------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - ---------------------------------------------------------------------------
(In millions of dollars)
Current tax expense $ - $248 $ 28
Deferred tax expense 47 144 352
- - ---------------------------------------------------------------------------
TOTAL INCOME TAX EXPENSE $ 47 $392 $380
===========================================================================
CNA FINANCIAL CORPORATION
-------------------------
83
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------------------------------------------
Note D - Income Taxes (cont.)
CNA's deferred income taxes reflect the net effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
CNA's deferred tax assets and liabilities as of December 31, 1998 and 1997,
respectively, are set forth in the table below. The 1998 amounts reflect an
increase in certain components of net deferred tax assets as a result of the
finalization of an Internal Revenue Service examination. Such increase resulted
in a corresponding reduction of intangible assets.
- - -----------------------------------------------------------------
Year Ended December 31 1998 1997
- - -----------------------------------------------------------------
(In millions of dollars)
Insurance reserves:
Property/casualty claim reserves $1,183 $ 1,101
Unearned premium reserves 372 283
Life reserves 195 157
Other insurance reserves 27 22
Deferred acquisition costs (748) (667)
Postretirement benefits other than pensions 142 149
Net unrealized gains (527) (278)
Restructuring costs 56 -
Other, net 295 303
- - -----------------------------------------------------------------
NET DEFERRED TAX ASSETS $ 995 $ 1,070
=================================================================
At December 31, 1998, gross deferred tax assets and liabilities amounted to
approximately $2.7 billion and $1.7 billion, respectively. At December 31, 1997,
gross deferred tax assets and liabilities amounted to approximately $2.7 billion
and $1.6 billion, respectively.
CNA has a history of profitability and as such, CNA's management believes it is
more likely than not that the net deferred tax assets will be realized.
CNA FINANCIAL CORPORATION
-------------------------
84
- - ------------------------------------------------------------------------------
Note E --Liability for Unpaid Claims and Claim Adjustment Expenses
Note E - Liability for Unpaid Claims and Claim Adjustment Expenses:
- - -------------------------------------------------------------------
CNA's property/casualty insurance claims and claim adjustment expense reserves
represent the estimated amounts necessary to settle all outstanding claims,
including claims which are incurred but not reported, 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, loss payments, pending levels of unpaid
claims and product mix, as well as court decisions, economic conditions and
public attitudes. All of these can affect the estimation of reserves.
Establishing loss reserves is an estimation process. Many factors can ultimately
affect the final settlement of a claim and, therefore, the reserve that is
needed. Changes in the law, results of litigation, medical costs, the cost of
repair materials and labor rates can all impact 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.
CNA FINANCIAL CORPORATION
-------------------------
85
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------------------------------------------
Note E -- Liability for Unpaid Claims and Claim Adjustment Expenses (cont.)
The table below provides a reconciliation between beginning and ending claim and
claim adjustment expense reserve balances for 1998, 1997 and 1996.
CHANGES IN RESERVES FOR PROPERTY/CASUALTY
CLAIMS AND CLAIM ADJUSTMENT EXPENSES
- - -------------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - -------------------------------------------------------------------------------
(In millions of dollars)
Reserves at beginning of year:
Gross $28,571 $29,395 $31,044
Ceded 5,326 5,660 6,089
- - -------------------------------------------------------------------------------
Net reserves at beginning of year 23,245 23,735 24,955
Net reserves of acquired insurance companies at date
of acquisition 122 57 --
- - -------------------------------------------------------------------------------
Total net reserves 23,367 23,792 24,955
- - -------------------------------------------------------------------------------
Net incurred claims and claim adjustment expenses:
Provision for insured events of current year 7,903 7,942 7,922
Increase (decrease) in provision for insured
events of prior years 263 (256) (91)
Amortization of discount 143 143 149
- - -------------------------------------------------------------------------------
Total net incurred 8,309 7,829 7,980
- - -------------------------------------------------------------------------------
Net payments attributable to:
Current year events 2,791 2,514 2,676
Prior year events 5,954 5,862 6,524
- - -------------------------------------------------------------------------------
Total net payments 8,745 8,376 9,200
- - -------------------------------------------------------------------------------
Net reserves at end of year 22,931 23,245 23,735
Ceded at end of year 5,424 5,326 5,660
- - -------------------------------------------------------------------------------
GROSS RESERVES AT END OF YEAR* $28,355 $28,571 $29,395
===============================================================================
* EXCLUDES LIFE CLAIM AND CLAIM EXPENSE RESERVES AND INTERCOMPANY ELIMINATIONS
OF $837 MILLION, $987 MILLION AND $1 BILLION AS OF DECEMBER 31, 1998, 1997 AND
1996, RESPECTIVELY, INCLUDED IN THE CONSOLIDATED BALANCE SHEET.
The increase (decrease) in provision for insured events of prior years (reserve
development) is comprised of the following components:
RESERVE DEVELOPMENT-adverse/(favorable)
- - -------------------------------------------------------------------------------
Year Ended December 31 1998 1997 1996
- - -------------------------------------------------------------------------------
(In millions of dollars)
Asbestos $ 243 $ 105 $ 51
Environmental pollution and other mass tort 227 -- 65
Other (207) (361) (207)
- - -------------------------------------------------------------------------------
TOTAL $ 263 $ (256) $ (91)
===============================================================================
CNA FINANCIAL CORPORATION
--------------------------
86
- - -------------------------------------------------------------------------------
Note E - Liability for Unpaid Claims and Claim Adjustment Expenses (cont.)
ENVIRONMENTAL, OTHER MASS TORT AND ASBESTOS RESERVES
- - ----------------------------------------------------
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
(PRPs). Superfund and the mini-Superfunds establish mechanisms to pay for
clean-up of waste sites if PRPs fail to do so, and to assign liability to PRPs.
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 (NPL). The
addition of new clean-up sites to the NPL has slowed in recent years.
Many clean-up sites have been designated by state authorities as well.
Many policyholders have made claims against various CNAF insurance subsidiaries
for defense costs and indemnification in connection with environmental pollution
matters. These claims relate to accident years 1989 and prior, which coincides
with CNA's adoption of the Simplified Commercial General Liability coverage form
which included an absolute pollution exclusion. CNA and the insurance industry
are disputing coverage for many such claims. Key coverage issues include whether
clean-up 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 definition of an occurrence. 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.
However, no reforms were enacted by Congress in 1998 and it is unclear as to
what positions the Congress or the Administration will take and 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 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 liability of CNA for
environmental pollution claims may vary substantially from the amount currently
recorded.
As of December 31, 1998 and 1997, CNA carried approximately $787 million and
$773 million, respectively, of claim and claim adjustment expense reserves, net
of reinsurance recoverables, for reported and unreported environmental pollution
and other mass tort claims. In 1998 CNA
CNA FINANCIAL CORPORATION
-------------------------
87
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------------------------------------------
Note E - Liability for Unpaid Claims and Claim Adjustment Expenses (cont.)
recorded $227 million of adverse development compared to no development in 1997.
The additional strengthening in 1998 was based upon the Company's continuous
review of these types of exposures, as well as its internal study and annual
analysis of environmental pollution and other mass tort claims. This analysis
indicated deterioration in claim experience related to pollution claims, as well
as some emerging mass tort exposures.
CNAF's insurance subsidiaries have exposure to asbestos claims, including those
attributable to CNA's litigation with Fibreboard Corporation. A detailed
discussion of CNA's litigation with Fibreboard Corporation regarding
asbestos-related bodily injury claims can be found in Note F. Estimation of
asbestos claim reserves involves many of the same limitations discussed above
for environmental pollution claims such as inconsistency of court decisions,
specific policy provisions, allocation of liability among insurers, missing
policies and proof of coverage. As of December 31, 1998 and 1997, CNA carried
approximately $1,456 million and $1,400 million, respectively, of claim and
claim adjustment expense reserves, net of reinsurance recoverables, for reported
and unreported asbestos-related claims. In 1998, CNA recorded $243 million of
adverse development compared to $105 million of adverse development in 1997. As
with the Company's exposure to environmental pollution and other mass tort
exposures, the additional reserve strengthening in 1998 for asbestos-related
claims, was a result of management's continuous review of development with
respect to these exposures, as well as a review of the results of the Company's
annual analysis of these claims which was completed in conjunction with the
study of environmental pollution and other mass tort claims. This analysis
indicated deterioration in claims experience and claim counts for
asbestos-related claims.
The results of operations in future years may continue to be adversely affected
by environmental pollution and asbestos claims and claim adjustment expenses.
Management will continue to monitor these liabilities and make further
adjustments as warranted.
OTHER PROPERTY AND CASUALTY RESERVES
- - -------------------------------------------------
Other lines favorable loss and loss adjustment expense reserve development for
1998 of $207 million was due to favorable loss development of approximately $100
million in commercial lines business and approximately $105 million of favorable
loss development in personal lines business. The favorable development in the
commercial lines business was primarily attributable to improved frequency and
severity in the commercial auto lines, as well as some continued improvement in
workers' compensation. The favorable development in the personal lines business
was attributable to improved trends, particularly in personal auto liability.
Other lines favorable loss and loss adjustment expense reserve development for
1997 of $361 million was due to favorable loss development of $540 million in
workers' compensation involuntary risks and $200 million of favorable loss
development in personal lines. This favorable development was offset in part by
unfavorable development in other commercial lines of $379 million.
The favorable loss development in involuntary risks is attributable to better
than expected results in workers' compensation and private passenger automobile
lines stemming from improved frequency and severity in these lines. This
favorable loss development was offset in part by unfavorable premium development
of $340 million as estimates of premiums for prior years were reduced.
CNA FINANCIAL CORPORATION
-------------------------
88
- - ------------------------------------------------------------------------------
Note E - Liability for Unpaid Claims and Claim Adjustment Expenses (cont.)
The favorable loss development in personal lines was attributable to improved
trends particularly in personal auto lines.
The unfavorable development in other commercial lines was attributable to
approximately $240 million in general liability lines as well as adverse trends
in construction defect coverages, approximately $130 million in commercial
multiperil, and adverse loss adjustment expense development of approximately
$215 million, offset in part by favorable development of $206 million, primarily
in workers' compensation and reinsurance lines. This unfavorable loss
development was offset in part by favorable premium development of $170 million.
The other favorable development during 1996 of $207 million was principally due
to favorable experience in the workers' compensation line of business.
CNA FINANCIAL CORPORATION
-------------------------
89
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------------------------------------------
Note E -- Liability for Unpaid Claims and Claim Adjustment Expenses (cont.)
The following tables provide additional data related to CNA's environmental
pollution, other mass tort and asbestos-related claims activity.
RESERVE SUMMARY
- - --------------------------------------------------------------------------------------
December 31 1998 1997
-------------------------- ---------------------------
Environmental Environmental
Pollution and Pollution and
Other Mass Tort Asbestos Other Mass Tort Asbestos
- - --------------------------------------------------------------------------------------
(In millions of dollars)
Reported claims:
Gross reserves $291 $1,305 $279 $1,198
Less reinsurance recoverable (41) (91) (36) (117)
-------------------------------------------------------
Net reported claims 250 1,214 243 1,081
Net unreported claims 537 242 530 319
- - --------------------------------------------------------------------------------------
NET RESERVES $787 $1,456 $773 $1,400
======================================================================================
ENVIRONMENTAL POLLUTION AND
OTHER MASS TORT
CHANGES IN RESERVES
- - ------------------------------------------------------------------
Year ended December 31 1998 1997 1996
- - ------------------------------------------------------------------
(In millions of dollars)
Net reserves at beginning of year $ 773 $ 908 $1,063
Reserve strengthening 227 -- 65
Less: Gross payments 274 258 304
Reinsurance recoveries (61) (123) (84)
------------------------------
Net payments 213 135 220
- - ------------------------------------------------------------------
NET RESERVES AT END OF YEAR $ 787 $ 773 $ 908
==================================================================
ASBESTOS CHANGES IN RESERVES
- - ------------------------------------------------------------------
Year ended December 31 1998 1997 1996
- - ------------------------------------------------------------------
(In millions of dollars)
Net reserves at beginning of year $1,400 $1,506 $2,191
Reserve strengthening 243 105 51
Less: Gross payments 239 268 787
Reinsurance recoveries (52) (57) (51)
-------------------------------
Net payments 187 211 736
- - --------------------------------------------------------------------
NET RESERVES AT END OF YEAR $1,456 $1,400 $1,506
====================================================================
CNA FINANCIAL CORPORATION
-------------------------
90
- - -----------------------------------------------------------------------------
Note F -- Legal Proceedings and Contingent Liabilities
Note F - Legal Proceedings and Contingent Liabilities:
- - ------------------------------------------------------
FIBREBOARD LITIGATION
- - ----------------------------------------
CNAF'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 Agreement to resolve all future
asbestos-related bodily injury claims involving Fibreboard, which is subject to
court approval.
Casualty, Fibreboard and Pacific Indemnity have also reached an agreement (the
"Trilateral Agreement") on a settlement to resolve the coverage litigation in
the event the Global Settlement Agreement 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 the matter to the Fifth Circuit for reconsideration in light of the
Supreme Court's decision in Amchem Products Co. v. Windsor.
-------------------------------
On January 27, 1998, a panel of the United States Fifth Circuit Court of Appeals
again approved the Global Settlement Agreement by a 2 to 1 vote. Two sets of
Objectors filed petitions for certiorari, which were docketed on April 16 and
17, 1998, by the United States Supreme Court. On June 22, 1998, the Supreme
Court granted the petition for certiorari filed by one set of Objectors. The
Supreme Court heard oral arguments on December 8, 1998. No opinion has yet been
released.
No further appeal was filed with respect to the Trilateral Agreement; therefore,
court approval of the Trilateral Agreement has become final.
SETTLEMENT AGREEMENTS
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.
On August 27, 1993, the Settling Parties reached an agreement in principle for
an omnibus settlement to resolve all future asbestos-related bodily
CNA FINANCIAL CORPORATION
-------------------------
91
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------------------------------------------
Note F - Legal Proceedings and Contingent Liabilities (cont.)
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.
(As used in this note, "present" claims generally refers to asbestos claims
filed against Fibreboard on or before August 27, 1993). An additional $10
million is to be contributed to the fund by Fibreboard. As indicated above, the
Global Settlement Agreement has been approved by the Fifth Circuit a second
time, but the Supreme Court granted a petition for certiorari and is currently
reviewing the Fifth Circuit decision.
On October 12, 1993, Casualty, Pacific Indemnity and Fibreboard entered into the
Trilateral Agreement to settle the coverage litigation to operate in the event
that the Global Settlement Agreement is disapproved. The Trilateral Agreement
calls for payment by Casualty and Pacific Indemnity of an aggregate $2.0
billion, of which Casualty's portion is approximately $1.46 billion, to
Fibreboard to resolve all claims by Fibreboard and all future and certain
present asbestos claimants arising under the policy issued to Fibreboard by
Casualty.
Under either the Global Settlement Agreement or the Trilateral Agreement,
Casualty is also obligated to pay prior settlements of present asbestos claims.
As a result of the final approval of the Trilateral Agreement, such obligation
has become final.
Through December 31, 1998, Casualty, Fibreboard and plaintiff attorneys had
reached settlements with respect to approximately 134,000 claims, for an
estimated settlement amount of approximately $1.63 billion plus any applicable
interest. Final court approval of the Trilateral Agreement obligated Casualty to
pay under these settlements. Approximately $1.69 billion (including interest of
$185 million) was paid through December 31, 1998. 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
substantially resolved Casualty's exposure with respect to asbestos claims
involving Fibreboard. While there does exist the possibility of further adverse
developments with respect to Fibreboard claims, management does not anticipate
subsequent reserve adjustments, if any, to materially affect the equity of CNAF.
Management will continue to monitor the potential liabilities with respect to
Fibreboard asbestos claims and will make adjustments to claim reserves if
warranted.
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, et. al., filed by the Attorney General for the State of Louisiana, in
- - -----------------
CNA FINANCIAL CORPORATION
-------------------------
92
- - ------------------------------------------------------------------------------
Note F - Legal Proceedings & Contingent Liabilities (cont.)
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.
In June of 1997, the above case was removed to the United States District Court
for the Western District of Louisiana. The district court's decision denying a
motion to remand the case to the state court 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.
On November 23, 1998, the cigarette manufacturers and the attorneys general for
46 states (including Louisiana), and six other governmental entities reached an
agreement regarding the resolution of their Medicaid reimbursement claims. The
cigarette manufacturers have agreed to make annual payments in perpetuity,
including a total of $206 billion through 2025. In exchange, the states have
agreed to release their claims against the cigarette manufacturers and have
further agreed to release any claims that they may have against cigarette
distributors, retailers, component part manufacturers and their insurers. None
of these latter entities are parties to the settlement agreement. The Attorney
General of Louisiana and the defendants in the Ieyoub litigation are
implementing procedures to secure dismissal of the Ieyoub litigation and
resolution of the Attorney General's claims. Thus, the litigation may be
dismissed with prejudice in the near future.
However, in other states, third parties have challenged the November 1998
settlement agreement, and the Medicaid reimbursement lawsuits in those states
may not be resolved for some time. In addition, the November 1998 settlement
does not preclude the cigarette manufacturers, or other entities named as
defendants in the various Medicaid reimbursement lawsuits, from seeking coverage
under the insurance policies issued to those defendants. Because of the
uncertainties inherent in assessing the risk of liability at this juncture,
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 CNAF.
OTHER LITIGATION
- - ----------------------------
CNAF 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 CNAF.
CNA FINANCIAL CORPORATION
-------------------------
93
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - -----------------------------------------------------------------------------
Note G -- Reinsurance
Note G -- Reinsurance
- - ---------------------
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 the reinsurers' credit
quality and claim settlement performance. Further, for carriers that are not
authorized reinsurers in CNA's states of domicile, CNA receives collateral,
primarily in the form of bank letters of credit. Such collateral totaled
approximately $774 million and $857 million at December 31, 1998 and 1997,
respectively.
CNA's largest recoverable from a single reinsurer, including prepaid reinsurance
premiums, is with Lloyds of London and approximated $416 million and $451
million at December 31, 1998 and 1997, respectively.
Insurance claims and policyholders' benefits expense is net of reinsurance
recoveries of $994 million, $1,309 million and $1,220 million for 1998, 1997 and
1996, respectively.
In the tables below, life premiums are primarily from long duration contracts,
property/casualty premiums are from short duration contracts, and accident and
health premiums are primarily from short duration contracts.
The effects of reinsurance on earned premiums are shown in the following tables:
- - -----------------------------------------------------------------------
Earned Assumed/
Premiums Net
---------------------------------- %
Year Ended December 31 Direct Assumed Ceded Net
- - -----------------------------------------------------------------------
(In millions of dollars)
1998
Property/casualty $ 8,327 $ 1,549 $ 897 $ 8,979 17.3%
Accident and health 3,584 181 261 3,504 5.2
Life 1,014 159 281 892 17.8
- - ----------------------------------------------------------------------
TOTAL PREMIUMS $12,925 $ 1,889 $ 1,439 $13,375 14.1%
======================================================================
1997
Property/casualty $ 8,528 $ 1,101 $ 612 $ 9,017 12.2%
Accident and health 3,603 111 154 3,560 3.1
Life 908 128 131 905 14.1
- - ----------------------------------------------------------------------
TOTAL PREMIUMS $13,039 $ 1,340 $ 897 $13,482 9.9%
======================================================================
1996
Property/casualty $ 9,003 $ 1,123 $ 989 $ 9,137 12.3%
Accident and health 3,575 187 176 3,586 5.2
Life 736 121 55 802 15.1
- - ----------------------------------------------------------------------
TOTAL PREMIUMS $13,314 $ 1,431 $ 1,220 $13,525 10.6%
======================================================================
CNA FINANCIAL CORPORATION
-------------------------
94
- - ------------------------------------------------------------------------------
Note G - Reinsurance (cont.)
The effects of reinsurance on written premiums are shown in the following
tables:
- - -----------------------------------------------------------------------
Written Assumed/
Premiums Net
--------------------------------- %
Year Ended December 31 Direct Assumed Ceded Net
- - -----------------------------------------------------------------------
(In millions of dollars)
1998
Property/casualty $ 8,765 $ 1,429 $ 969 $ 9,225 15.5%
Accident and health 3,785 178 257 3,706 4.8
Life 1,014 159 281 892 17.8
- - -----------------------------------------------------------------------
TOTAL PREMIUMS $13,564 $ 1,766 $ 1,507 $13,823 12.8%
=======================================================================
1997
Property/casualty $ 8,576 $ 1,262 $ 693 $ 9,145 13.8%
Accident and health 3,592 133 155 3,570 3.7
Life 908 128 131 905 14.1
- - ----------------------------------------------------------------------
TOTAL PREMIUMS $13,076 $ 1,523 $ 979 $13,620 11.2%
======================================================================
1996
Property/casualty $ 9,078 $ 1,197 $ 852 $ 9,423 12.7%
Accident and health 3,708 188 183 3,713 5.1
Life 736 121 55 802 15.1
- - ----------------------------------------------------------------------
TOTAL PREMIUMS $13,522 $ 1,506 $ 1,090 $13,938 10.8%
======================================================================
The impact of reinsurance on life insurance in-force is shown in the following
schedule:
- - --------------------------------------------------------------------------
Life Insurance In-Force
------------------------------------
Assumed/
(In millions of dollars) Direct Assumed Ceded Net Net %
- - --------------------------------------------------------------------------
DECEMBER 31, 1998 $297,488 $96,906 $128,896 $265,498 36.5%
December 31, 1997 235,468 76,130 74,262 237,336 32.1
December 31, 1996 171,715 65,294 32,561 204,448 31.9
==========================================================================
CNA FINANCIAL CORPORATION
-------------------------
95
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - -------------------------------------------------------------------------------
Note H -- Debt
Note H - Debt:
- - --------------
DEBT
- - -----------------------------------------------------------------------------------------
December 31 1998 1997
- - -----------------------------------------------------------------------------------------
(In millions of dollars)
Variable Rate Debt:
Commercial Paper $ 500 $ 675
Credit Facility - CNAF 235 400
Credit Facility - CNA Surety 113 118
Senior Notes:
8.875%, due March 1, 1998 -- 150
8.25%, due April 15, 1999 100 102
7.25%, due March 1, 2003 147 146
6.25%, due November 15, 2003 249 249
6.50% , due April 15, 2005 497 --
6.75%, due November 15, 2006 248 248
6.45%, due January 15, 2008 149 --
6.60%, due December 15, 2008 199 --
8.375%, due August 15, 2012 98 98
6.95%, due January 15, 2018 148 --
7.25% Debenture, due November 15, 2023 247 247
11.0% Secured Mortgage Notes, due June 30, 2013 157 389
6.9% - 16.29% Secured Capital Leases, due through December 31, 2011 46 47
Other debt, due through 2019 (rates of 1.0% to 12.71%) 27 28
- - -----------------------------------------------------------------------------------------
TOTAL DEBT $3,160 $2,897
=========================================================================================
CNAF has a $795 million revolving credit facility that expires in May 2001. The
amount available is reduced by CNAF's outstanding commercial paper borrowings.
As of December 31, 1998, there was $60 million of unused borrowing capacity
under the facility. The interest rate on the bank loans 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 bank
loans under the credit facility at December 31, 1998, 1997 and 1996, was 5.49%,
6.16% and 5.72%, respectively.
To offset the variable rate characteristics of the facility, CNAF entered into
interest rate swap agreements with several banks having a total notional
principal amount at December 31, 1998 and 1997 of $650 million and $950 million,
respectively, which terminate from May 2000 to December 2000. These agreements
provide that CNAF pay interest at a fixed rate, averaging 6.07% at December 31,
1998 and 6.20% for both December 31, 1997 and 1996, respectively, 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 approximately $2
million, $4 million and $7 million for the years ended December 31, 1998, 1997
and 1996, respectively.
CNA FINANCIAL CORPORATION
-------------------------
96
- - -------------------------------------------------------------------------------
Note H - Debt (cont.)
The commercial paper borrowings are classified as long-term as the program is
fully supported by the committed credit facility. The weighted average interest
rate on commercial paper at December 31, 1998 was 5.89% compared to 6.05% and
5.67% at December 31, 1997 and 1996, respectively.
The weighted average interest rate (interest and facility fees) on the combined
revolving credit facility, commercial paper borrowings and interest rate swaps
was 6.36%, 6.35% and 6.28% at December 31, 1998, 1997 and 1996, respectively.
In 1998, CNAF issued $1 billion of senior notes under a $1 billion Registration
Statement on Form S-3 filed with the Securities and Exchange Commission on
August 18, 1997. This shelf registration incorporated $250 million of securities
remaining available for issuance from a prior shelf registration. Since filing
the shelf registration, the Company has issued senior notes in four separate
offerings senior notes with an aggregate principal amount of $1 billion.
On September 30, 1997, CNA Surety, a 61% owned subsidiary of CNAF, entered into
a $130 million, 5 year revolving credit facility. The interest rate on facility
borrowings is based on LIBOR plus 20 basis points. Additionally, there is a
facility fee of 10 basis points annually. At December 31, 1998 and 1997, the
outstanding borrowings under this facility were $113 million and $118 million
and the weighted average interest rate was 5.53% and 6.17%, respectively.
The following table shows the future minimum principal payments on debt:
FUTURE MINIMUM PRINCIPAL PAYMENTS
- - ---------------------------------------
(In millions of dollars)
1999 $ 103
2000 3
2001 739
2002 116
2003 403
Thereafter 1,814
Less: original issue discount (18)
- - ---------------------------------------
TOTAL $3,160
=======================================
CNA FINANCIAL CORPORATION
-------------------------
97
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - --------------------------------------------------------------------------
Note I -- Benefit Plans
Note I - Benefit Plans:
- - -----------------------
PENSION PLANS
- - -------------------------
CNA has noncontributory pension plans covering all full-time employees age 21 or
over who have completed at least one year of service. While the benefits for the
plans vary, they are generally based on years of credited service and the
employee's highest sixty consecutive months of compensation.
CNA's funding policy is to make contributions in accordance with applicable
governmental regulatory requirements. The assets of the plans are invested
primarily in U.S. government securities with the balance in short-term
investments, common stocks and other fixed income securities.
Effective January 1, 1996, the retirement plans redefined compensation to
include base pay, overtime and bonuses. This amendment generated an unrecognized
prior service cost of $20 million.
POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFITS
- - ------------------------------------------------------
CNA provides certain health care benefits for eligible retirees, through age 64,
and provides life insurance and reimbursement of Medicare Part B premiums for
all eligible retired persons. Funding for these plans is generally to pay
covered expenses as they are incurred.
In 1998, CNA amended the Continental post-retirement plan to make the benefits
available to Continental retirees equivalent to the benefits available to CNA
retirees. As a result of this amendment, CNA's postretirement benefit obligation
was reduced by $99 million.
As a result of the Company's restructuring activities discussed in Note N, the
Company recorded curtailment charges of approximately $19 million related to its
pension and post-retirement plans. Additionally these curtailments resulted in a
reduction of the pension and postretirement benefit obligations of $88 million
and $34 million, respectfully.
CNA FINANCIAL CORPORATION
-------------------------
98
- - ----------------------------------------------------------------------------
Note I - Benefit Plans (cont.)
The following provides a reconciliation of benefit obligations:
- - -------------------------------------------------------------------------------
POSTRETIREMENT
PENSION BENEFITS BENEFITS
- - -------------------------------------------------------------------------------
December 31 1998 1997 1998 1997
- - -------------------------------------------------------------------------------
(In millions of dollars)
Change in benefit obligation:
Benefit obligation at January 1 $1,780 $1,567 $ 377 $ 319
Service cost 58 54 11 10
Interest cost 126 119 28 25
Participants' contributions - - 5 2
Plan amendments - 1 (99) -
Actuarial loss 118 122 67 41
Curtailment (88) - (34) -
Benefits paid (94) (83) (34) (20)
- - -------------------------------------------------------------------------------
Benefit obligation at December 31 1,900 1,780 321 377
- - -------------------------------------------------------------------------------
Change in plan assets:
Fair value of plan assets at January 1 1,313 1,206 - -
Actual return on plan assets 105 104 - -
Company contributions 100 86 29 19
Participants' contributions - - 5 2
Benefits paid (94) (83) (34) (21)
- - -------------------------------------------------------------------------------
Fair value of plan assets at December 31 1,424 1,313 - -
- - -------------------------------------------------------------------------------
Funded status (476) (467) (321) (377)
Unrecognized net actuarial loss 239 218 51 19
Unrecognized prior service cost (benefit) 60 88 (97) -
Unrecognized net transition obligation - (2) - -
- - -------------------------------------------------------------------------------
ACCRUED BENEFIT COST $ (177) $ (163) $(367) $(358)
===============================================================================
NET PERIODIC BENEFIT COSTS
- - ------------------------------------------------------------------------------
POSTRETIREMENT
PENSION BENEFITS BENEFITS
- - ------------------------------------------------------------------------------
December 31 1998 1997 1996 1998 1997 1996
- - ------------------------------------------------------------------------------
(In millions of dollars)
Service cost - benefits attributed to
employee service during the year $ 58 $ 54 $ 55 $11 $10 $12
Interest cost on projected
benefit obligation 126 119 111 28 25 24
Expected return on plan assets (97) (98) (91) - - -
Prior service cost amortization 10 11 10 (4) - -
Actuarial loss 4 6 5 1 - -
Transition amount amortization (2) (5) (6) - - -
Curtailment loss 17 - - 2 - -
- - ------------------------------------------------------------------------------
NET PERIODIC BENEFIT COST $116 $ 87 $ 84 $38 $35 $36
==============================================================================
CNA FINANCIAL CORPORATION
-------------------------
99
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ----------------------------------------------------------------------------
Note I -- Benefit Plans (cont.)
Actuarial assumptions are set forth in the following table:
- - ---------------------------------------------------------------------------
POSTRETIREMENT
PENSION BENEFITS BENEFITS
- - ---------------------------------------------------------------------------
December 31 1998 1997 1996 1998 1997 1996
- - ---------------------------------------------------------------------------
Discount rate 6.75% 7.25% 7.50% 6.75% 7.25% 7.50%
Expected return on plan assets 7.00 7.50 7.75-8.50 N/A N/A N/A
Rate of compensation increases 5.70 5.70 5.70 N/A N/A N/A
- - ---------------------------------------------------------------------------
The assumed health care cost trend rate used in measuring the accumulated
postretirement benefit obligation was 8% in 1998, declining to an ultimate rate
of 5% in 2002. The health care cost trend rate assumption has a significant
effect on the amount of the benefit obligation and periodic cost reported. An
increase in the assumed health care cost trend rate of 1% in each year would
increase the accumulated postretirement benefit obligation as of December 31,
1998 by $16 million and the aggregate net periodic postretirement benefit cost
for 1998 by $3 million. A decrease in the assumed health care cost trend rate of
1% in each year would decrease the accumulated postretirement benefit obligation
as of December 31, 1998 by $14 million and the aggregate net periodic
postretirement benefit cost for 1998 by $3 million.
SAVINGS PLANS
- - -------------------------------
CNA has savings plans, which are generally contributory plans, which allow
employees to make regular contributions of up to 6% of their salary. CNA
contributes an additional amount equal to 70% of the employee's regular
contribution. Employees may also make additional contributions of up to 10% of
their salaries for which there is no additional contribution by CNA.
Contributions by the Company to the savings plans were $25 million, $23 million
and $24 million in 1998, 1997 and 1996, respectively.
CNA FINANCIAL CORPORATION
-------------------------
100
- - -----------------------------------------------------------------------------
Note J -- Leases
Note J - Leases:
- - ----------------
CNA occupies facilities under lease agreements that expire at various dates
through 2011. CNA's home office is partially situated on grounds under leases
expiring in 2058. In addition, data processing and office and transportation
equipment are leased under agreements that expire at various dates through 2003.
Most leases contain renewal options that provide for rent increases based on
prevailing market conditions. Lease expense, net of sublease income, for the
years ended December 31, 1998, 1997 and 1996 was $130 million, $100 million and
$85 million, respectively.
The table below shows the future minimum lease payments to be made under
non-cancelable leases at December 31, 1998.
- - ----------------------------------------------
Future Minimum Lease Payments
- - ----------------------------------------------
(IN MILLIONS OF DOLLARS)
1999 $100
2000 87
2001 76
2002 63
2003 45
Thereafter 126
- - ----------------------------------------------
TOTAL $497
==============================================
CNA FINANCIAL CORPORATION
-------------------------
101
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ---------------------------------------------------------------------------
Note K -- Stockholders' Equity and Statutory Financial Information
Note K - Stockholders' Equity and Statutory Financial Information:
- - ------------------------------------------------------------------
SUMMARY OF CAPITAL STOCK
- - -----------------------------------------------------------------------------
Number of Shares
--------------------------
December 31 1998 1997
- - -----------------------------------------------------------------------------
Preferred stock, without par value, non-voting:
Authorized 12,500,000 12,500,000
Money market cumulative preferred stock,
without par value, non-voting;
Issued and outstanding:
Series E (stated value $100,000 per share) 750 750
Series F (stated value $100,000 per share) 750 750
Cumulative, exchangeable preferred stock,
without par value, non-voting;
Series G (stated value $100,000 per share) 2,000 --
Common stock with par value of $2.50;
Authorized 200,000,000 200,000,000
Issued 185,525,907 185,525,907
Outstanding 183,889,569 185,394,786
Treasury stock 1,636,338 131,121
- - -----------------------------------------------------------------------------
On May 6, 1998, CNAF's Board of Directors approved a three-for-one split of
CNAF's common stock and authorized a commensurate increase in the outstanding
common shares from 61,798,262 to 185,394,786. The shares were distributed on
June 1, 1998 at a rate of three shares for each one held by shareholders of
record at the close of business on May 22, 1998. The table above reflects the
effect of this stock split as if it had occurred on December 31, 1997.
The dividend rate on money market preferred stock is determined approximately
every 49 days by auction. The money market preferred stock is redeemable at
CNAF's option, as a whole or in part, at $100,000 per share plus accrued and
unpaid dividends. As of December 31, 1998, preferred dividends declared and
payable were approximately $7 million.
On August 5, 1998, CNAF's Board of Directors approved a plan (the Share
Repurchase Program) to purchase, in the open market or through privately
negotiated transactions, its outstanding common stock from time to time, as the
Company's management deems appropriate. During 1998, pursuant to the announced
Share Repurchase Program, CNAF purchased 2,734,800 shares of its common stock
for approximately $102 million. Total shares purchased by CNAF and classified on
the December 31, 1998 balance sheet as treasury stock are 1,636,338 for a
decrease in stockholders' equity of approximately $61 million.
CNA FINANCIAL CORPORATION
-------------------------
102
- - ------------------------------------------------------------------------------
Note K - Stockholders' Equity and Statutory Financial Information (cont.)
On October 9, 1998, CNAF filed a Registration Statement on Form S-8 with the
Securities and Exchange Commission registering $60 million of $2.50 par value
common stock, to be offered pursuant to the CNAF Officer Stock Ownership Plan.
On October 9, 1998, prior to the opening of the trading session on the New York
Stock Exchange, CNAF sold 1,229,583 shares of common stock that were held in
treasury to certain senior officers of CNAF at the average of the highest and
lowest sale price on the New York Stock Exchange, composite transactions, which
was a price of $34.91 per share. The purchases were financed by full recourse,
collateralized loans from CNAF which, at December 31, 1998, totaled
approximately $44 million, including accrued interest. The loans are ten year
notes, which bear interest at the Applicable Federal Rate for October 1998
(5.39%), compounding semi-annually.
On December 23, 1998, CNAF issued 2,000 shares of Series G cumulative,
exchangeable preferred stock to Loews for $200 million. The dividend rate on the
exchangeable preferred stock is reset quarterly at a rate equal to the 3 month
London Interbank Offering Rate (LIBOR) on the reset date plus four basis points.
On the fifth anniversary of the stocks' issuance, the interest rate increases to
the 3 month LIBOR on the reset date plus one hundred and four basis points. The
preferred stock is redeemable at the end of each calendar quarter without a
premium at CNAF's option. After the fifth year, the stock is also exchangeable,
at CNAF's option, into notes maturing on the tenth anniversary of the issuance
of the Series G preferred stock and bearing a market rate of interest.
CNA FINANCIAL CORPORATION
--------------------------
103
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - -----------------------------------------------------------------------------
Note K - Stockholders' Equity and Statutory Financial Information (cont.)
STATUTORY ACCOUNTING PRACTICES
- - ------------------------------------------
CNAF's insurance subsidiaries are domiciled in various jurisdictions. These
subsidiaries prepare statutory financial statements in accordance with
accounting practices prescribed or otherwise permitted by the respective
jurisdiction's insurance regulator. Prescribed statutory accounting practices
are set forth in a variety of publications of the National Association of
Insurance Commissioners as well as state laws, regulations, and general
administrative rules. The Company's insurance subsidiaries have no material
permitted accounting practices.
CNAF's ability to pay dividends to its stockholders is affected, in part, by
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 subsidiaries' domiciliary jurisdiction is limited to formula amounts. As of
December 31, 1998, approximately $663 million of dividend payments are not
subject to insurance department's pre-approval.
Statutory capital and surplus and net income, determined in accordance with
accounting practices prescribed by the regulation and statute of various
insurance regulators, for property/casualty and life insurance subsidiaries are
as follows:
- - -------------------------------------------------------------------------------
Statutory Capital and Surplus Statutory Net Income(Loss)
- - -------------------------------------------------------------------------------
December 31 Year Ended December 31
- - -------------------------------------------------------------------------------
(Unaudited) 1998 1997 1998 1997 1996
- - -------------------------------------------------------------------------------
(In millions of dollars)
Property/casualty companies* $7,593 $7,123 $161 $1,043 $1,208
Life insurance companies 1,109 1,224 (57) 43 58
- - -------------------------------------------------------------------------------
* SURPLUS INCLUDES EQUITY OF PROPERTY/CASUALTY COMPANIES' OWNERSHIP IN LIFE
INSURANCE SUBSIDIARIES.
CNA FINANCIAL CORPORATION
-------------------------
104
- - ----------------------------------------------------------------------------
Note L -- Accumulated Other Comprehensive Income
Note L -- Accumulated Other Comprehensive Income:
- - ------------------------------------------------
Comprehensive income is comprised of all changes to stockholders' equity,
including net income, except those changes resulting from investments by and
distributions to stockholders. The change in the components of accumulated other
comprehensive income are shown below:
- - ------------------------------------------------------------------------------
Pre-tax Tax (expense) Net
Year ended December 31 amount benefit Amount
- - ------------------------------------------------------------------------------
(In millions of dollars)
1998
Net unrealized gains (losses) on investments:
Gains arising during the period $ 933 $(327) $ 606
Allocated to minority interest (9) 3 (6)
Reclassification adjustment for (gains)
included in net income (207) 75 (132)
Foreign currency translation adjustment 7 -- 7
- - ------------------------------------------------------------------------------
TOTAL OTHER COMPREHENSIVE INCOME $ 724 $(249) $ 475
==============================================================================
- - ------------------------------------------------------------------------------
Pre-tax Tax (expense) Net
Year ended December 31 amount benefit Amount
- - ------------------------------------------------------------------------------
(In millions of dollars)
1997
Net unrealized gains (losses) on investments:
Gains arising during the period $ 570 $(171) $ 399
Allocated to minority interest (8) 3 (5)
Allocated to participating policyholders' (4) -- (4)
Reclassification adjustment for (gains)
included in net income (186) 67 (119)
Foreign currency translation adjustment 19 -- 19
- - ------------------------------------------------------------------------------
TOTAL OTHER COMPREHENSIVE INCOME $ 391 $(101) $ 290
==============================================================================
- - ------------------------------------------------------------------------------
Pre-tax Tax (expense) Net
Year ended December 31 amount benefit Amount
- - ------------------------------------------------------------------------------
(In millions of dollars)
1996
Net unrealized gains (losses) on investments:
Losses arising during the period $(368) $ 129 $(239)
Allocated to minority interest 8 (3) 5
Allocated to participating policyholders' 18 -- 18
Reclassification adjustment for (gains)
included in net income (659) 231 (428)
Foreign currency translation adjustment 10 -- 10
- - ------------------------------------------------------------------------------
TOTAL OTHER COMPREHENSIVE LOSS $(991) $ 357 $(634)
==============================================================================
CNA FINANCIAL CORPORATION
-------------------------
105
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - -----------------------------------------------------------------------------
Note L - Accumulated Other Comprehensive Income (cont.)
The following tables display the changes in and the components of accumulated
other comprehensive income included in the consolidated balance sheet and
statements of stockholders' equity for 1998 and 1997.
- - -------------------------------------------------------------------------------
TOTAL
FOREIGN NET ACCUMULATED
CURRENCY UNREALIZED OTHER
TRANSLATION GAINS/(LOSSES) COMPREHENSIVE
ADJUSTMENT ON INVESTMENTS INCOME
- - -------------------------------------------------------------------------------
(In millions of dollars)
Beginning Balance January 1, 1997 $47 $252 $ 299
Current Period Change 19 271 290
- - ------------------------------------------------------- -----------------------
Ending balance December 31, 1997 66 523 589
Current Period Change 7 468 475
- - -------------------------------------------------------------------------------
ENDING BALANCE DECEMBER 31, 1998 $73 $991 $1,064
===============================================================================
CNA FINANCIAL CORPORATION
-------------------------
106
- - -----------------------------------------------------------------------------
Note M -- Business Segments
Note M - Business Segments:
- - ----------------------------
The Company's reportable segments are strategic businesses that offer different
types of products and services.
The Company has seven operating segments: Agency Market Operations, Specialty
Operations, CNA Re, Global Operations, Risk Management, Group Operations and
Life Operations. Agency Market Operations provides a wide range of
property/casualty products to individuals and small to mid-size businesses.
Specialty Operations provides a broad array of professional, financial and
specialty property/casualty products and services. CNA Re offers primarily
traditional property/casualty treaty reinsurance. Global Operations provides
marine, casualty, surety, warranty and specialty products. Risk Management
serves the property/casualty needs of large domestic commercial businesses
offering customized, solution-based strategies to address risk management needs.
Group Operations offers a broad array of group life and health insurance and
reinsurance products to employers, affinity groups and other entities that
purchase insurance as a group. Life Operations provides financial protection to
individuals through a full product line of term life insurance, universal life
insurance, long-term care insurance, annuities and provides retirement service
products to institutional markets.
Corporate results consist of interest expense on corporate borrowings, certain
run-off insurance operations, asbestos claims related to Fibreboard Corporation,
financial guarantee insurance contracts, and certain non-insurance operations,
principally the operations of Agency Management Systems, Inc., an information
technology and agency software development subsidiary.
The accounting policies of the segments are the same as those described in the
summary of significant accounting polices. The Company manages its assets on a
legal entity basis while segment operations are conducted across legal entities,
as such assets are not readily identifiable by individual segment. In addition,
distinct investment portfolios are not maintained for each segment, and
accordingly, allocation of assets to each segment is not performed. Therefore
investment income and realized investment gains/losses are allocated based on
each segment's carried insurance reserves, as adjusted.
CNA FINANCIAL CORPORATION
-------------------------
107
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ----------------------------------------------------------------------------
Note M -- Business Segments (cont.)
All intercompany income and expense as well as intercompany dividends have been
eliminated.
Income taxes have been allocated on the basis of taxable income of the
respective segments.
Approximately 96% of the Company's premiums are derived from the United States.
Premiums from any individual foreign country are not significant.
Through August 1, 1989, CNA's property/casualty operations wrote financial
guarantee insurance contracts. These contracts primarily represent industrial
development bond guarantees and equity guarantees typically extending from ten
to thirteen years. For these guarantees, CNA received an advance premium, which
is recognized over the exposure period and in proportion to the underlying
exposure insured.
At December 31, 1998 and 1997, gross exposure of financial guarantee insurance
contracts amounted to $507 million and $553 million, respectively. The degree of
risk attached to this exposure is substantially reduced through reinsurance,
diversification of exposures and collateral requirements. In addition, security
interests in the real estate are also obtained. Approximately 36% and 39% of the
risks were ceded to reinsurers at December 31, 1998 and 1997, respectively.
Total exposure, net of reinsurance, amounted to $323 million and $337 million at
December 31, 1998 and 1997, respectively. At December 31, 1998 and 1997,
collateral consisting of letters of credit and debt service reserves amounted to
$38 million and $23 million, respectively.
CNA FINANCIAL CORPORATION
-------------------------
108
- - ----------------------------------------------------------------------------
Note M -- Business Segments (cont.)
Gross unearned premium reserves for financial guarantee contracts were $7
million and $5 million at December 31, 1998 and 1997, respectively. Gross claim
and claim expense reserves totaled $232 million and $377 million at December 31,
1998 and 1997, respectively.
Group segment revenues include $2.0 billion, $2.1 billion and $2.1 billion in
1998, 1997 and 1996, respectively, under contracts covering U.S. government
employees and their dependents (FEHBP).
CNA FINANCIAL CORPORATION
-------------------------
109
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ----------------------------------------------------------------------------
Note M - Business Segments (cont.)
- - --------------------------------------------------------------------------------------------------------------
Agency Market Specialty Global
YEAR ENDED DECEMBER 31, 1998 Operations Operations CNA Re Operations
- - --------------------------------------------------------------------------------------------------------------
(In millions of dollars)
Revenues, excluding realized investment gains:
Premiums $5,247 $1,092 $ 944 $ 941
Net investment income 744 245 163 110
Other 107 27 5 82
- - --------------------------------------------------------------------------------------------------------------
Total revenues, excluding realized investment gains 6,098 1,364 1,112 1,133
Benefits and expenses:
Insurance claims and policyholder benefits 4,431 951 707 585
Amortization of deferred acquisition costs 1,239 175 252 224
Interest expense -- -- -- 11
Restructuring and other related charges 96 5 1 1
Other 491 169 57 251
- - --------------------------------------------------------------------------------------------------------------
Total benefits and expenses 6,257 1,300 1,017 1,072
- - --------------------------------------------------------------------------------------------------------------
Operating income before income tax (159) 64 95 61
Income tax (expense) benefit 105 (6) (27) (18)
- - --------------------------------------------------------------------------------------------------------------
Net operating income (excluding realized
investment gains/losses) (54) 58 68 43
Realized investment gains, net of tax 171 57 27 17
Minority interest -- -- -- (25)
- - --------------------------------------------------------------------------------------------------------------
NET INCOME $ 117 $ 115 $ 95 $ 35
==============================================================================================================
- - --------------------------------------------------------------------------------------------------------------
Agency Market Specialty Global
Year Ended December 31, 1997 Operations Operations CNA Re Operations
- - --------------------------------------------------------------------------------------------------------------
(In millions of dollars)
Revenues, excluding realized investment gains:
Premiums $5,092 $1,251 $ 898 $ 854
Net investment income 787 268 153 117
Other 50 14 5 29
- - --------------------------------------------------------------------------------------------------------------
Total revenues, excluding realized investment gains 5,929 1,533 1,058 1,000
Benefits and expenses:
Insurance claims and policyholder benefits 3,871 1,011 670 490
Amortization of deferred acquisition costs 1,242 247 247 173
Interest expense -- -- -- --
Other 384 149 79 221
- - --------------------------------------------------------------------------------------------------------------
Total benefits and expenses 5,497 1,407 996 884
- - --------------------------------------------------------------------------------------------------------------
Operating income before income tax 432 126 62 116
Income tax (expense) benefit (106) (31) (11) (35)
- - --------------------------------------------------------------------------------------------------------------
Net operating income (excluding realized
investment gains/losses) 326 95 51 81
Realized investment gains, net of tax 187 63 34 20
Minority interest -- -- -- (29)
- - --------------------------------------------------------------------------------------------------------------
Net income $ 513 $ 158 $ 85 $ 72
==============================================================================================================
- - --------------------------------------------------------------------------------------------------------------
Agency Market Specialty Global
Year Ended December 31, 1996 Operations Operations CNA Re Operations
- - --------------------------------------------------------------------------------------------------------------
Revenues, excluding realized investment gains:
Premiums $5,346 $1,217 $ 944 $ 945
Net investment income 828 273 161 134
Other 13 -- 7 34
- - --------------------------------------------------------------------------------------------------------------
Total revenues, excluding realized investment gains 6,187 1,490 1,112 1,113
Benefits and expenses:
Insurance claims and policyholder benefits 4,277 1,092 694 594
Amortization of deferred acquisition cost 1,183 232 119 221
Interest expense -- -- -- --
Other 560 79 172 145
- - --------------------------------------------------------------------------------------------------------------
Total benefits and expenses 6,020 1,403 985 960
- - --------------------------------------------------------------------------------------------------------------
Operating income before income tax 167 87 127 153
Income tax (expense) benefit (13) (15) (38) (44)
- - --------------------------------------------------------------------------------------------------------------
Net operating income (excluding realized
investment gains/losses) 154 72 89 109
Realized investment gains, net of tax 133 44 21 21
Minority interest -- -- -- (9)
- - --------------------------------------------------------------------------------------------------------------
Net income $ 287 $ 116 $ 110 $ 121
=============================================================================================================
CNA FINANCIAL CORPORATION
--------------------------
110
- - ---------------------------------------------------------------------------
Note M - Business Segments (cont.)
- - ---------------------------------------------------------------------------
Risk Group Life Total
Management Operations Operations Corporate Eliminations Segments
- - ---------------------------------------------------------------------------
$ 823 $3,712 $ 684 $ (27) $(41) $13,375
144 133 525 82 -- 2,146
230 24 115 298 (30) 858
- - ---------------------------------------------------------------------------
1,197 3,869 1,324 353 (71) 16,379
909 3,177 871 127 (41) 11,717
98 5 178 9 -- 2,180
4 -- 14 219 (29) 219
88 39 7 9 -- 246
234 -- 731 104 326 -- 2,363
- - ---------------------------------------------------------------------------
1,333 3,952 1,174 690 (70) 16,725
- - ---------------------------------------------------------------------------
(136) (83) 150 (337) (1) (346)
48 35 (58) 121 -- 200
- - ---------------------------------------------------------------------------
(88) (48) 92 (216) (1) (146)
31 29 96 20 -- 448
-- -- -- 5 -- (20)
- - ---------------------------------------------------------------------------
$ (57) $ (19) $ 188 $(191) $(1) $ 282
===========================================================================
- - ---------------------------------------------------------------------------
Risk Group Life Total
Management Operations Operations Corporate Eliminations Segments
- - ---------------------------------------------------------------------------
$ 776 $3,093 $ 688 $ 20 $-- $13,482
158 117 501 108 -- 2,209
194 17 105 236 (24) 628
- - ---------------------------------------------------------------------------
1,128 4,037 1,294 364 (24) 16,319
893 3,375 855 103 -- 11,268
101 -- 120 8 -- 2,138
-- -- -- 222 (24) 198
196 680 147 244 -- 2,100
- - ---------------------------------------------------------------------------
1,190 4,055 1,122 577 (24) 15,704
- - ---------------------------------------------------------------------------
(62) (18) 172 (213) -- 615
25 10 (66) 82 -- (132)
- - ---------------------------------------------------------------------------
(37) (8) 106 (131) -- 483
37 28 139 (15) -- 493
-- -- -- 19 -- (10)
- - ---------------------------------------------------------------------------
$ -- $ 20 $ 245 $(127) $-- $ 966
===========================================================================
- - ---------------------------------------------------------------------------
Risk Group Life Total
Management Operations Operations Corporate Eliminations Segments
- - ---------------------------------------------------------------------------
$ 572 $3,816 $ 654 $ 53 $(22) $13,525
179 118 485 98 -- 2,276
222 8 106 190 (12) 568
- - ---------------------------------------------------------------------------
973 3,942 1,245 341 (34) 16,369
567 3,272 838 59 (22) 11,371
60 (24) 61 4 -- 1,856
-- -- -- 212 (12) 200
248 674 144 185 -- 2,207
- - ---------------------------------------------------------------------------
875 3,922 1,043 460 (34) 15,634
- - ---------------------------------------------------------------------------
98 20 202 (119) -- 735
(24) (3) (74) 48 -- (163)
- - ---------------------------------------------------------------------------
74 17 128 (71) -- 572
29 21 117 16 -- 402
-- -- -- -- -- (9)
- - ---------------------------------------------------------------------------
$ 103 $ 38 $ 245 $ (55) $-- $ 965
===========================================================================
CNA FINANCIAL CORPORATION
-------------------------
111
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ------------------------------------------------------------------------------
Note N - Restructuring and Other Related Charges
Note N -- Restructuring and Other Related Charges:
- - --------------------------------------------------
The Company finalized and approved a restructuring plan (the "Plan") in August
1998. In connection with the Plan, the Company incurred various expenses that
were recorded in the third and fourth quarters of 1998. These restructuring and
other related charges primarily related to the following activities: planned
reductions in the workforce; the consolidation of certain processing centers;
the exiting of certain businesses and facilities; the termination of related
lease obligations; and the writeoff of certain assets related to these
activities. The Plan contemplates a gross reduction in workforce of 4,500
employees, resulting in a planned net reduction of approximately 2,400
employees. According to the Plan, the various activities and workforce
reductions should be completed by the end of 1999.
The restructuring and other related charges were comprised of the following
costs and expenses: a) costs and benefits related to planned employee
terminations of $98 million, of which $53 million related to severance and
outplacement costs and $24 million related to other employee transition related
costs and $21 million related to benefit plan curtailment losses; b) writedown
of certain assets to their fair value of $74 million, of which $59 million
related to a writedown of an intangible asset, and $15 million abandoned
leasehold improvements and other related fixed assets associated with leases
that were terminated as part of the restructuring plan; c) lease termination
costs of $42 million; d) losses incurred on the exiting of certain businesses of
$32 million.
The Company recorded $220 million of these restructuring and other related
charges in the third quarter of 1998. Other charges such as parallel processing
costs, relocation costs, and retention bonuses, did not qualify for accrual at
the end of the third quarter under generally accepted accounting principles and
are being expensed as incurred. In the fourth quarter of 1998, $26 million of
these charges were recorded.
The 1998 restructuring and other related charges for Agency Market Operations
totaled approximately $96 million. The charges included employee severance and
outplacement costs of $34 million related to the planned net reduction in the
workforce of approximately 1,200 employees. Approximately $29 million of lease
termination costs were also incurred in connection with the consolidation of
four regional offices into two zone offices and a reduction of the number of
claim processing offices from 24 to 8. The Agency Market Operations charges also
included benefit plan costs of $12 million, parallel processing charges of $7
million and $5 million of other fixed asset writedowns. Other charges, including
travel, relocation and other transition-related activity, which were expensed as
incurred, totaled approximately $9 million.
Through December 31, 1998, approximately 364 Agency Market Operations employees,
the majority of whom were loss adjusters and office support staff, had been
released at a cost of $8 million.
CNA FINANCIAL CORPORATION
-------------------------
112
- - -----------------------------------------------------------------------------
Note N - Restructuring and Other Related Charges (cont.)
The 1998 restructuring and other related charges for Risk Management totaled
approximately $88 million. The charges included lease termination costs
associated with the consolidation of claim offices in 36 market territories that
totaled approximately $8 million. In addition, employee severance and
outplacement costs relating to the planned net reduction in workforce of
approximately 200 employees were approximately $10 million and the writedown of
fixed and intangible assets totaled approximately $64 million. Parallel
processing and other charges totaled approximately $6 million.
The charges related to fixed and intangible assets were primarily due to a
writedown of an intangible asset (goodwill) related to a business that had been
acquired several years earlier. As part of the Company's periodic reviews of
asset recoverability and as a result of several adverse events, the Company
concluded, based on its discounted cash flow analysis completed in the third
quarter of 1998, that a $59 million writeoff was necessary. The adverse events
contributing to this conclusion included operating losses from the business, the
loss of several significant customers whose business volume with this operation
constituted a large portion of the revenue base, and substantial changes in the
overall market demand for the services offered by this operation which, in turn,
had negative effects on the prospects for achieving the profitability levels
necessary to recover the intangible asset.
Through December 31, 1998, approximately 152 Risk Management employees had been
released at a cost of $2 million. The majority of the employees were adjusters
and office support staff.
The 1998 restructuring and other related charges for Group Operations totaled
approximately $39 million. The charges included approximately $29 million of
costs related to the Company's decision to exit the Employer Health and Affinity
lines of business. These costs represent the Company's estimate of losses in
connection with fulfilling the remaining obligations under contracts related to
these lines. Earned premiums for these lines of business approximated $400
million in 1998. The 1998 charges also included employee severance and
outplacement costs of approximately $7 million related to the planned net
reduction in workforce of approximately 400 employees. Charges for lease
termination costs and fixed asset writedowns totaled $3 million.
Through December 31, 1998, approximately 56 Group Operations employees had been
released at a cost of $1 million. The majority of the employees were claims and
sales support staff.
For the other segments of the Company, restructuring and other related charges
totaled approximately $23 million for 1998. Charges related primarily to the
closing of leased facilities were $3 million and employee severance and
outplacement costs related to planned net reductions of 600 employees in the
current workforce and benefit costs associated with those reductions were $13
million. In addition, there were charges of $4 million related to the writedown
of certain assets and $3 million related to the exiting of certain businesses.
Through December 31, 1998, approximately 270 employees of these other segments,
most of whom were underwriters and office support staff, had been released at a
cost of $3 million.
CNA FINANCIAL CORPORATION
-------------------------
113
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - -------------------------------------------------------------------------------
Note N - Restructuring and Other Related Charges (cont.)
The following table sets forth the major categories of restructuring and other
related charges that were initially accrued and recorded upon the finalization
and approval of the Plan and the activity in the accrual for such costs during
1998.
- - -------------------------------------------------------------------------------
Employee
Termination and Lease Business
Related Benefit Writedown Termination Exit
Costs of Assets Costs Costs Total
------------------------------------------------------
Initial charge recorded
in third quarter of 1998 $ 72 $ 74 $ 42 $ 32 $ 220
Less payments charged
against liability (14) -- -- -- (14)
Less costs that do not
use cash (21) (74) -- -- (95)
- - -------------------------------------------------------------------------------
ACCRUED COSTS AT
DECEMBER 31, 1998 $ 37 $ -- $ 42 $ 32 $ 111
===============================================================================
CNA FINANCIAL CORPORATION
-------------------------
114
- - -----------------------------------------------------------------------------
Note O -- Merger with Capsure Holdings Corp.
Note O - Merger with Capsure Holdings Corp:
- - -------------------------------------------
In the fourth quarter of 1996, CNA entered into a merger agreement with Capsure
Holdings Corp. (Capsure) to merge CNA's surety business with the business of
Capsure and form a new stock company, CNA Surety Corporation ("CNA Surety"), in
which CNA has an approximate 61% interest. The transaction closed on September
30, 1997 and was accounted for as a sale of approximately 39% of CNA's previous
surety business and a purchase of 61% of Capsure. In conjunction with the
closing of the transaction, CNA realized an investment gain of $95 million. CNA
Surety's results of operations have been included in CNA's consolidated results
of operations, net of minority interest subsequent to September 30, 1997. At
December 31, 1997, total assets of CNA Surety were $727 million. CNA Surety's
revenues and net income for the three months ended December 31, 1997 were
approximately $71 million and $11 million, respectively.
CNA FINANCIAL CORPORATION
-------------------------
115
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- - ----------------------------------------------------------------------------
Note P -- Unaudited Quarterly Financial Data
Note P - Unaudited Quarterly Financial Data:
- - --------------------------------------------
- - ------------------------------------------------------------------------------
First Second Third Fourth Year
- - ------------------------------------------------------------------------------
(In millions of dollars, except per share data)
1998 QUARTERS
Revenues $4,328 $4,429 $4,129 $4,188 $17,074
Net operating income (loss)
Excluding realized gains/losses 117 64 (70) (263) (152)
Net realized investment gains 116 146 56 116 434
--------------------------------------------
Net income (loss) 233 210 (14) (147) 282
--------------------------------------------
Earnings (loss) per share 1.25 1.12 (0.09) (0.81) 1.49
1997 QUARTERS
Revenues $4,132 $4,243 $4,309 $4,388 $17,072
Net operating income
Excluding realized gains/losses 136 126 121 105 488
Net realized investment gains 42 109 153 174 478
--------------------------------------------
Net income 178 235 274 279 966
--------------------------------------------
Earnings per share 0.95 1.26 1.47 1.49 5.17
1996 QUARTERS
Revenues $4,315 $4,095 $4,256 $4,322 $16,988
Net operating income
Excluding realized gains/losses 145 152 161 120 578
Net realized investment gains 184 50 78 75 387
--------------------------------------------
Net income 329 202 239 195 965
--------------------------------------------
Earnings per share 1.77 1.08 1.28 1.04 5.17
- - ------------------------------------------------------------------------------
CNA FINANCIAL CORPORATION
-------------------------
116
INDEPENDENT AUDITORS' REPORT
- - ----------------------------------------------------------------------------
THE BOARD OF DIRECTORS AND STOCKHOLDERS CNA FINANCIAL CORPORATION
We have audited the consolidated balance sheets of CNA Financial Corporation (an
affiliate of Loews Corporation) and subsidiaries as of December 31, 1998 and
1997, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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
subsidiaries as of December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998 in conformity with generally accepted accounting principles.
S/DELOITTE & TOUCHE LLP
Chicago, Illinois
February 10, 1999
CNA FINANCIAL CORPORATION
---------------------------
117
COMMON STOCK INFORMATION
- - ---------------------------------------------------------------------------
CNA's common stock is listed on the New York Stock, Chicago Stock and Pacific
Exchanges and is also traded on the Philadelphia Stock Exchange. The number of
holders of record of CNA's common stock as of March 1, 1999, was 2,732. As of
March 1, 1999, Loews Corporation owned approximately 85 percent of CNA's
outstanding common stock.
The table below sets forth the high and low closing sales prices for CNA's
common stock based on the New York Stock Exchange Composite Transactions. No
dividends have been paid on CNA's common stock in order to develop and maintain
a strong surplus position for CNA's insurance subsidiaries, which is necessary
to support business growth in an increasingly competitive environment. CNA's
ability to pay dividends is influenced, in part, by dividend restrictions of its
principal operating insurance subsidiaries as described in Note K to the
Consolidated Financial Statements.
COMMON STOCK INFORMATION
- - --------------------------------------------------------------------
1998 1997
------------------------------------------
Quarter High Low High Low
- - --------------------------------------------------------------------
Fourth 44 11/16 34 1/2 43 15/16 39 23/32
Third 47 35 1/8 43 3/8 35 31/32
Second 53 5/16 45 1/2 35 5/32 32 5/16
First 51 42 1/6 38 1/4 34 3/8
- - --------------------------------------------------------------------
Invitation to the Annual Meeting
- - --------------------------------
Shareholders are cordially invited to attend the annual meeting at 10 a.m.
Wednesday, May 5, 1999, in Room 207N, CNA Plaza, 333 South Wabash Avenue,
Chicago. Shareholders unable to attend are requested to exercise their right to
vote by proxy. Proxy material will be mailed to shareholders prior to the
meeting.
Form 10-K
- - -------------------------------------
A copy of CNA Financial Corporation's annual report on Form 10-K, which is filed
with the Securities and Exchange Commission, will be furnished to shareholders
without charge upon written request to:
Jonathan D. Kantor
Senior Vice President,
General Counsel and Secretary
CNA Financial Corporation
CNA Plaza, 43 South
Chicago, Illinois 60685
CNA FINANCIAL CORPORATION
-------------------------
118
CORPORATE DIRECTORY
- - -----------------------------------------------------------------------------
DIRECTORS
- - ------------------------------------------
Antoinette Cook Bush
Partner; Skadden, Arps, Slate, Meagher & Flom
Dennis H. Chookaszian*
Chairman of the Executive Committee,
CNA Financial Corporation
Philip L. Engel
President,
CNA
Robert P. Gwinn
Retired Chairman and Chief Executive Officer,
Encyclopedia Britannica
Bernard L. Hengesbaugh*
Chairman and Chief Executive Officer,
CNA
Walter F. Mondale
Partner; Dorsey & Whitney, LLP
Edward J. Noha
Chairman of the Board,
CNA Financial Corporation
Joseph Rosenberg
Senior Investment Strategist,
Loews Corporation
Richard L. Thomas**
Chairman, Audit Committee;
Retired Chairman of the Board,
First Chicago NBD Corporation and
The First National Bank of Chicago
James S. Tisch
Chairman, Finance Committee;
Chief Executive Officer and President,
Loews Corporation
Laurence A. Tisch
Chief Executive Officer of CNA Financial Corporation,
Co-Chairman of the Board
Loews Corporation
Preston R. Tisch
Co-Chairman of the Board,
Loews Corporation
Marvin Zonis
Professor of International Political Economy,
Graduate School of Business University of Chicago
- - ------------------------------------------------------------------------------
*Mr. Chookaszian resigned as Chairman of the Board and Chief Executive Officer
of CNA effective February 9, 1999. He was replaced by Mr. Hengesbaugh.
**Mr. Thomas will not stand for re-election in May 1999.
***Mr. Tisch retired as Chairperson effective February 10, 1999 and was replaced
by Mr. Chookaszian.
****Ms. Bush resigned as Chairperson effective February 12, 1999.
CNA FINANCIAL CORPORATION
-------------------------
119
CORPORATE DIRECTORY
- - ---------------------------------------------------------------------------
EXECUTIVE COMMITTEE
- - ----------------------------------------
Preston R. Tisch ***
Antoinette Cook Bush
Dennis H. Chookaszian***
Philip L. Engel
Robert P. Gwinn
Bernard L. Hengesbaugh
Walter F. Mondale
Edward J. Noha
Joseph Rosenberg
Richard L. Thomas**
James S. Tisch
Laurence A. Tisch
Marvin Zonis
FINANCE COMMITTEE
- - ---------------------------------------------
James S. Tisch, Chairperson
Antoinette Cook Bush
Dennis H. Chookaszian
Philip L. Engel
Robert P. Gwinn
Bernard L. Hengesbaugh
Walter F. Mondale
Edward J. Noha
Joseph Rosenberg
Richard L. Thomas**
Laurence A. Tisch
Preston R. Tisch
Marvin Zonis
AUDIT COMMITTEE
- - --------------------------------------------------
Richard L. Thomas, Chairperson**
Antoinette Cook Bush
Robert P. Gwinn
Walter F. Mondale
Marvin Zonis
INCENTIVE COMPENSATION COMMITTEE
- - --------------------------------------------------
Antoinette Cook Bush, Chairperson ****
Robert P. Gwinn
Richard L. Thomas**
Marvin Zonis
OFFICERS
- - ----------------------------------------------------
Laurence A. Tisch
Chief Executive Officer,
CNA Financial Corporation
Dennis H. Chookaszian *
Chairman and Chief Executive Officer,
CNA
Philip L. Engel
President,
CNA
Bernard L. Hengesbaugh*
Chairman and Chief Executive Officer,
CNA
Jonathan D. Kantor
Senior Vice President,
General Counsel and Secretary,
CNA Financial Corporation
W. James MacGinnitie
Senior Vice President and Chief Financial Officer,
CNA Financial Corporation
CNA ADMINISTRATIVE OFFICES
- - ------------------------------------------------------------------
CNA Plaza
Chicago, Illinois 60685
312-822-5000
TRANSFER AGENT AND REGISTRAR
- - ------------------------------------------------------------------
First Chicago Trust Company of New York
P.O. Box 2500
Jersey City, New Jersey 07303-2500
INDEPENDENT AUDITORS
- - ------------------------------------------------------------------
Deloitte & Touche LLP
180 North Stetson Avenue
Chicago, Illinois 60601
- - -----------------------------------------------------------------------------
*Mr. Chookaszian resigned as Chairman of the Board and Chief Executive Officer
of CNA effective February 9, 1999. He was replaced by Mr. Hengesbaugh.
**Mr. Thomas will not stand for re-election in May 1999.
***Mr. Tisch retired as Chairperson effective February 10, 1999 and was
replaced by Mr. Chookaszian.
****Ms. Bush resigned as Chairperson effective February 12, 1999.
CNA FINANCIAL CORPORATION
-------------------------
120
CNA FINANCIAL CORPORATION
APPENDIX
OMITTED GRAPH MATERIAL AND OTHER
Exhibit 13.1 - CNA Financial Corporation Annual Report:
* Bar graphs of:
- Revenues for the period 1988 through 1998.
- Assets for the period 1988 through 1998.
- Stockholders' equity for the period 1988 through 1998.
- Book value per common share 1988 through 1998.
(See page 3 of Exhibit 13.1 for a table showing the data points used in the
above graphs.
* The following are outquotes located in the margins from the "Letters to Our
Shareholders", found on pages 4 through 7 of the annual report.
Page Outquotes
4 We see an insurance environment being transformed by consolidation,
convergence of financial services, gloabalization and intense
competition
5 We are fully focused on improved earnings and continued growth of
shareholder value.
6 We will continue to concentrate our full management attention on
improving the Company's bottom line.
7 We will continue to challenge all our businesses on the basis of their
ability to sustain profitable, long-term growth.