================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2000 COMMISSION FILE NUMBER 1-5823
--------------------------
CNA FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 36-6169860
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
CNA PLAZA
CHICAGO, ILLINOIS 60685
(Address of principal executive offices) (Zip Code)
(312) 822-5000
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter periods that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No...
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
CLASS OUTSTANDING AT MAY 3, 2000
- ----------------------------- --------------------------
Common Stock, Par value $2.50 183,293,131
================================================================================
Page 1 of 44
CNA FINANCIAL CORPORATION
INDEX
PART I. FINANCIAL INFORMATION PAGE NO.
- ------ --------------------- --------
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
INDEPENDENT ACCOUNTANTS' REPORT 3
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, 2000 (Unaudited) and DECEMBER 31, 1999................... 4
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2000 AND 1999................. 5
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2000 AND 1999................. 6
NOTES TO CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS (Unaudited) MARCH 31, 2000.............................. 7
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.......................................... 20
PART II. OTHER INFORMATION
- ------- -----------------
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K...................... 42
SIGNATURES ...................................................... 42
EXHIBIT 15 LETTER REGARDING UNAUDITED INTERIM
FINANCIAL INFORMATION................................ 43
EXHIBIT 27 FINANCIAL DATA SCHEDULE............................... 44
Page 2 of 44
INDEPENDENT ACCOUNTANTS' REPORT
Board of Directors and Stockholders
CNA Financial Corporation
Chicago, Illinois
We have reviewed the accompanying condensed consolidated balance sheets of CNA
Financial Corporation (an affiliate of Loews Corporation) and subsidiaries (the
"Company") as of March 31, 2000, and the related condensed consolidated
statements of operations and cash flows for the three month periods ended March
31, 2000 and 1999. These financial statements are the responsibility of the
Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such condensed consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of CNA
Financial Corporation (an affiliate of Loews Corporation) and subsidiaries as of
December 31, 1999 and the related consolidated statements of operations,
stockholders' equity, and cash flows for the year then ended (not presented
herein); and in our report dated February 23, 2000, we expressed an unqualified
opinion on those consolidated financial statements. In our opinion, the
information set forth in the accompanying condensed consolidated balance sheet
as of December 31, 1999 is fairly stated, in all material respects, in relation
to the consolidated balance sheet from which it has been derived.
DELOITTE & TOUCHE LLP
CHICAGO, ILLINOIS
MAY 12, 2000
Page 3 of 44
CNA FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
- ------------------------------------------------------------------------------------------------------------------------------------
MARCH 31, DECEMBER 31,
2000 1999
(In millions of dollars, except share data) (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------------
ASSETS
Investments:
Fixed maturity securities available-for-sale (amortized cost: $26,542 and $27,948) ..... $ 26,045 $ 27,248
Equity securities available-for-sale (cost: $1,250 and $1,150) ......................... 3,550 3,610
Mortgage loans and real estate (less accumulated depreciation: $1 and $1) .............. 48 47
Policy loans ........................................................................... 192 192
Other invested assets .................................................................. 1,112 1,108
Short-term investments ................................................................. 5,723 3,355
----------- -----------
TOTAL INVESTMENTS ................................................................. 36,670 35,560
Cash ........................................................................................ 179 153
Receivables:
Reinsurance ............................................................................ 9,031 8,023
Insurance .............................................................................. 4,747 4,483
Less allowance for doubtful accounts ................................................... (305) (310)
Deferred acquisition costs .................................................................. 2,539 2,436
Prepaid reinsurance premiums ................................................................ 1,598 1,468
Accrued investment income ................................................................... 358 387
Receivables for securities sold ............................................................. 632 284
Federal income taxes recoverable (includes: $89 and $241 due from Loews)...................... 101 269
Deferred income taxes ....................................................................... 831 852
Property and equipment at cost (less accumulated depreciation: $768 and $701) ............... 764 746
Intangibles ................................................................................. 334 328
Other assets ................................................................................ 1,950 1,937
Separate account business ................................................................... 4,765 4,603
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 64,194 $ 61,219
====================================================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Insurance reserves:
Claim and claim adjustment expense ..................................................... $ 27,668 $ 27,356
Unearned premiums ...................................................................... 5,534 5,103
Future policy benefits ................................................................. 6,164 5,996
Policyholders' funds ................................................................... 673 710
Collateral on loaned securities ............................................................. 2,853 1,300
Payables for securities purchased ........................................................... 633 135
Participating policyholders' equity ......................................................... 125 121
Debt ........................................................................................ 2,875 2,881
Other liabilities ........................................................................... 3,737 3,881
Separate account business ................................................................... 4,765 4,603
----------- -----------
TOTAL LIABILITIES ................................................................... 55,027 52,086
----------- -----------
Commitments and contingencies
Minority Interest................................................................................. 202 195
Stockholders' equity:
Common stock ($2.50 par value;
Authorized - 500,000,000 shares;
Issued - 185,525,907 shares;
Outstanding as of March 31, 2000 - 183,293,131 shares,
Outstanding as of December 31, 1999 - 184,406,931 shares) ............................... 464 464
Preferred stock ............................................................................. 71 150
Additional paid-in capital .................................................................. 126 126
Retained earnings ........................................................................... 7,255 7,114
Accumulated other comprehensive income ...................................................... 1,184 1,188
Treasury stock, at cost ..................................................................... (71) (41)
----------- -----------
9,029 9,001
Notes receivable for the issue of stock ..................................................... (64) (63)
----------- -----------
TOTAL STOCKHOLDERS' EQUITY .......................................................... 8,965 8,938
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 64,194 $ 61,219
====================================================================================================================================
See accompanying Notes to Condensed
Consolidated Financial Statements (Unaudited).
Page 4 of 44
CNA FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
- ---------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
(In millions of dollars, except per share data) 2000 1999
- ---------------------------------------------------------------------------------------------------------
Revenues:
Premiums .................................................................... $ 2,770 $ 3,439
Net investment income ....................................................... 495 512
Realized investment gains, net of participating policyholders'
and minority interests .................................................... 89 222
Other......................................................................... 155 174
------- -------
Total revenues.................................................................. 3,509 4,347
------- -------
Claims, benefits and expenses:
Insurance claims and policyholders' benefits ................................ 2,343 2,881
Amortization of deferred acquisition costs .................................. 393 557
Other operating expenses .................................................... 514 579
Restructuring and other related charges ..................................... -- 35
Interest .................................................................... 52 62
------- -------
Total claims, benefits and expenses............................................. 3,302 4,134
------- -------
Income before income tax and cumulative
effect of a change in accounting principle ................................ 207 213
Income tax expense ............................................................ (60) (35)
Minority interest expense ..................................................... (6) (6)
------- -------
Income before cumulative effect of a change in accounting principle ............ 141 172
Cumulative effect of a change in accounting principle, net of tax of $95 ...... -- (177)
- --------------------------------------------------------------------------------------------------------
Net income (loss) ............................................................. $ 141 $ (5)
========================================================================================================
BASIC AND DILUTED EARNINGS PER SHARE AVAILABLE
TO COMMON STOCKHOLDERS
Income before cumulative effect of a change in accounting principle ........... $ 0.76 $ 0.91
Cumulative effect of a change in accounting principle, net of tax .............. -- (0.96)
------- -------
Net income (loss) .............................................................. $ 0.76 $ (0.05)
======= =======
Weighted average outstanding common shares
and common stock equivalents (in millions of shares) ...................... 184.2 184.0
========================================================================================================
See accompanying Notes to
Condensed Consolidated Financial Statements (Unaudited)
Page 5 of 44
CNA FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
(In millions of dollars) 2000 1999
- ------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ....................................................................... $ 141 $ (5)
Adjustments to reconcile net income (loss) to net cash flows from operating activities:
Minority interest ..................................................................... 6 6
Deferred income tax provision ......................................................... 30 (94)
Net realized investment gains ......................................................... (89) (222)
Amortization of intangibles ........................................................... 6 5
Amortization (accretion) of bond discount/premium ................................... (7) 2
Depreciation .......................................................................... 40 45
Changes in:
Receivables, net ................................................................... (1,277) (1,202)
Deferred acquisition costs ......................................................... (117) (68)
Accrued investment income .......................................................... 28 12
Federal income taxes recoverable ................................................... 167 120
Prepaid reinsurance premiums ....................................................... (130) (124)
Insurance reserves ................................................................. 907 1,282
Other .............................................................................. (154) 341
-------- --------
Total adjustments .......................................................... (590) 103
-------- --------
NET CASH FLOWS FROM OPERATING ACTIVITIES ................................... (449) 98
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of fixed maturity securities ................................................. (7,885) (11,744)
Proceeds from fixed maturity securities:
Sales ................................................................................ 8,769 10,392
Maturities, calls and redemptions .................................................... 585 889
Purchases of equity securities ......................................................... (621) (144)
Proceeds from sale of equity securities ................................................ 618 184
Change in short-term investments ....................................................... (2,366) (795)
Change in collateral on loaned securities .............................................. 1,554 1,213
Change in other investments ............................................................ 39 112
Purchases of property and equipment, net ............................................... (106) (75)
Acquisitions, net of cash acquired....................................................... (11) --
Other, net ............................................................................. 53 44
-------- --------
NET CASH FLOWS FROM INVESTING ACTIVITIES ................................... 629 76
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid to preferred shareholders ............................................... (1) (5)
Sale (purchase) of treasury stock ...................................................... (30) 1
Receipts from investment contracts credited to policyholder account balances ........... 1 2
Return of policyholder account balances on investment contracts ........................ (38) (20)
Principal payments on long-term debt ................................................... (7) (189)
Proceeds from issuance of long-term debt ............................................... -- 175
Redemption of preferred stock............................................................ (79) --
-------- --------
NET CASH FLOWS FROM FINANCING ACTIVITIES .................................. (154) (36)
-------- --------
Net cash flows ..................................................... 26 138
Cash at beginning of period ............................................................... 153 217
- ------------------------------------------------------------------------------------------------------------------------
CASH AT END OF PERIOD $ 179 $ 355
========================================================================================================================
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash received (paid):
Interest expense ....................................................................... $ (18) $ (42)
Federal income taxes ................................................................... 135 127
NON-CASH TRANSACTIONS:
Notes receivable from issuance of treasury stock ....................................... -- (11)
See accompanying Notes to Condensed
Consolidated Financial Statements (Unaudited).
Page 6 of 44
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE A - BASIS OF PRESENTATION
The condensed consolidated financial statements (unaudited) 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. As of March 31, 2000, Loews Corporation
(Loews) owned approximately 87% of the outstanding common stock of CNAF.
The accompanying condensed consolidated financial statements are unaudited
and have been prepared in conformity with generally accepted accounting
principles (GAAP). Certain financial information that is normally included in
annual financial statements, including financial statement footnotes, prepared
in accordance with GAAP, but that is not required for interim reporting
purposes, has been condensed or omitted. These statements should be read in
conjunction with the consolidated financial statements and notes thereto
included in CNAF's Annual Report to Shareholders for the year ended December 31,
1999 (incorporated by reference in Form 10-K filed with the Securities and
Exchange Commission for the year ended December 31, 1999). In the opinion of
management, these statements include all adjustments (consisting of normal
recurring accruals) that are necessary for the fair presentation of the
consolidated financial position, results of operations and cash flows. The
operating results for the interim periods are not necessarily indicative of the
results to be expected for the full year. Certain amounts applicable to prior
periods have been reclassified to conform to classifications followed in 2000.
All material intercompany amounts have been eliminated.
In the first quarter of 2000, the Company adopted the American Institute of
Certified Public Accountants' Statement of Position (SOP) 98-7, "Accounting for
Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk."
Adoption of the SOP did not have a material impact on the financial position or
results of operations of the Company.
In the first quarter of 1999, the Company adopted the American Institute of
Certified Public Accountants' SOP 97-3, "Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments." SOP 97-3 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 an entity to pay an imposed or probable assessment
has occurred on or before the date of the financial statements. Adoption of the
SOP resulted in an after-tax charge of $177 million as a cumulative effect of a
change in accounting principle.
Page 7 of 44
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
NOTE B - EARNINGS PER SHARE
Earnings per share applicable to common stock is based on weighted-average
outstanding shares, retroactively adjusted for all stock splits. The computation
of earnings per share for the quarters ended March 31, 2000 and 1999 follows.
- --------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
(In millions of dollars, except per share data) 2000 1999
- --------------------------------------------------------------------------------
Net income (loss) $ 141 $ (5)
Less: Preferred dividend (1) (5)
------ ------
Net income (loss) applicable to common stockholders
140 (10)
Weighted average outstanding common shares and common
stock equivalents 184.2 184.0
------ ------
Basic and diluted earnings (loss) per share available to
common stockholders $ 0.76 $(0.05)
====== ======
NOTE C - RESTRICTED INVESTMENTS
The Company's largest equity holding in a single issuer is in Global
Crossing, Ltd. (Global Crossing) common stock. As of March 31, 2000, the Company
owned 36.1 million shares valued at $1.48 billion, representing approximately
4.5% of Global Crossing's outstanding common stock. Because the Company's
holdings of Global Crossing were not acquired in a public offering, the shares
may not be sold to the public unless the sale is registered or exempt from the
registration requirements of the Securities Act of 1933 (the Act). Such
exemptions include sales pursuant to Rule 144 under the Act. The Company also
has the right, other than as discussed below, to require Global Crossing to
register under the Act up to 25% of the Company's original holdings, and
beginning on August 13, 2000, to require Global Crossing to register up to an
additional 25% of the Company's original holdings.
See Note G for discussion of a hedge the Company entered into relating to a
portion of this investment.
On March 31, 2000, the Company entered into an agreement (the Lockup) with
Global Crossing's underwriters which restricts the direct or indirect sale of
approximately 10.4 million of the Company's Global Crossing shares. The Lockup
expires on May 25, 2000. The Company's rights to require Global Crossing to
register securities under the Act, as mentioned above, are suspended during the
term of the Lockup.
NOTE D - LEGAL PROCEEDINGS AND CONTINGENT LIABILITIES
FIBREBOARD CORPORATION LITIGATION
An agreement between Continental Casualty Corporation (Casualty), Pacific
Indemnity and Fibreboard Corporation (Fibreboard) (the Trilateral Agreement) has
obtained final court approval and its implementation has substantially resolved
Casualty's exposure with respect to asbestos claims involving Fibreboard. 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 (a) all claims by Fibreboard, (b) all filed
but unsettled asbestos claims as of August 23, 1993, and, all future asbestos
Page 8 of 44
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
claims against Fibreboard. Casualty has paid all amounts required under this
obligation of the Trilateral Agreement. Casualty is also obligated to pay
asbestos claims settled as of August 23, 1993.
Through March 31, 2000, Casualty, Fibreboard and plaintiff attorneys had
reached settlements with respect to approximately 133,000 claims, for an
estimated settlement amount of approximately $1.63 billion plus any applicable
interest. Approximately $1.73 billion (including interest of $184 million) was
paid by Casualty through March 31, 2000. Such payments have been partially
recovered from Pacific Indemnity.
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 CNA. 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
Three insurance subsidiaries of the Company are defendants in a lawsuit
arising out of policies allegedly issued to Liggett Group, Inc. (Liggett).
Although it did not issue policies to Liggett, the Company also has been named
as a defendant in this lawsuit, which was filed by Liggett and Brooke Group
Holding Inc. in Delaware Superior Court, New Castle County on January 26, 2000.
The lawsuit, which involves numerous insurers, concerns coverage issues relating
to hundreds of tobacco-related claims asserted against Liggett over the past
twenty years. However, Liggett only began submitting claims for coverage under
the policies in January 2000. All of the policies issued by subsidiaries of the
Company that have been located to date contain exclusions for tobacco-related
claims. Based on facts and circumstances currently known, management believes
that the ultimate outcome of the pending litigation should not materially affect
the financial condition of CNA.
IGI CONTINGENCY
In 1997, CNA Reinsurance Company Limited (CNA Re Ltd.) entered into an
arrangement with IOA Global, Ltd. (IOA), an independent managing general agent
based in Philadelphia, Pennsylvania, to develop and manage a book of accident
and health coverages. Pursuant to this arrangement, IGI Underwriting Agencies,
Ltd. (IGI), a personal accident reinsurance managing general underwriter, was
appointed to underwrite and market the book under the supervision of IOA. Over
the past three years, IGI bound CNA Re Ltd. on a number of reinsurance
arrangements with respect to personal accident insurance worldwide (the IGI
Program). Under various arrangements, CNA Re Ltd. both assumed risks as a
reinsurer and also ceded a substantial portion of those risks to other
companies, including other CNA insurance subsidiaries and ultimately a group of
reinsurers participating in a reinsurance pool known as the Associated Accident
and Health Reinsurance Underwriters (AAHRU) Facility. CNA's Group Operations
business unit participated as a pool member in the AAHRU Facility in varying
percentages over the past three years.
CNA has undertaken a review of the IGI Program and, among other things, has
determined that approximately $20 million of premium was assumed by CNA Re Ltd.
with respect to United States workers' compensation "carve-out" insurance. CNA
is aware that a number of reinsurers with respect to such carve-out insurance
have disavowed their obligations under various legal theories. If one or more
such companies are successful in avoiding or reducing their liabilities, then it
is likely that CNA's liability will also be reduced. Moreover, based on
information known at this time, CNA reasonably believes it has strong grounds
for avoiding altogether a substantial portion of its carve-out exposure through
legal action.
Page 9 of 44
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
As noted, CNA arranged substantial reinsurance protection to manage its
exposures under the IGI Program. Although CNA believes it has valid and
enforceable reinsurance contracts with the AAHRU Facility and other reinsurers
with respect to United States workers' compensation carve-out business, it is
unable to predict to what extent such reinsurers would dispute their liabilities
to CNA. Legal actions could result, and the resolution of any such actions could
take years.
CNA recorded net incurred losses of $50 million for the year ended December
31, 1999 with respect to the United States workers' compensation carve-out
exposure it incurred through the IGI Program. These losses were established net
of estimated recoveries from retrocessionaires and the estimate of ultimate
losses is subject to considerable uncertainty. As a result of these
uncertainties, the results of operations in future years may be adversely
affected by potentially significant reserve additions. Management does not
believe that any such future reserve additions will be material to equity.
OTHER LITIGATION
CNAF and its subsidiaries are also parties to other litigation arising in
the ordinary course of business. The outcome of such other litigation will not,
in the opinion of management, materially affect the results of operations or
equity of CNAF.
ENVIRONMENTAL POLLUTION AND OTHER MASS TORT AND ASBESTOS
CNA's property/casualty insurance companies have potential exposures
related to environmental pollution and other mass tort and asbestos claims.
Environmental pollution clean-up is the subject of both federal and state
regulation. By some estimates, there are thousands of potential waste sites
subject to clean-up. The insurance industry is involved in extensive litigation
regarding coverage issues. Judicial interpretations in many cases have expanded
the scope of coverage and liability beyond the original intent of the policies.
The Comprehensive Environmental Response Compensation and Liability Act of
1980 (Superfund) and comparable state statutes (mini-Superfunds) 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 (EPA) 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 CNA 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 includes 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 the 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 have been enacted by Congress in 1999 or thus far
in 2000 and it is unclear as to what positions the Congress or the
Page 10 of 44
Administration will take and what legislation, if any, will result in the
future. If there is legislation, and in some circumstances even if there is no
legislation, the federal role in environmental clean-up may be significantly
reduced in favor of state action. Substantial changes in the federal statute or
the activity of the EPA may cause states to reconsider their environmental
clean-up statutes and regulations. There can be no meaningful prediction of the
pattern of regulation that would result.
Due to the inherent uncertainties described above, including the
inconsistency of court decisions, the number of waste sites subject to clean-up,
and the standards for clean-up and liability, the ultimate liability of CNA for
environmental pollution claims may vary substantially from the amount currently
recorded.
As of March 31, 2000 and December 31, 1999, CNA carried $437 million and
$463 million, respectively, of claim and claim expense reserves, net of
reinsurance recoverables, for reported and unreported environmental pollution
and other mass tort claims.
CNA's property/casualty insurance subsidiaries have exposure to asbestos
claims, including those attributable to CNA's litigation with Fibreboard
Corporation. 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 March
31, 2000 and December 31, 1999, CNA carried approximately $684 million of claim
and claim expense reserves, net of reinsurance recoverables, for reported and
unreported asbestos-related claims, including those related to Fibreboard.
Unfavorable asbestos claim reserve development for the three months ended
March 31, 2000 and 1999 totaled $27 million and $34 million, respectively. There
was no environmental pollution and other mass tort reserve development for the
three months ended March 31, 2000 and 1999, respectively.
The results of operations in future years may continue to be adversely
affected by environmental pollution and asbestos claims and claim expenses.
Management will continue to monitor these liabilities and make further
adjustments as warranted.
The following table provides additional data related to CNA's environmental
pollution, other mass tort and asbestos-related claim and claim adjustment
expense reserves.
- --------------------------------------------------------------------------------------------------------------------
MARCH 31, 2000 DECEMBER 31, 1999
----------------------------------- ---------------------------------
ENVIRONMENTAL ENVIRONMENTAL
POLLUTION AND POLLUTION AND
OTHER MASS OTHER MASS
(In millions of dollars) TORT ASBESTOS TORT ASBESTOS
- --------------------------------------------------------------------------------------------------------------------
Gross reserves $590 $952 $618 $946
Less ceded reserves (153) (268) (155) (262)
---- ---- ---- ----
Net reserves $437 $684 $463 $684
==== ==== ==== ====
Page 11 of 44
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
NOTE E - REINSURANCE
The effects of reinsurance on earned premiums are shown in the following
table.
- --------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31 EARNED PREMIUMS
(In millions of dollars) DIRECT ASSUMED CEDED NET
- --------------------------------------------------------------------------------
2000
Property/casualty $2,117 $ 519 $ 961 $1,675
Accident and health 920 63 107 876
Life 282 58 121 219
------ ------ ------ ------
Total premiums $3,319 $ 640 $1,189 $2,770
====== ====== ====== ======
1999
Property/casualty $2,275 $ 362 $ 268 $2,369
Accident and health 928 36 96 868
Life 259 40 97 202
------ ------ ------ ------
Total premiums $3,462 $ 438 $ 461 $3,439
====== ====== ====== ======
See Note J for discussion of the Personal Insurance transaction, which had the
effect of increasing ceded premiums for the first quarter of 2000.
NOTE F - DEBT
Debt is comprised of the following obligations.
- ---------------------------------------------------------------------------------------------------
MARCH 31, DECEMBER 31,
(In millions of dollars) 2000 1999
- ---------------------------------------------------------------------------------------------------
Variable rate debt:
Commercial paper $ 675 $ 675
Credit facility--CNA 77 77
Credit facility--CNA Surety 100 100
Senior notes:
7.25%, due March 1, 2003 137 143
6.25%, due November 15, 2003 249 249
6.50%, due April 15, 2005 debenture 497 497
6.75%, due November 15, 2006 249 248
6.45%, due January 15, 2008 149 149
6.60%, due December 15, 2008 199 199
8.375%, due August 15, 2012 80 81
6.95%, due January 15, 2018 148 148
7.25%, debenture, due November 15, 2023 247 247
8.0% - 17.02% secured capital leases, due through December 31, 2011 41 42
Other debt, due through 2019 (rates of 1.0% to 6.60%) 27 26
------- -------
Total debt $ 2,875 $ 2,881
======= =======
Page 12 of 44
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
NOTE G - 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 owners. The components of comprehensive income are shown below.
- ----------------------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
(In millions of dollars) 2000 1999
- ----------------------------------------------------------------------------------------------
Net income (loss) $ 141 $ (5)
Other comprehensive income:
Change in unrealized gains/losses on general account investments
Holding gains (losses) arising during the period 78 1,138
Unrealized losses (gains) at beginning of period included in
realized gains/losses during the period (80) (121)
----- ------
Net change in unrealized gains/losses on general account
investments (2) 1,017
Net change in unrealized gains (losses) on separate accounts and
other 8 (1)
Foreign currency translation adjustment (2) 32
Allocation to participating policyholders and minority interest (6) 3
----- ------
Other comprehensive income (loss), before tax (2) 1,051
Deferred income tax expense related to other comprehensive income (2) (357)
----- ------
Other comprehensive income (loss), net of tax (4) 694
----- ------
Total comprehensive income $ 137 $ 689
===== ======
During the first quarter of 2000, the Company entered into option
agreements intended to hedge market risk associated with approximately
19.3 million of the 36.1 million shares of Global Crossing owned by the Company.
These option agreements were structured as collars in which the Company
purchased put options and sold call options on Global Crossing common stock. The
average exercise prices were $51.70 and $65.40 on the put options and call
options, respectively, subject to adjustments on the call options under certain
limited circumstances. The options expire in the first half of 2002 and are only
exercisable on their expiration dates. The Company has elected hedge accounting
treatment for these transactions. At March 31, 2000 the Company had an
unrealized gain of $1.59 billion on its Global Crossing common stock and
collars, which was a decrease of $176 million from December 31, 1999. The net
decrease consisted of a $343 million decrease in unrealized gain on the
Company's Global Crossing common stock partially offset by a $167 million
unrealized gain from the collars. The fair value of the collars is presented in
equity securities available-for-sale in the accompanying condensed consolidated
balance sheet as of March 31, 2000.
Page 13 of 44
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
NOTE H - BUSINESS SEGMENTS
The Company's reportable segments are strategic businesses that offer
different types of products and services. The Company has seven segments: Agency
Market Operations, Specialty Operations, CNA Re, Global Operations, Risk
Management, Group Operations and Life Operations.
All significant intercompany income and expenses, as well as intercompany
dividends, have been eliminated. Risk Management intrasegment revenues and
expenses, amounting to $41 million and $45 million for the three months ended
March 31, 2000 and 1999, respectively, have been eliminated at the consolidated
level. The Corporate segment results include interest expense on corporate
borrowings of approximately $48 million and $51 million for the three months
ended March 31, 2000 and 1999, respectively.
Page 14 of 44
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------------
AGENCY RISK GROUP LIFE
THREE MONTHS ENDED MARCH 31, 2000 MARKET SPECIALTY GLOBAL MANAGE- OPERA- OPERA- ELIMI-
(In millions of dollars) OPERATIONS OPERATIONS CNA RE OPERATIONS MENT TIONS TIONS CORPORATE NATIONS TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
Net earned premiums $ 833 $ 192 $ 243 $ 274 $ 144 $ 883 $ 212 $ (1) $ (10) $ 2,770
Benefits and expenses 945 195 262 272 180 903 317 32 (10) 3,096
------ ------ ------ ------ ------ ------ ------ ------ ------ -------
Underwriting gain (loss) (112) (3) (19) 2 (36) (20) (105) (33) -- (326)
Net investment income 148 54 46 33 40 33 142 (1) -- 495
Other revenues 30 8 -- 23 80 11 48 1 (45) 155
Other expenses 35 9 1 26 84 13 24 60 (45) 206
------ ------ ------ ------ ------ ------ ------ ------ ------ -------
Pre-tax operating income (loss) 31 50 26 32 -- 11 61 (93) -- 118
Income tax benefit (expense) (4) (15) (8) (11) 2 (3) (20) 31 -- (28)
Minority interest -- -- -- (6) -- -- -- -- -- (6)
------ ------ ------ ------ ------ ------ ------ ------ ------ -------
Net operating income (loss)
(excluding realized
Investment gains (losses)) 27 35 18 15 2 8 41 (62) -- 84
Realized investment gains (losses),
net of tax, participating
policyholders' interest
and minority interest 31 12 6 5 8 4 (6) (3) -- 57
------ ------ ------ ------ ------ ------ ------ ------ ------ -------
Net income (loss) $ 58 $ 47 $ 24 $ 20 $ 10 $ 12 $ 35 $ (65) $ -- $ 141
====== ====== ====== ====== ====== ====== ====== ====== ====== =======
Page 15 of 44
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED
(UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------------
AGENCY RISK GROUP LIFE
THREE MONTHS ENDED MARCH 31, 1999 MARKET SPECIALTY GLOBAL MANAGE- OPERA- OPERA- ELIMI-
(In millions of dollars) OPERATIONS OPERATIONS CNA RE OPERATIONS MENT TIONS TIONS CORPORATE NATIONS TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
Net earned premiums $ 1,359 $ 276 $ 252 $ 246 $ 209 $ 867 $ 203 $ 35 $ (8) $ 3,439
Benefits and expenses 1,582 291 274 246 219 890 295 91 (14) 3,874
Restructuring and other
related charges 20 -- -- -- -- 5 -- 5 -- 30
------- ------- ------- ------- ------- ------- ------- ------- ------ -------
Underwriting gain (loss) (243) (15) (22) -- (10) (28) (92) (61) 6 (465)
Net investment income 172 57 39 30 36 33 145 -- -- 512
Other revenues 16 4 1 28 74 9 16 70 (44) 174
Other expenses 13 7 -- 24 67 11 14 127 (38) 225
Non-insurance restructuring
& other related charges -- -- -- -- 5 -- -- -- -- 5
------- ------- ------- ------- ------- ------- ------- ------- ------ -------
Pre-tax operating income (loss) (68) 39 18 34 28 3 55 (118) -- (9)
Income tax benefit (expense) 35 (10) (4) (10) (7) -- (19) 58 -- 43
Minority interest -- -- -- (7) -- -- -- 1 -- (6)
------- ------- ------- ------- ------- ------- ------- ------- ------ -------
Net operating income (loss)
(excluding realized
investment gains (losses)) (33) 29 14 17 21 3 36 (59) -- 28
Realized investment gains,
net of tax, participating
policyholders' interest and
minority interest 68 22 10 9 10 7 12 6 -- 144
Cumulative effect of a change
in accounting principle,
net of tax (93) (3) -- (3) (75) (1) (2) -- -- (177)
------- ------- ------- ------- ------- ------- ------- ------- ------ -------
Net income (loss) $ (58) $ 48 $ 24 $ 23 $ (44) $ 9 $ 46 $ (53) $ -- $ (5)
======= ======= ======= ======= ======= ======= ======= ======= ====== =======
Page 16 of 44
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED)
NOTE I - RESTRUCTURING AND OTHER RELATED CHARGES
As part of the Company's restructuring plan (the Plan) that was initiated
in August 1998, restructuring-related charges of $35 million were recorded in
the three months ended March 31, 1999. These charges did not qualify for the
initial accrual under generally accepted accounting principles at the end of the
third quarter of 1998 and therefore, were expensed as incurred. The charges
included the following:
In the first three months of 1999, restructuring-related charges for Agency
Market Operations totaled approximately $20 million. The charges included
employee severance and outplacement costs of $10 million related to the planned
net reduction in the workforce. The Agency Market Operations charges also
included consulting costs of $1 million and parallel processing charges of
$3 million. Other charges, including relocation and facility charges, totaled
approximately $6 million.
In the first three months of 1999, restructuring-related charges for Risk
Management totaled approximately $5 million. The charges included parallel
processing costs and other charges of approximately $3 million and consulting
costs of approximately $2 million.
In the first three months of 1999, restructuring-related charges for Group
Operations totaled approximately $5 million and related to employee severance
and other charges.
For the other segments of the Company, restructuring-related charges
totaled approximately $5 million for the first three months of 1999 and related
primarily to employee severance costs.
No restructuring expenses were incurred during the first quarter of 2000;
however, payments were made related to amounts accrued as of December 31, 1999.
The following table sets forth the major categories of the restructuring accrual
and changes therein during the first quarters of 2000.
- ------------------------------------------------------------------------------------------------
EMPLOYEE
TERMINATION AND LEASE BUSINESS
RELATED BENEFIT TERMINATION EXIT
(In millions of dollars) COSTS COSTS COSTS TOTAL
- ------------------------------------------------------------------------------------------------
Accrued costs at December 31, 1999 $ 4 $ 27 $ 15 $ 46
Payments charged against liability (3) (6) (3) (12)
---- ---- ---- ----
Accrued costs at March 31, 2000 $ 1 $ 21 $ 12 $ 34
==== ==== ==== ====
NOTE J - SIGNIFICANT TRANSACTIONS
PERSONAL INSURANCE TRANSACTION
On October 1, 1999, certain subsidiaries of CNA completed a transaction with The
Allstate Corporation (Allstate), whereby CNA's personal lines insurance business
and related employees were transferred to Allstate. Approximately $1.1 billion
of cash and $1.1 billion of additional assets (primarily premium receivables and
deferred policy acquisition costs) were transferred to Allstate, and Allstate
assumed $2.2 billion of claim and claim adjustment expense reserves.
Additionally, CNA received $140 million in cash which consisted of (i)
$120 million in ceding commission for the reinsurance of the CNA personal
insurance business by Allstate, and (ii) $20 million for an option exercisable
during 2002 to purchase 100% of the common stock of five CNA insurance
Page 17 of 44
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED)
subsidiaries at a price equal to the GAAP carrying value as of the exercise
date. Also, CNA invested $75 million in a ten year equity-linked note issued by
Allstate.
CNA will continue to write new and renewal personal insurance policies and to
reinsure this business with Allstate companies, until such time as Allstate
exercises its option to buy the five CNA subsidiaries. Prior to 2002, the
Company will concentrate the direct writing of personal lines insurance business
into the five optioned companies, such that most, if not all, business related
to this transaction will be written by those companies by the date Allstate
exercises its option. CNA continues to have primary liability on policies
reinsured by Allstate.
CNA will continue to have an ongoing interest in the profitability of CNA's
personal lines insurance business and the related successor business through an
agreement licensing the "CNA Personal Insurance" trademark and a portion of
CNA's Agency Market Operations distribution system to Allstate for use in
Allstate's personal insurance agency business for a period of five years. Under
this agreement, CNA will receive a royalty fee based on the business volume of
personal insurance policies sold through the CNA agents for a period of six
years. In addition, the $75 million equity-linked note will be redeemed on
September 30, 2009 (subject to earlier redemption on stated contingencies) for
an amount equal to the face amount plus or minus an amount not exceeding
$10 million, depending on the underwriting profitability of the CNA personal
insurance business.
CNA also shares in any reserve development related to claim and claim adjustment
expense reserves transferred to Allstate at the transaction date. Under the
reserve development sharing agreement, 80% of any favorable or adverse reserve
development up to $40 million and 90% of any favorable or adverse reserve
development in excess of $40 million inure to CNA. CNA's obligation with respect
to unallocated loss adjustment expense reserves was settled at the transaction
date, and is therefore not subject to the reserve sharing arrangement.
The retroactive portion of the reinsurance transaction, consisting primarily of
the cession of claim and claim adjustment expense reserves approximating
$1.0 billion, was not recognized as reinsurance because criteria for risk
transfer was not met for this portion of the transaction. The related
consideration paid was recorded as a deposit and is included in reinsurance
receivables in the consolidated balance sheets. The prospective portion of the
transaction, which as of the transaction date consisted primarily of the cession
of $1.1 billion of unearned premium reserves, has been recorded as reinsurance.
The related consideration paid was recorded as prepaid reinsurance premiums.
Premiums ceded after the transaction date will follow this same treatment. The
$20 million received from Allstate for the option to purchase the five CNA
subsidiaries was deferred and will not be recognized until Allstate exercises
its option, at which time it will be recorded in realized gains and losses.
The ceding commission related to the prospective portion of the transaction will
be recognized in proportion to the recognition of the unearned premium reserve
to which it relates. Approximately $37 million of the ceding commission and
$6 million of royalty fees were earned during the first quarter of 2000.
The Personal Insurance lines transferred to Allstate contributed net earned
premiums of $447 million and net operating income of $10 million during the
three months ended March 31, 1999.
SALE OF AMS SERVICES, INC.
On November 30, 1999, CNA sold the majority of its interest in AMS Services,
Inc. (AMS), a software development company serving the insurance agency market.
Prior to the sale, CNA owned 89% of AMS and consolidated AMS in its financial
Page 18 of 44
CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED
(UNAUDITED)
statements. As a result of the sale, CNA owns 9% of AMS and therefore AMS is no
longer consolidated. CNA's share of AMS' operating results were $59 million of
operating revenue and $8 million of operating losses for the three months ended
March 31, 1999.
NOTE K - RELATED PARTY TRANSACTIONS
CNA reimburses Loews, or pays directly to Loews employees, approximately
$13 million annually for management fees, travel and related expenses, and
expenses of investment facilities and services provided to CNA.
CNA and its eligible subsidiaries are included in the consolidated Federal
income tax return of Loews and its eligible subsidiaries. During the first
quarter of 2000, CNA received a tax refund of $136 million from Loews.
CNA writes, at standard rates, a limited amount of insurance for Loews and its
affiliates. Total premiums from Loews and its affiliates are less than
$10 million on an annual basis.
CNA assumes the risk for a limited amount of insurance from R.V.I. Guaranty
Company, Inc. (RVI), a 50% owned affiliate. Written premiums assumed are less
than $10 million on an annual basis.
CNA sponsors a stock ownership plan whereby the Company finances the purchase of
Company stock by certain executive officers.
Page 19 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
CONSOLIDATED OPERATIONS
The following discussion and analysis should be read in conjunction with
the condensed consolidated financial statements and notes thereto found on pages
4 to 19, which contain additional information helpful in evaluating operating
results and financial condition.
CNA is one of the largest insurance organizations in the United States and
based on 1998 net written premiums, is the fifth largest property/casualty
company and the thirty-fifth largest life insurance company.
CNA's overall goal is to create long-term enterprise value by pursuing
disciplined underwriting as well as operating efficiencies.
CNA conducts its operations through seven operating segments. In addition to the
seven operating segments, certain other activities are reported in the corporate
segment. 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.
OPERATING RESULTS
The following chart summarizes key components of operating results for the
three months ended March 31, 2000 and 1999.
- -------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
(In millions of dollars except per share data) 2000 1999
- -------------------------------------------------------------------------------------------------------------
Operating revenues (excluding realized investment gains/losses):
Premiums $2,770 $3,439
Net investment income 495 512
Other 155 174
------ ------
Total operating revenues (excluding realized investment gains/losses) 3,420 4,125
Benefits and expenses 3,302 4,099
Restructuring and related charges - 35
------ ------
Operating income (loss) before income tax 118 (9)
Income tax (expense) benefit (28) 43
Minority interest (6) (6)
------ ------
Net operating income (excluding realized investments gains/losses) 84 28
Realized investment gains (losses), net of tax and minority interest 57 144
------ ------
Income before cumulative effect of a change in accounting principle 141 172
Cumulative effect of a change in accounting principle, net of tax - (177)
------ ------
Net income (loss) $ 141 $ (5)
====== ======
BASIC AND DILUTED EARNINGS PER SHARE AVAILABLE TO COMMON STOCKHOLDERS
Net operating income (excluding realized investments gains/losses) $ 0.45 $ 0.13
Realized investment gains (losses), net of tax and minority interest 0.31 0.78
Cumulative effect of a change in accounting principle, net of tax - (0.96)
------ ------
Net income (loss) $ 0.76 $(0.05)
====== ======
Page 20 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
The following chart summarizes net operating income (loss) for the three
months ended March 31, 2000 and 1999.
- -------------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
(In millions of dollars) 2000 1999
- -------------------------------------------------------------------------------------------------------------
Agency Market Operations $ 27 $ (33)
Specialty Operations 35 29
CNA Re 18 14
Global Operations 15 17
Risk Management 2 21
Group Operations 8 3
Life Operations 41 36
Corporate and Eliminations (62) (59)
------ ------
Total $ 84 $ 28
====== ======
Net operating income, which excludes net realized investment gains and the
cumulative effect of a change in accounting principle, was $84 million, or $0.45
per share, for the first three months of 2000, compared with net operating
income of $28 million, or $0.13 per share, for the same period in 1999.
Net income for the first three months of 2000 was $141 million, or $0.76
per share, compared with a net loss of $5 million, or $0.05 per share, for the
first three months of 1999. Included in the net loss for the three months ended
March 31, 1999 was a charge of $177 million, net of tax, or $0.96 per share, for
the cumulative effect of a change in accounting principle for insurance-related
assessments.
Discussions of the results of operations from the Company's segments
follow:
AGENCY MARKET OPERATIONS
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 businesses.
Business products include workers' compensation, commercial packages, general
liability and commercial auto, as well as a variety of creative risk management
services.
- --------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
(In millions of dollars) 2000 1999
- --------------------------------------------------------------------------------
Net written premiums $ 827 $ 1,327
Net earned premiums 833 1,359
Underwriting loss (112) (243)
Net operating income (loss) 27 (33)
Loss ratio 81.4% 84.8%
Expense ratio 29.8 32.6
Dividend ratio 2.2 0.5
------ --------
Combined ratio 113.4% 117.9%
====== ========
Page 21 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Net written premiums for Agency Markets Operations decreased 38% to
$827 million for the first three months of 2000 as compared to $1,327 million
for the same period in 1999. 1999 net written premiums include $478 million
related to CNA Personal Insurance which was transferred to Allstate on October
1, 1999. In addition, the Personal Insurance transaction had an impact of
$447 million on the net earned premium decline of 39% to $833 million for the
first quarter of 2000 as compared to the same period in 1999. Aside from the
effects of the personal lines transaction, commercial insurance premiums
declined slightly due to continued efforts to write and renew only profitable
business and to obtain adequate rates.
The combined ratio improved 4.5 points to 113.4% for the three months ended
March 31, 2000 as compared with 1999. The loss ratio improvement of 3.4 points
reflects the impact of increased use of reinsurance, continued efforts to
achieve adequate pricing and the non-renewal of unprofitable business. The
expense ratio declined 2.8 points partially due to restructuring related
expenses to implement a new operating model which were incurred in the first
quarter of 1999, which did not recur in 2000, as well as the reduction of
acquisition expenses. Underwriting results improved by $131 million to a loss of
$112 million as compared to the same period in 1999 attributable principally to
the lower loss ratio and reduced operating expenses. Net operating income
increased to $27 million for the first three months of 2000 from a loss of
$33 million during the same period in 1999 based on improved underwriting
results partially offset by lower investment income.
SPECIALTY OPERATIONS
Specialty Operations provides a broad array of professional, financial and
specialty property/casualty products and services distributed through a network
of brokers, managing general agencies and independent agencies.
- --------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
(In millions of dollars) 2000 1999
- --------------------------------------------------------------------------------
Net written premiums $ 169 $ 267
Net earned premiums 192 276
Underwriting loss (3) (15)
Net operating income 35 29
Loss ratio 77.6% 81.4%
Expense ratio 24.1 24.0
Dividend ratio -- 0.1
----- ------
Combined ratio 101.7% 105.5%
===== ======
Net written premiums for Specialty Operations declined $98 million, or 37%,
for the first three months of 2000, as compared with the same period in 1999.
The premium decline related principally to active decisions to renew only
profitable business. Earned premiums likewise declined to $192 million for the
first quarter of 2000 from $276 million in the same period during 1999.
The combined ratio improved by 3.8 points to 101.7% for the three months
ended March 31, 2000 as compared with the same period in 1999. This improvement
resulted from the decrease in the loss ratio attributable mainly to the effects
of reinsurance for medical malpractice lines of business and the continued
actions to renew only profitable business. Underwriting results improved by
$12 million for the first three months of 2000 as compared with the same period
during 1999 principally as the result of the improvement in the loss ratio
through commitment to prudent underwriting. Net operating income increased to
$35 million for the first three months of 2000 as compared to $29 million
in 1999 principally as a result of the improved underwriting results.
Page 22 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
CNA RE
CNA Re operates globally as a reinsurer in the broker market, offering
both treaty and facultative products through major offices in Chicago and
London. CNA Re's primary product is traditional treaty reinsurance; in addition,
it is developing positions in facultative and financial reinsurance.
- --------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
(In millions of dollars) 2000 1999
- --------------------------------------------------------------------------------
Net written premiums $ 380 $ 415
Net earned premiums 243 252
Underwriting loss (19) (22)
Net operating income 18 14
Loss ratio 70.2% 77.6%
Expense ratio 37.7 30.9
----- -----
Combined ratio 107.9% 108.5%
===== =====
For the three months ended March 31, 2000, net written premiums decreased
$35 million or 8% as compared with the same period in 1999. This decrease
reflects decisions not to renew a number of contracts that do not meet CNA Re's
profitability targets, particularly in the international treaty and domestic
standard lines business units. Earned premiums likewise decreased $9 million or
4% for the first three months of 2000 as compared with the same period in 1999.
The combined ratio improved 0.6 points to 107.9% for the three months ended
March 31, 2000 as compared with the same period in 1999. This decrease was a
result of favorable loss development which more than offset increases in
acquisition and underwriting expenses. Underwriting results improved by
$3 million to a $19 million loss for the first three months of 2000 as compared
with the same period in 1999. Net operating income increased to $18 million for
the first three months of 2000 as compared with $14 million in 1999 based on
improvements in underwriting results and an increase in net investment income.
Page 23 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
GLOBAL OPERATIONS
Global Operations provides products and services to U.S.-based customers,
customers expanding overseas and foreign customers. The major product lines
include marine, commercial and contract surety, warranty and specialty products,
as well as commercial property and casualty.
- --------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
(In millions of dollars) 2000 1999
- --------------------------------------------------------------------------------
Net written premiums $ 281 $ 267
Net earned premiums 274 246
Underwriting gain 2 --
Net operating income 15 17
Loss ratio 56.7% 56.1%
Expense ratio 42.4 43.6
Dividend ratio 0.2 0.3
----- -----
Combined ratio 99.3% 100.0%
===== =====
Net written premiums for Global Operations increased 5% to $281 million for
the first three months of 2000 as compared to the same period in 1999. This
increase was a result of continued growth in surety, warranty and European
operations partially offset by a decrease in Canadian operations. Earned premium
results increased 11% to $274 million for the first quarter of 2000 as compared
to the same period in 1999.
The combined ratio improved by 0.7 points to 99.3% for the three months
ended March 31, 2000 as compared with the same period in 1999. Decreased
underwriting and acquisition expenses contributed to the improvement. The loss
ratio increase is attributable to warranty's vehicle insurance line of business,
partially offset by improvements in Canadian operations because of the
underwriting focus undertaken during 1999 that reduced exposure to large
property losses. Underwriting results improved $2 million for the first quarter
of 2000 when compared to the same period in 1999 driven by strong premium
growth. Net operating income decreased slightly for the quarter.
Page 24 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
RISK MANAGEMENT
Risk Management serves the property/casualty needs of large domestic
commercial businesses, offering customized strategies to address risk
management.
- --------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
(In millions of dollars) 2000 1999
- --------------------------------------------------------------------------------
Net written premiums $ 222 $ 255
Net earned premiums 144 209
Underwriting loss (36) (10)
Risk Management service revenues 80 74
Net operating income 2 21
Loss ratio 91.6% 78.0%
Expense ratio 33.7 26.6
Dividend ratio -- 0.1
----- -----
Combined ratio 125.3% 104.7%
===== =====
Net written premiums for Risk Management declined $33 million, or 13%, for
the first three months of 2000, as compared with the same period in 1999. This
decrease resulted from the Company's decision to cede a larger portion of its
direct premiums, as well as a sustained, intense reunderwriting focus. These
operational efforts resulted in a $65 million decrease in net earned premiums
for the first quarter of 2000 as compared to the same period in 1999.
The combined ratio increased by 20.6 points to 125.3% for the three months
ended March 31, 2000 as compared to the same period in 1999. The combination of
changing the reinsurance structure and the $26 million deterioration of the
underwriting loss led to a 20.6 point increase in the combined ratio.
Underwriting losses increased to $36 million for the first quarter of 2000 as
compared to $10 million in the same period in 1999 due to unfavorable audit
premiums and adverse property losses from the prior year. Net operating income
decreased by $19 million in 2000 primarily due to the poor underwriting results
in the property business line, which were partially offset by favorable casualty
underwriting trends and higher investment income.
Risk management service revenues consist principally of RSKCo, a total risk
management services organization. Risk management services revenue increased to
$80 million for the first three months of 2000 through increased claims handling
and billing revenues.
Page 25 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
GROUP OPERATIONS
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. Group Operations also provides health insurance
to 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.
- --------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
(In millions of dollars) 2000 1999
- --------------------------------------------------------------------------------
Net earned premiums $883 $867
Net operating income 8 3
Group Operations net earned premiums for the three months ended March 31,
2000 increased $16 million as compared with the same period in 1999. This
increase in earned premiums is primarily attributable to continued growth in the
life reinsurance business.
Net operating income for the first quarter of 2000 was $8 million as
compared with $3 million for the same period in 1999. This increase in net
operating income year-over-year was attributable to decreased restructuring and
other costs from having exited the Employer Health and Affinity business in
1999.
LIFE OPERATIONS
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 products to institutions in the form of various investment
products and administration services.
- --------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
(In millions of dollars) 2000 1999
- --------------------------------------------------------------------------------
Sales volume $903 $607
Net earned premiums 212 203
Net operating income 41 36
Sales volume increased by $296 million for the first three months of 2000
as compared with the same period in 1999. Life Operations continued to have
strong sales volume, particularly in retirement related products, such as its
Index 500 Plus and variable annuity products, as well as an increasing base of
direct premiums for life and long term care. Sales volume is a cash-based
measure which includes premium and annuity considerations, investment deposits,
and other sales activity that are not reported as premium under generally
accepted accounting principles.
Net earned premium for Life Operations increased 4% to $212 million for the
first three months of 2000 as compared to $203 million in the same period in
1999. The increase was the result of strong growth in term products, associated
with an increase of pre-Regulation XXX sales, sales of long-term care, and sales
of annuities in Chile.
Page 26 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Net operating income for the first three months of 2000 was $5 million
higher than net operating income for the same period in 1999. This increase was
principally a result of strong earnings in retirement related and term products.
CORPORATE
The corporate segment 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.
Net operating loss increased slightly to a loss of $62 million for the
first three months of 2000 as compared with the same period during 1999.
RESTRUCTURING AND OTHER RELATED CHARGES
The details of the restructuring and other related charges recognized in
the quarter ended March 31, 1999 are discussed in Note I to the Condensed
Consolidated Financial Statements (Unaudited).
The table below presents the remaining accrued restructuring and other
related charges as of March 31, 2000, and management's estimate of the timing of
its ultimate payout.
- ----------------------------------------------------------------------------------------------------------
EMPLOYEE
TERMINATION
AND RELATED LEASE BUSINESS
BENEFIT TERMINATION EXIT
(In millions of dollars) COSTS COSTS COSTS TOTAL
- ----------------------------------------------------------------------------------------------------------
Accrued costs at March 31, 2000 $ 1 $ 21 $ 12 $ 34
==== ==== ==== ====
Remainder of 2000 $ 1 $ 6 $ 10 $ 17
2001 - 6 2 8
2002 - 4 - 4
2003 - 2 - 2
2004 - 1 - 1
2005 and thereafter - 2 - 2
---- ---- ---- ----
Total future payments $ 1 $ 21 $ 12 $ 34
==== ==== ==== ====
Page 27 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
INVESTMENTS
The components of net investment income for the three months ended
March 31, 2000 and 1999 are presented in the following table:
- --------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
(In millions of dollars) 2000 1999
- --------------------------------------------------------------------------------
Fixed maturity securities:
Bonds:
Taxable $ 381 $ 361
Tax-exempt 58 80
Short-term investments 32 45
Other 38 34
----- ------
509 520
Investment expenses (14) (8)
----- ------
Net investment income $ 495 $ 512
===== ======
Lower net investment income in the first quarter of 2000 as compared with
the same period in 1999 is due to lower invested assets as assets were
liquidated in the fourth quarter in connection with the Personal Insurance
transaction with Allstate and the payout of $1.1 billion from escrow to the
Fibreboard trust. The bond segment of the investment portfolio yielded 6.4% in
the first quarter of 2000 as compared to 5.8% in the same period in 1999 due to
fluctuations in interest rates and a decrease in the concentration of tax-exempt
holdings.
Page 28 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
The components of net realized investment gains for the three months ended
March 31, 2000 and 1999 are presented in the following table:
- --------------------------------------------------------------------------------
THREE MONTHS ENDED MARCH 31
(In millions of dollars) 2000 1999
- --------------------------------------------------------------------------------
Realized investment gains (losses):
Fixed maturity securities:
U.S. Government bonds $ (26) $ -
Corporate and other taxable bonds (25) 24
Tax-exempt bonds (26) 26
Asset-backed securities (17) 4
------ ------
Total fixed maturity securities (94) 54
Equity securities 85 22
Derivative securities (2) 27
Other invested assets 99 119
------ ------
Total realized investment gains 88 222
Allocated to participating policyholders 1 -
Income tax expense (32) (78)
------ ------
Net realized investment gains $ 57 $ 144
====== ======
The change in realized gains and losses between the first quarter of 2000
and the same period in 1999 was principally driven by losses on fixed maturity
securities of $94 million, compared to gains of $54 million for the prior year
reflecting the impact of rising interest rates.
Substantially all invested assets are marketable securities classified as
available-for-sale in the accompanying financial statements. Accordingly,
changes in fair value for these securities are reported in other comprehensive
income. The following table presents the carrying values of the Company's
investments as of March 31, 2000 and December 31, 1999, and the change in
unrealized gains/(losses) of those securities included in other comprehensive
income for the three months ended March 31, 2000.
Page 29 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
- ---------------------------------------------------------------------------------------------------------
THREE MONTHS ENDED
MARCH 31, 2000
CHANGE IN
MARCH 31, DECEMBER 31, UNREALIZED
(In millions of dollars) 2000 1999 GAINS/(LOSSES)
- ---------------------------------------------------------------------------------------------------------
Fixed maturity securities:
U. S. Treasury securities and obligations of $ 7,527 $ 8,318 $ 164
Government agencies
Asset-backed securities 6,196 7,039 37
Tax-exempt securities 4,019 4,396 72
Taxable securities 8,253 7,365 2
Redeemable preferred 50 130 (72)
-------- -------- -------
Total fixed maturity securities 26,045 27,248 203
Equity securities:
Common stock 3,296 3,344 (156)
Non-redeemable preferred stock 254 266 (1)
-------- -------- -------
Total equity securities 3,550 3,610 (157)
Short-term investments 5,723 3,355 --
Other investments 1,352 1,347 (48)
-------- -------- -------
Total investments $ 36,670 $ 35,560 (2)
======== ========
Separate account business and other 2
--------
Change in unrealized gains reported in other comprehensive
income $ --
========
The Company's general investment portfolio consists primarily of publicly
traded government bonds, asset-backed securities, mortgage-backed securities,
municipal bonds and corporate bonds.
A primary objective in the management of the fixed maturity portfolio is to
maximize total return relative to underlying liabilities and appropriate market
benchmarks. In achieving this goal, assets may be sold to take advantage of
market conditions, other investment opportunities and credit and tax
considerations. This activity will produce realized gains and losses depending
on then-current interest rates.
Total net unrealized gains of the general account investments for the first
quarter of 2000 was $1,820 million down slightly from $1,822 million in the
first quarter of 1999. The unrealized position at the first quarter of 2000 was
composed of an unrealized loss of $496 million for fixed maturities, an
unrealized gain of $2,300 million for equity securities, and an unrealized gain
of $16 million for other invested assets.
Page 30 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
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.
The general account portfolio consists primarily of high quality (rated BBB
or higher) bonds, 93.7% and 94.2% of which are rated as investment grade at
March 31, 2000 and December, 31, 1999, respectively. The following table
summarizes the ratings of CNA's general account bond portfolio at carrying
value.
- ----------------------------------------------------------------------------------
MARCH 31, DECEMBER 31,
(In millions of dollars) 2000 % 1999 %
- ----------------------------------------------------------------------------------
U.S. government and affiliated securities $ 8,488 33% $ 8,781 32%
Other AAA rated 8,840 34 9,692 36
AA and A rated 4,612 18 4,465 16
BBB rated 2,420 9 2,598 10
Below investment grade 1,636 6 1,582 6
------- --- ------- ---
Total $25,995 100% $27,118 100%
======= === ======= ===
In the above table, approximately 96.3% and 95.4% of the general account
portfolio are U.S. Government agencies or were rated by Standard & Poor's or
Moody's Investors Service at March 31, 2000 and December 31, 1999, respectively.
The remaining bonds were rated by other rating agencies, outside brokers or
Company management.
Below investment grade bonds are high yield securities rated below BBB by
bond rating agencies, as well as other unrated securities which, in the opinion
of management, are below investment grade. High yield securities generally
involve a greater degree of risk than investment grade securities. However,
expected returns should compensate for the added risk. This risk is also
considered in the interest rate assumptions in the underlying insurance
products. CNA's concentration in high yield bonds was 6.3% and 5.8% of total
investments as of March 31, 2000 and December 31, 1999, respectively.
Included in CNA's fixed maturity securities at March 31, 2000 are
$6.2 billion of asset-backed securities, at fair value, consisting of
approximately 23.5% in U.S. government agency issued pass-through certificates
and corporate mortgage-backed pass-through certificates (MBS'), 58.6% in
collateralized mortgage obligations (CMOs), and 17.9% in corporate asset-backed
obligations. The majority of CMOs held are actively traded in liquid markets and
are priced by broker-dealers.
CMOs/MBS' are subject to prepayment risks that tend to vary with changes in
interest rates. During periods of declining interest rates, CMOs/MBS' generally
prepay faster as the underlying mortgages are prepaid and refinanced by the
borrowers in order to take advantage of the lower rates.
Page 31 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
Conversely, during periods of rising interest rates, prepayments generally slow,
which may result in a decrease in yield as a result of the slower prepayments.
CNA limits the risks associated with interest rate fluctuations and prepayments
by concentrating its CMO investments in structured classes. CNA avoids
investments in complex mortgage derivatives without readily ascertainable market
prices. At March 31, 2000, net unrealized losses on asset-backed securities
within the general account portfolio were approximately $177 million compared to
$214 million at December 31, 1999.
Short-term investments at March 31, 2000 and December 31, 1999 primarily
consisted of commercial paper and money market funds. The components of the
general account short-term investments portfolio are presented in the following
table:
- ---------------------------------------------------------------------------
MARCH 31, DECEMBER 31,
(In millions of dollars) 2000 1999
- ---------------------------------------------------------------------------
Commercial paper $4,780 $1,988
U.S. Treasury securities 128 41
Money market funds 408 904
Other 407 422
------ ------
Total short-term investments $5,723 $3,355
====== ======
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 the derivatives in its general account to be 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. 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; adjustments to fair value are not
recognized. Derivatives in certain separate accounts are held for trading
purposes. The Company uses these derivatives to mitigate the risk of the
contract liability relating to Index 500 Plus group annuity contract exposure.
Changes in fair value of Index 500 Plus separate account derivatives held for
trading purposes are reported as a component of net operating income.
The Company's largest equity holding in a single issuer is Global Crossing,
Ltd. (Global Crossing) common stock. As of March 31, 2000, the Company owned
36.1 million shares of Global Crossing valued at approximately $1.48 billion,
representing approximately 4.5% of Global Crossing's outstanding common stock.
During the first quarter of 2000, the Company entered into option agreements
intended to hedge market risk associated with approximately 19.3 million
shares of Global Crossing. These option agreements were negotiated as zero cost
collars in which the Company purchased put options and sold call options on
Global Crossing common stock. At March 31, 2000, the weighted average exercise
prices were $51.70 and $65.40 on the put options and call options, respectively,
Page 32 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
subject to adjustments on the call options under certain limited circumstances.
The options expire in the first half of 2002 and are only exercisable on their
expiration dates. The Company has elected hedge accounting treatment for these
transactions. At March 31, 2000, the Company had an unrealized capital gain of
$1.59 billion on the Global Crossing common stock and related collars, which was
a $176 million decrease from December 31, 1999. The net decrease in unrealized
gains consisted of a $343 million decrease in unrealized gain on the Company's
Global Crossing common stock, partially offset by a $167 million unrealized gain
from the collars.
Because the Company's holdings of Global Crossing were not acquired in a
public offering, the shares may not be sold to the public unless the sale is
registered or exempt from the registration requirements of the Securities Act of
1933 (the Act). Such exemptions include sales pursuant to Rule 144 under the
Act. The Company also has the right, other than as discussed below, to require
Global Crossing to register under the Act up to 25% of the Company's original
holdings, and beginning on August 13, 2000, to require Global Crossing to
register up to an additional 25% of the Company's original holdings.
On March 31, 2000, the Company entered into an agreement (the Lockup) with
Global Crossing's underwriters which restricts the direct or indirect sale of
approximately 10.4 million of the Company's Global Crossing shares. The Lockup
expires on May 25, 2000. The Company's rights to require Global Crossing to
register securities under the Act, as mentioned above, are suspended during the
term of the Lockup.
During the first quarter of 2000, the Company also experienced a net
decrease in unrealized gains of $73 million on its position in Canary Wharf
Group plc common stock, which was valued at $549 million on March 31, 2000. This
decrease was attributable to the sale of shares that generated a $33 million
realized gain and a $40 million decrease in unrealized gains on the remaining
95 million shares of Canary Wharf.
MARKET RISK
Market risk is a broad term related to economic losses due to adverse
changes in the fair value of a financial instrument. 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
Page 33 of 44
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 general
account market risk sensitive instruments presented in the tables on pages 35 to
38 are classified as held for purposes other than trading. The Company does not
generally hold or issue general account derivatives for trading purposes.
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 change 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 March 31,
2000 and December 31, 1999 due to instantaneous parallel changes in the period
end yield curve of a 100 and 150 basis point increase. The Company's exposure to
changes in the market value of its interest sensitive assets and liabilities
stemming from interest rate risk is relatively unchanged from year-end.
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 March 31, 2000
and December 31, 1999, with all other variables held constant. The Company's
equity holdings were assumed to be positively correlated with the Index. At
March 31, 2000, a 10% and 25% decrease in the Index would result in a
$454 million and $1.1 billion decrease, respectively, compared to $505 million
and $1.3 billion decrease, respectively, at December 31, 1999, in the market
rate of the Company's equity investments. Of these amounts, $115 million and
$288 million, respectively, in the current period, and $105 million and
$261 million, respectively, at December 31, 1999, 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 March 31, 2000 and December 31, 1999, with all other variables held constant.
Page 34 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
The Company's exposure to changes in the market value of its interest sensitive
assets and liabilities stemming from currency risk is relatively unchanged from
year-end.
The following tables reflect the estimated effects on the market value of
the Company's financial instruments at March 31, 2000 and December 31, 1999, due
to an increase in interest rates of 100 basis points, a 10% decline in the S&P
500 index, and an unfavorable change of 10% in foreign currency exchange rates.
- ------------------------------------------------------------------------------------------
MARCH 31, 2000 MARKET INTEREST CURRENCY EQUITY
(In millions of dollars) VALUE RATE RISK RISK RISK
- ------------------------------------------------------------------------------------------
HELD FOR OTHER THAN TRADING PURPOSES
General Account:
Fixed maturity securities $ 26,045 $ (1,268) $ (141) $ (22)
Equity securities 3,359 -- (77) (336)
Short term investments 5,723 (3) (13) --
Interest rate caps 3 5 -- --
Other derivative securities 195 (19) 58 45
-------- -------- -------- --------
TOTAL GENERAL ACCOUNT 35,325 (1,285) (173) (313)
-------- -------- -------- --------
Separate Account Business:
Fixed maturity securities 2,782 (101) (8) 3
Equity securities 264 -- (1) (24)
Short term investments 98 -- -- --
Other derivative securities (1) (4) -- --
-------- -------- -------- --------
TOTAL SEPARATE ACCOUNT BUSINESS 3,143 (105) (9) (21)
-------- -------- -------- --------
TOTAL ALL SECURITIES HELD FOR OTHER
THAN TRADING PURPOSES 38,468 (1,390) (182) (334)
-------- -------- -------- --------
HELD FOR TRADING PURPOSES
Separate Account Business:
Fixed maturity securities 361 (11) (1) (3)
Equity securities 25 -- -- (2)
Short term investments 444 -- -- --
Equity index futures -- 2 -- (115)
Other derivative securities 1 (3) -- --
-------- -------- -------- --------
TOTAL ALL SECURITIES HELD FOR
TRADING PURPOSES 831 (12) (1) (120)
-------- -------- -------- --------
TOTAL ALL SECURITIES $ 39,299 $ (1,402) $ (183) $ (454)
======== ======== ======== ========
DEBT $ (2,875) $ 129 $ -- $ --
======== ======== ======== ========
Page 35 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
- ------------------------------------------------------------------------------------------
DECEMBER 31, 1999 MARKET INTEREST CURRENCY EQUITY
(In millions of dollars) VALUE RATE RISK RISK RISK
- ------------------------------------------------------------------------------------------
HELD FOR OTHER THAN TRADING PURPOSES
General Account:
Fixed maturity securities $ 27,248 $ (1,268) $ (149) $ (14)
Equity securities 3,610 -- (84) (361)
Short term investments 3,355 (2) (26) --
Interest rate caps 4 5 -- --
Equity index futures -- 19 -- --
Other derivative securities 12 (8) 59 3
-------- -------- -------- --------
TOTAL GENERAL ACCOUNT 34,229 (1,254) (200) (372)
-------- -------- -------- --------
Separate Account Business:
Fixed maturity securities 2,927 (115) (16) (2)
Equity securities 240 -- -- (24)
Short term investments 59 -- -- --
Other derivative securities (1) (7) -- --
-------- -------- -------- --------
TOTAL SEPARATE ACCOUNT BUSINESS 3,225 (122) (16) (26)
-------- -------- -------- --------
TOTAL ALL SECURITIES HELD FOR OTHER
THAN TRADING PURPOSES 37,454 (1,376) (216) (398)
-------- -------- -------- --------
HELD FOR TRADING PURPOSES
Separate Account Business:
Fixed maturity securities 333 (12) (1) --
Equity securities 19 -- -- (2)
Short term investments 430 -- (2) --
Equity index futures -- 2 -- (105)
Other derivative securities -- (1) -- --
-------- -------- -------- --------
TOTAL ALL SECURITIES HELD FOR
TRADING PURPOSES 782 (11) (3) (107)
-------- -------- -------- --------
TOTAL ALL SECURITIES $ 38,236 $ (1,387) $ (219) $ (505)
======== ======== ======== ========
DEBT $ (2,881) $ 132 $ -- $ --
======== ======== ======== ========
Page 36 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
The following tables reflect the estimated effects on the market value of
the Company's financial instruments at March 31, 2000 and December 31, 1999, due
to an increase in interest rates of 150 basis points, a 25% decline in the S&P
500 index, and an unfavorable change of 20% in foreign currency exchange rates.
- ------------------------------------------------------------------------------------------
MARCH 31, 2000 MARKET INTEREST CURRENCY EQUITY
(In millions of dollars) VALUE RATE RISK RISK RISK
- ------------------------------------------------------------------------------------------
HELD FOR OTHER THAN TRADING PURPOSES
General Account:
Fixed maturity securities $ 26,045 $ (1,878) $ (281) $ (56)
Equity securities 3,359 -- (153) (840)
Short term investments 5,723 (4) (27) --
Interest rate caps 3 15 -- --
Other derivative securities 195 (31) 116 114
-------- -------- -------- --------
TOTAL GENERAL ACCOUNT 35,325 (1,898) (345) (782)
-------- -------- -------- --------
Separate Account Business:
Fixed maturity securities 2,782 (150) (17) 7
Equity securities 264 -- (1) (60)
Short term investments 98 -- -- --
Other derivative securities (1) (6) -- 1
-------- -------- -------- --------
TOTAL SEPARATE ACCOUNT BUSINESS 3,143 (156) (18) (52)
-------- -------- -------- --------
TOTAL ALL SECURITIES HELD FOR OTHER
THAN TRADING PURPOSES 38,468 (2,054) (363) (834)
-------- -------- -------- --------
HELD FOR TRADING PURPOSES
Separate Account Business:
Fixed maturity securities 361 (17) (3) (7)
Equity securities 25 -- -- (6)
Short term investments 444 -- -- --
Equity index futures -- 3 -- (288)
Other derivative securities 1 12 -- --
-------- -------- -------- --------
TOTAL ALL SECURITIES HELD FOR
TRADING PURPOSES 831 (2) (3) (301)
-------- -------- -------- --------
TOTAL ALL SECURITIES $ 39,299 $ (2,056) $ (366) $ (1,135)
======== ======== ======== ========
DEBT $ (2,875) $ 188 $ -- $ --
======== ======== ======== ========
Page 37 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
- ------------------------------------------------------------------------------------------
DECEMBER 31, 1999 MARKET INTEREST CURRENCY EQUITY
(In millions of dollars) VALUE RATE RISK RISK RISK
- ------------------------------------------------------------------------------------------
HELD FOR OTHER THAN TRADING PURPOSES
General Account:
Fixed maturity securities $ 27,248 $ (1,878) $ (298) $ (35)
Equity securities 3,610 -- (168) (902)
Short term investments 3,355 (3) (51) --
Interest rate caps 4 11 -- --
Equity index futures -- 29 -- --
Other derivative securities 12 (13) 118 9
-------- -------- -------- --------
TOTAL GENERAL ACCOUNT 34,229 (1,854) (399) (928)
-------- -------- -------- --------
Separate Account Business:
Fixed maturity securities 2,927 (170) (32) (4)
Equity securities 240 -- -- (60)
Short term investments 59 -- (1) --
Other derivative securities (1) (11) -- --
-------- -------- -------- --------
TOTAL SEPARATE ACCOUNT BUSINESS 3,225 (181) (33) (64)
-------- -------- -------- --------
TOTAL ALL SECURITIES HELD FOR OTHER
THAN TRADING PURPOSES 37,454 (2,035) (432) (992)
-------- -------- -------- --------
HELD FOR TRADING PURPOSES
Separate Account Business:
Fixed maturity securities 333 (18) (1) (1)
Equity securities 19 -- -- (5)
Short term investments 430 -- (4) --
Equity index futures -- 3 -- (261)
Other derivative securities -- (2) -- --
-------- -------- -------- --------
TOTAL ALL SECURITIES HELD FOR
TRADING PURPOSES 782 (17) (5) (267)
-------- -------- -------- --------
TOTAL ALL SECURITIES $ 38,236 $ (2,052) $ (437) $ (1,259)
======== ======== ======== ========
DEBT $ (2,881) $ 193 $ -- $ --
======== ======== ======== ========
Page 38 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
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.
For the three months ended March 31, 2000, net cash used in operating
activities was $449 million as compared with a net cash inflow of $98 million
for the same period in 1999. The significant increase in net cash used in
operating activities for the first quarter of 2000 was attributable to cash
outflows of increased paid claims of approximately $200 million, an accelerated
benefit plan funding of approximately $130 million, and no current quarter
counterpart to the cash inflow generated by Personal Insurance in 1999 which
approximated $100 million.
For the three months ended March 31, 2000, net cash inflows from investment
activities was $629 million as compared with $76 million for the same period in
1999. Cash flows from investing activities were principally related to purchases
and sales of invested assets. Cash inflows increased from the prior year as
invested asset sales increased primarily to fund operating cash shortfalls.
For the three months ended March 31, 2000, net cash used in financing
activities was $154 million as compared with $36 million for the same period in
1999. Cash flows from financing activities include proceeds from the issuance of
debt or equity, outflows for dividends or repayment of debt, and outlays to
reacquire equity instruments. Cash outflows increased from the prior year due to
a $79 million redemption of preferred stock and a $30 million buyback of CNA
common stock, and an increase in the surrender of deferred annuities by
policyholders.
On March 8, 2000, the Company announced that it is exploring the sale of
its individual life insurance and life reinsurance businesses. As expected,
several of the major rating agencies placed their ratings of the Continental
Assurance Company Pool (CAC Pool) under review as a result of this announcement.
When an insurance company experiences a significant event which might be
pertinent to its financial strength rating or claims-paying ability rating, the
major rating agencies generally place that company's rating under special
review. Such events may include merger, sale, recapitalization, regulatory
action, or other significant event.
On March 20, 2000, CNA announced that Continental Casualty Company (CCC), a
wholly owned subsidiary, proposed to CNA Surety Corporation a cash tender offer
at $13.00 per share for all shares of CNA Surety common stock not already owned
by CCC and its affiliates. CCC and its affiliates currently own approximately 63
percent of the outstanding shares of CNA Surety common stock. This tender offer,
if accepted by the minority shareholders of CNA Surety Corporation, will result
in a cash outlay of approximately $220 million.
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CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
On February 15, 2000, Standard's & Poor's lowered the Company's senior debt
rating from A- to BBB and lowered the Company's preferred stock rating from BBB
to BB+. As a result of these actions, the facility fee payable on the aggregate
amount of CNA's $795 million revolving credit facility (Facility) was increased
to 12.5 basis points per annum and the interest rate was increased to London
Interbank Offered Rate (LIBOR) plus 27.5 basis points. Effective April 1, 2000,
CNA's revolving credit facility was reduced from $795 million to $770 million.
As a result of Standard's & Poor's actions the Company has purchased and retired
approximately $79 million of its outstanding money market preferred stock in the
first quarter of 2000. A final redemption was made on April 24, 2000, to redeem
and retire the remaining money market preferred stock. The redemption of the
money market preferred stock will increase annual after-tax earnings to common
shareholders by approximately $1.5 million.
The table below reflects ratings issued by A.M. Best, Standard and Poor's,
Moody's and Duff & Phelps for the CCC Pool, the CIC Pool and the CAC 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 PREFERRED STOCK RATINGS
- -------------------- ----------- ----------- ---------- ------------------------------------------- ---------------
CCC CAC CIC CNA Continental
----------- ----------- ---------- ------------------------------------------- ---------------
FINANCIAL STRENGTH Senior Commercial Preferred Senior
Debt Paper Stock Debt
---------------------------------- -------------- --------------- ------------ ---------------
A.M. Best A A A- - - - -
Moody's A2 A2* A3 Baa1 P2 baa1 Baa2
Standard & Poor's A AA- A- BBB A2 BB+ BBB-
----------- ---------- -----------
CLAIMS PAYING ABILITY
----------------------------------
Duff & Phelps AA- AA - A- - BBB+ -
- -------------------- ----------- ---------- ----------- -------------- --------------- ------------ ---------------
*Continental Assurance Company and Valley Forge Life are rated separately by
Moody's and both have an A1 rating.
ACCOUNTING STANDARDS
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
derivative instruments as either assets or liabilities in the balance sheet 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
Page 40 of 44
CNA FINANCIAL CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS - CONTINUED
after June 15, 2000. CNA is currently evaluating the effects of this Statement
on its accounting and reporting for derivative securities and hedging
activities.
FORWARD LOOKING STATEMENTS
The statements contained in this management discussion and analysis which
are not historical facts are forward-looking statements. When included in this
management 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); changes in foreign,
political, social and economic conditions; regulatory initiatives and compliance
with governmental regulations; judicial decisions and rulings; changes in rating
agency policies and practices; the results of financing efforts; changes in the
Company's composition of operating segments; 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 Company's Securities and
Exchange Commission filings. These forward-looking statements speak only as of
the date of this management discussion and analysis. 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.
Page 41 of 44
CNA FINANCIAL CORPORATION
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
EXHIBIT PAGE
DESCRIPTION OF EXHIBIT NUMBER NUMBER
---------------------- ------- ------
Letter Regarding Unaudited Interim
Financial Information 15.1 43
Financial Data Schedule 27 44
(b) REPORTS ON FORM 8-K:
On March 10, 2000, CNA Financial Corporation filed a report on Form 8-K
related to its announcement to explore the possible sale of its individual life
insurance and life reinsurance businesses.
On March 17, 2000, CNA Financial Corporation filed a report on Form 8-K
related to the completion and filing of its audited financial statements for
year ended December 31, 1999.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CNA FINANCIAL CORPORATION
Date: MAY 12, 2000 By: ____________________________
Robert V. Deutsch
Senior Vice President and
Chief Financial Officer
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