-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, JOjxct2cYfxWQUrKvioGaPbXh/95VVQqs9OUujMc9XHnI8DA7VD9nMIia1+Qveb8 oD2njctSr7SnkBrk6k2hQw== 0000021175-99-000014.txt : 19990409 0000021175-99-000014.hdr.sgml : 19990409 ACCESSION NUMBER: 0000021175-99-000014 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 DATE AS OF CHANGE: 19990408 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CNA FINANCIAL CORP CENTRAL INDEX KEY: 0000021175 STANDARD INDUSTRIAL CLASSIFICATION: 6331 IRS NUMBER: 366169860 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-05823 FILM NUMBER: 99584167 BUSINESS ADDRESS: STREET 1: CNA PLZ CITY: CHICAGO STATE: IL ZIP: 60685 BUSINESS PHONE: 3128225000 MAIL ADDRESS: STREET 1: CNA PLAZA CITY: CHICAGO STATE: IL ZIP: 60685 10-K 1 1998 FORM 10-K - - -------------------------------------------------------------------------------- - - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Year Ended December 31, 1998 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) SECURITIES REGISTERED PURSUANT TO SECTION 12(B)OF THE ACT: Name of each exchange on Title of each class which registered - - -------------------- ------------------------- Common Stock New York Stock Exchange with a par value Chicago Stock Exchange of $2.50 per share Pacific Exchange SECURITIES REGISTERED PURSUANT TO SECTION 12(G)OF THE ACT: None Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No.... As of March 1, 1999, 183,889,569 shares of common stock were outstanding and the aggregate market value of the common stock of CNA Financial Corporation held by non-affiliates was approximately $936 million. DOCUMENTS INCORPORATED BY REFERENCE: Portions of the CNA Financial Corporation 1998 Annual Report to Shareholders are incorporated by reference into Parts I and II of this Report. Portions of the CNA Financial Corporation Proxy Statement prepared for the 1999 annual meeting of shareholders, pursuant to Regulation 14A, are incorporated by reference into Part III of this Report. - - -------------------------------------------------------------------------------- - - -------------------------------------------------------------------------------- CNA FINANCIAL CORPORATION ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1998 Item Page Number PART I Number - - ------ ------ 1. Business........................................................... 3 2. Properties......................................................... 10 3. Legal Proceedings.................................................. 11 4. Submission of Matters to a Vote of Security Holders................ 11 PART II 5. Market for the Registrant's Common Stock and Related Stockholder Matters...................................... 13 6. Selected Financial Data............................................ 13 7. Management's Discussion and Analysis of Financial Condition and Results of Operations............................................ 13 7A. Quantitative and Qualitative Disclosures about Market Risk......... 13 8. Financial Statements and Supplementary Data........................ 13 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure........................... 13 PART III 10. Directors and Executive Officers of the Registrant................. 14 11. Executive Compensation............................................. 14 12. Security Ownership of Certain Beneficial Owners and Management..... 14 13. Certain Relationships and Related Transactions..................... 14 PART IV 14. Financial Statements, Schedules, Exhibits and Reports on Form 8-K.. 14 2 PART I ITEM 1. BUSINESS CNA Financial Corporation (CNAF) was incorporated in 1967 and is the parent company of Continental Casualty Company (CCC), incorporated in 1897, and Continental Assurance Company (CAC), incorporated in 1911. In 1975, CAC became a wholly-owned subsidiary of CCC. In 1995, CNAF acquired The Continental Corporation and it became a wholly-owned subsidiary of CNAF. The Continental Corporation (Continental), a New York corporation incorporated in 1968, is an insurance holding company. Its principal subsidiary, The Continental Insurance Company (CIC), was organized in 1853. The principal business of Continental is the ownership of a group of property and casualty insurance companies. CNAF is a holding company whose primary subsidiaries consist of property/casualty and life insurance companies, collectively these subsidiaries are CNA. CNA's property/casualty insurance operations are conducted by CCC and its affiliates and CIC and its affiliates. Life insurance operations are conducted by CAC and its life insurance affiliates. CNA's principal business is insurance conducted through its insurance subsidiaries. CNA underwrites property, casualty, life and accident and health coverages, as well as pension products and annuities. CNA's principal market for insurance products is the United States. COMPETITION All aspects of the insurance business are highly competitive. CNA competes with a large number of stock and mutual insurance companies and other entities for both producers and customers, and must continuously allocate resources to refine and improve insurance products and services. There are approximately 3,400 individual companies that sell property/casualty insurance in the United States. CNAF's consolidated property/casualty subsidiaries ranked as the third largest property/casualty insurance organization based upon 1997 statutory net written premiums. There are approximately 1,600 companies selling life insurance in the United States. CAC is ranked as the thirty-second largest life insurance organization based on 1997 consolidated statutory premium volume. DIVIDENDS BY INSURANCE SUBSIDIARIES The payment of dividends to CNAF by its insurance affiliates without prior approval of the affiliates' domiciliary state insurance commissioners is limited to amounts determined by formula in accordance with the accounting practices prescribed or permitted by each state's insurance department. This formula varies by state. The formula used by the majority of the states provides that the greater of 10% of prior year statutory surplus or prior year statutory net income, less the aggregate of all dividends paid during the twelve months prior to date of payment is available to dividend to the parent company. Some states, however, have an additional stipulation that dividends can't exceed prior year's surplus. Based upon the formulas applied by the respective domiciliary states of the operating companies, approximately $663 million in dividends can be paid to CNAF by its insurance affiliates in 1999 without prior approval. All dividends must be reported to the domiciliary insurance department prior to declaration and payment. 3 REGULATION The insurance industry is subject to comprehensive and detailed regulation and supervision throughout the United States. Each state has established supervisory agencies with broad administrative powers relative to licensing insurers and agents, approving policy forms, establishing reserve requirements, fixing minimum interest rates for accumulation of surrender values and maximum interest rates of policy loans, prescribing the form and content of statutory financial reports, regulating solvency and the type and amount of investments permitted. Such regulatory powers also extend to premium rate regulations which require that rates not be excessive, inadequate or unfairly discriminatory. In addition to regulation of dividends by insurance subsidiaries discussed above, intercompany transfers of assets may be subject to prior notice or approval by the state insurance regulator, depending on the size of such transfers and payments in relation to the financial position of the insurance affiliates making the transfer. Insurers are also required by the states to provide coverage to insureds who would not otherwise be considered eligible by the insurers. Each state dictates the types of insurance and the level of coverage which must be provided to such involuntary risks. CNA's share of these involuntary risks is mandatory and generally a function of its respective share of the voluntary market by line of insurance in each state. Reform of the U.S.'s tort liability system is another issue facing the insurance industry. Although federal standards would create more uniform laws, tort reform supporters still look primarily to the states for passage of reform measures. Over the last decade, many states have passed some type of reform, but more recently, a number of state courts have modified or overturned these reforms. Additionally, new causes of action and theories of damages continue to be proposed in state court actions or by legislatures. Continued unpredictability in the law means that insurance underwriting and rating is difficult in commercial lines, professional liability and some specialty coverages. Although the federal government and its regulatory agencies do not directly regulate the business of insurance, federal legislative and regulatory initiatives can impact the insurance business in a variety of ways. These initiatives include tort reform proposals; measures to limit Year 2000 liability; proposals to overhaul the Superfund hazardous waste removal and liability statute; financial services modernization legislation, which includes provisions to remove barriers that prevent banks from engaging in the insurance business; and various tax proposals affecting insurance companies. In 1998, federal legislation to provide a new and comprehensive framework for affiliation and regulation of the banking, insurance and securities industries was passed by the House of Representatives but not by the Senate. Congress is expected to continue efforts to enact legislation in the financial services area. This legislation could result in significant regulatory changes in the financial services industry. Environmental clean-up remains the subject of both federal and state regulation. For the last several years Congress and the Executive branch have failed to reach an agreement on ways to overhaul the federal Superfund hazardous waste program. The legislative stalemate is the result of a failure by Superfund stakeholders and Congress to reach a compromise on clean-up standards, the repeal of retroactive liability and the methodology for financing future clean-up costs. Although Superfund reform continues to be listed as one of Congress' legislative priorities, at this time it is unclear if any reform will be enacted. 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 concerning clean up of hazardous waste. Judicial interpretations in many cases have expanded the scope of coverage and liability beyond the original intent of the policies. For further discussion, see Note E of the Consolidated Financial Statements of the 1998 Annual Report to Shareholders, incorporated by reference in Item 8, herein. In recent years, increased scrutiny of state regulated insurer solvency requirements by certain members of the U.S. Congress resulted in the National Association of Insurance Commissioners developing industry minimum Risk-Based Capital (RBC) requirements. The RBC requirements establish a formal state accreditation process designed to regulate for solvency more closely, minimize the diversity of approved statutory accounting and actuarial practices, and increase the annual statutory statement disclosure requirements. 4 REGULATION--(CONTINUED) The RBC formulas are designed to identify an insurer's minimum capital requirements based upon the inherent risks (e.g., asset default, credit and underwriting) of its operations. In addition to the minimum capital requirements, the RBC formula and related regulations identify various levels of capital adequacy and corresponding actions that the state insurance departments should initiate. The level of capital adequacy below which insurance departments would take action is defined as the Company Action Level. As of December 31, 1998, all of CNAF's property/casualty and life insurance affiliates had adjusted capital amounts in excess of Company Action Levels. REINSURANCE Information as to CNA's reinsurance business is set forth in Note G of the Consolidated Financial Statements of the 1998 Annual Report to Shareholders, incorporated by reference in Item 8, herein. EMPLOYEE RELATIONS CNA has approximately 23,600 full-time equivalent employees and has experienced satisfactory labor relations. CNA has never had work stoppages due to labor disputes. CNA has comprehensive benefit plans for substantially all of its employees, including retirement plans, savings plans, disability programs, group life programs and group health care programs. See Note I of the Consolidated Financial Statements of the 1998 Annual Report to Shareholders for further discussion, incorporated by reference in Item 8, herein. GOVERNMENT CONTRACTS CNA's premium revenues includes premiums under contracts involving U.S. government employees and their dependents. Such premiums amounted to approximately $2.0 billion, $2.1 billion and $2.1 billion in 1998, 1997 and 1996, respectively. 5 BUSINESS SEGMENTS Information as to CNA's business segments is set forth in Note M of the Consolidated Financial Statements of the 1998 Annual Report to Shareholders, incorporated by reference in Item 8, herein. Additional information as to CNA's business segments is set forth in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of the 1998 Annual Report to Shareholders, incorporated by reference in Item 7, herein. SUPPLEMENTARY INSURANCE DATA The following table sets forth supplementary insurance data.
- - -------------------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 (in millions of dollars, except ratio information) - - -------------------------------------------------------------------------------------- Trade Ratios - GAAP basis (a) Loss ratio............................... 80.8% 77.1% 76.4% Expense ratio............................ 32.8 31.3 30.9 Combined ratio (before policyholder dividends) 113.6 108.4 107.3 Policyholder dividend ratio.............. 1.1 0.5 1.6 Trade Ratios - Statutory basis (a) Loss ratio............................... 81.5% 77.5% 76.8% Expense ratio............................ 32.7 30.7 30.6 Combined ratio (before policyholder dividends) 114.2 108.2 107.4 Policyholder dividend ratio.............. 1.0 0.8 1.4 Gross Life Insurance In-Force Group.................................... $317,720 $239,843 $172,213 Life (c)................................. 76,674 71,755 64,796 -------- -------- -------- $394,394 $311,598 $237,009 ======== ======== ======== Other Data - Statutory basis (b) Property/casualty capital and surplus*... $ 7,593 $ 7,123 $ 6,349 Life capital and surplus................. 1,109 1,223 1,163 Written premium to surplus ratio........ 1.4 1.4 1.6 Capital and surplus-percent of total liabilities 20.5% 22.4% 25.5% Participating policyholders-percent of gross 0.5% 0.7% 0.5% life insurance in force.................. - - ---------------------------------------------------------------------------------------- *Surplus includes equity of property/casualty companies' ownership in life insurance subsidiaries.
(a) GAAP trade ratios reflect the results of CNA's property/casualty insurance subsidiaries. Trade ratios are industry measures of property/casualty underwriting results. The loss ratio is the percentage of incurred claim and claim adjustment expenses to premiums earned. Under generally accepted accounting principles, the expense ratio is the percentage of underwriting expenses, including the change in deferred acquisition costs, to premiums earned. Under statutory accounting principles, the expense ratio is the percentage of underwriting expenses (with no deferral of acquisition costs) to premiums written. The combined ratio is the sum of the loss and expense ratios. The policyholder dividend ratio is the ratio of dividends incurred to premiums earned. (b) Other data is determined on the statutory basis of accounting. Dividends of $410 million, $175 million, $545 million, were paid to CNAF by CCC in 1998, 1997, and 1996, respectively. Insurance subsidiaries have received, or will receive, reimbursement from CNAF for general management and administrative expenses, unallocated loss adjustment expenses and investment expenses of $187 million, $217 million and $223 million, in 1998, 1997, and 1996, respectively. Life statutory capital and surplus as a percent of total liabilities is determined after excluding Separate Account liabilities and reclassifying the statutorily required Asset Valuation and Interest Maintenance Reserves as surplus. (c) Lapse ratios for individual life insurance, as measured by surrenders and withdrawals as a percentage of average ordinary life insurance in force, were 14.7%, 6.4%, and 7.2% in 1998, 1997, and 1996, respectively. 6 SUPPLEMENTARY INSURANCE DATA--(CONTINUED) The following table displays the distribution of gross written premiums for the CNA's property/casualty operations: - - -------------------------------------------------------------------------------- Gross Written Premiums % of Total ---------------------- Year Ended December 31 1998 1997 1996 - - -------------------------------------------------------------------------------- New York.................................................... 9.5 9.9 9.3 California.................................................. 8.2 8.8 8.5 Texas....................................................... 6.0 6.2 6.0 Pennsylvania................................................ 4.7 5.1 4.9 Florida..................................................... 4.6 4.8 4.2 Illinois.................................................... 4.5 4.4 5.3 New Jersey.................................................. 4.4 4.3 4.1 All other states, countries or political subdivisions (*)... 48.0 48.0 46.8 Reinsurance assumed: Voluntary............................................... 9.1 9.7 9.1 Involuntary............................................. 1.0 (1.2) 1.8 ------ ------- ------ 100.0 100.0 100.0 ================================================================================ (*) No other state, country or political subdivision accounts for more than 3.0% of gross written premiums. Approximately 96% of CNA's premiums are derived from the United States. Premiums from any individual foreign country are not significant. PROPERTY/CASUALTY CLAIM AND CLAIM ADJUSTMENT EXPENSES The following loss reserve development table illustrates the change over time of reserves established for property/casualty claim and claim adjustment expenses at the end of various calendar years for CNA's property/casualty operations. The first section shows the reserves as originally reported at the end of the stated year. The second section, reading down, shows the cumulative amounts paid as of the end of successive years with respect to the originally reported reserve liability. The third section, reading down, shows re-estimates of the original recorded reserve as of the end of each successive year which is the result of the Company's property/casualty insurance subsidiaries' expanded awareness of additional facts and circumstances that pertain to the unsettled claims. The last section compares the latest re-estimated reserve to the reserve originally established, and indicates whether the original reserve was adequate or inadequate to cover the estimated costs of unsettled claims. 7 PROPERTY/CASUALTY CLAIM AND CLAIM ADJUSTMENT EXPENSES--(CONTINUED) The loss reserve development table for property/casualty operations is cumulative and, therefore, ending balances should not be added since the amount at the end of each calendar year includes activity for both the current and prior years.
- - ----------------------------------------------------------------------------------------------------------------------- SCHEDULE OF PROPERTY/CASUALTY LOSS RESERVE DEVELOPMENT CALENDAR YEAR ENDED 1988(a) 1989(a) 1990(a) 1991(a) 1992(a) 1993(a) 1994(b) 1995(c) 1996 1997(d) 1998(e) (In millions of dollars) - - ---------------------------------------------------------------------------------------------------------------------- Gross reserves for unpaid claim and claim expenses.... $ -- $ -- $16,530 $17,712 $20,034 $20,812 $21,639 $31,044 $29,395 $28,571 $28,355 Ceded recoverable..... -- -- 3,440 3,297 2,867 2,491 2,705 6,089 5,660 5,326 5,424 ----- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- Net reserves for unpaid claim and claim expenses.... 9,552 11,267 13,090 14,415 17,167 18,321 18,934 24,955 23,735 23,245 22,931 ----- ------- ------- ------- ------- ------- ------- ------- ------ ------ ------- CUMULATIVE NET PAID AS OF: One year later........ 2,040 2,670 3,285 3,411 3,706 3,629 3,656 6,510 5,851 5,954 -- Two years later....... 3,622 4,724 5,623 6,024 6,354 6,143 7,087 10,485 9,796 -- -- Three years later..... 4,977 6,294 7,490 7,946 8,121 8,764 9,195 13,363 -- -- -- Four years later...... 6,078 7,534 8,845 9,218 10,241 10,318 10,624 -- -- -- -- Five years later...... 6,960 8,485 9,726 10,950 11,461 22,489 -- -- -- -- -- Six years later....... 7,682 9,108 11,207 11,951 12,308 -- -- -- -- -- -- Seven years later..... 8,142 10,393 12,023 12,639 -- -- -- -- -- -- -- Eight years later..... 9,303 11,086 12,592 -- -- -- -- -- -- -- -- Nine years later...... 9,924 11,563 -- -- -- -- -- -- -- -- -- Ten years later.......10,342 -- -- -- -- -- -- -- -- -- -- NET RESERVES RE-ESTIMATED AS OF: End of initial year... 9,552 11,267 13,090 14,415 17,167 18,321 18,934 24,955 23,735 23,245 22,931 One year later........ 9,737 11,336 12,984 16,032 17,757 18,250 18,922 24,864 23,479 23,508 -- Two years later....... 9,781 11,371 14,693 16,810 17,728 18,125 18,500 24,294 23,140 -- -- Three years later..... 9,796 13,098 15,737 16,944 17,823 17,868 18,008 23,814 -- -- -- Four years later......11,471 14,118 15,977 17,376 17,765 17,511 17,354 -- -- -- -- Five years later......12,496 14,396 16,440 17,329 17,560 17,082 -- -- -- -- -- Six years later.......12,742 14,811 16,430 17,293 17,285 -- -- -- -- -- -- Seven years later.....13,167 14,810 16,551 17,069 -- -- -- -- -- -- -- Eight years later.....13,174 14,995 16,487 -- -- -- -- -- -- -- -- Nine years later......13,396 14,973 -- -- -- -- -- -- -- -- -- Ten years later.......13,431 -- -- -- -- -- -- -- -- -- -- ------- ------- -------- ------ ------ ------ ------ ------ ------ ------ ------ Total net (deficiency)(3,879) (3,706) (3,397) (2,654) (118) 1,239 1,580 1,141 595 (263) -- redundancy - - ------------------------------------------------------------------------------------------------------------------------
- - ----------------------------------------------------------------------------------------------------------------------- Schedule of Property/Casualty Loss Reserve Development Calendar Year Ended 1988(a) 1989(a) 1990(a) 1991(a) 1992(a) 1993(a) 1994(b) 1995(c) 1996 1997(d) 1998(e) (In millions of dollars) - - ---------------------------------------------------------------------------------------------------------------------- Reconciliation to gross re-estimated reserves: Net reserves 13,431 14,973 16,487 17,069 17,285 17,082 17,354 23,814 23,140 23,508 -- re-estimated Re-estimated ceded -- -- 3,339 3,173 2,714 2,287 2,480 6,420 5,940 5,646 -- ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ recoverable Total gross re-estimated -- -- 19,826 20,242 19,999 19,369 19,834 30,234 29,080 29,154 -- reserves - - ----------------------------------------------------------------------------------------------------------------------- - - ------------------------------------------------------------------------------------------------------------------------ Net (deficiency) redundancy related to: Asbestos claims (3,190) (3,092) (2,958) (2,911) (1,222) (622) (587) (399) (348) (243) -- Environmental claims... (1,013) (988) (981) (937) (894) (451) (279) (289) (226) (227) -- ------- ------ ------ ------ ------ ------ ------ ------ -------------- ----- Total asbestos and (4,203) (4,080) (3,939) (3,848) (2,116)(1,073) (866) (688) (574) (470) -- environmental Other claims........... 324 374 542 1,194 1,998 2,312 2,446 1,829 1,169 207 -- ------ ------ ------ ------ ------ ------ ------ ------ ------- ------- ----- Total net (deficiency) (3,879) (3,706) (3,397) (2,654) (118) 1,239 1,580 1,141 595 (263) -- redundancy ======= ======= ======= ======= ====== ====== ====== ====== ======= ======= ======= - - -----------------------------------------------------------------------------------------------------------------------
(a) Reflects reserves of CNA's property/casualty insurance subsidiaries, excluding Continental reserves, which were acquired on May 10, 1995 (the Acquisition Date). Accordingly, the reserve development (net reserves recorded at the end of the year, as initially estimated, less net reserves re-estimated as of subsequent .years) does not include Continental. (b) Reserve development related to the 1994 reserves of CNA, excluding Continental, as determined by the balances in this column, plus adverse reserve development of $134 million related to the reserves of Continental, on the Acquisition Date, which are not reflected in this column, were recorded by CNA in 1995 and subsequent periods. (c) Includes Continental gross reserves of $9,713 million and net reserves of $6,063 million acquired on the Acquisition Date and subsequent development thereon. (d) Includes net and gross reserves of acquired companies of $57 million and $64 million. (e) Includes net and gross reserves of acquired companies of $122 million and $223 million. 8 PROPERTY/CASUALTY CLAIM AND CLAIM ADJUSTMENT EXPENSES--(CONTINUED) Additional information as to CNA's property/casualty claim and claim expense reserves is set forth in Notes A and E of the Consolidated Financial Statements of the 1998 Annual Report to Shareholders, incorporated by reference in Item 8, herein. Information as to CNA's reserve development is set forth in Note E of the Consolidated Financial Statements of the 1998 Annual Report to Shareholders, incorporated by reference in Item 8, herein. INVESTMENTS Information as to the Company's investments is set forth in Note B of the Consolidated Financial Statements of the 1998 Annual Report to Shareholders, incorporated by reference in Item 8, herein. Additional information as to the Company's investments is set forth in the Management's Discussion and Analysis of Financial Condition and Results of Operations section of the 1998 Annual Report to Shareholders, incorporated by reference in Item 7, herein. At December 31, 1998, CNA had an approximate 25% ownership interest in C.W. Investments Limited Partnership (CWI) with a carrying value of approximately $25 million. CNA accounted for CWI under the equity method. CWI was the sole shareholder of Canary Wharf Group P.L.C. (CWG). On March 25, 1999, CWG shares were sold in an initial public offering (IPO) at a price of (pound)3.30 per share and listed on the London Stock Exchange. As a result of the IPO, CNA will receive approximately 100 million shares of CWG stock and approximately $143 million in cash. After completion of the transaction, CNA will own approximately 15% of the outstanding stock of CWG. CNA will account for its ownership in CWG as an available-for-sale security with a carrying value of approximately $535 million (based upon the IPO price of (pound)3.30 per share). Additionally the original investors, including CNA, have entered into a lock-up agreement with the underwriters, under which they may not sell their shares of CWG until September 30, 1999. 9 ITEM 2. PROPERTIES CNA Plaza, owned by Continental Assurance Company, serves as the home office for CNAF and its insurance subsidiaries. An adjacent building (located at 55 E. Jackson Blvd.), jointly owned by Continental Casualty Company and Continental Assurance Company, is partially situated on grounds under leases expiring in 2058. Approximately 15% of the adjacent building is rented to non-affiliates. CNAF's subsidiaries lease office space in various cities throughout the United States and in other countries. The following table sets forth certain information with respect to the principal office buildings owned or leased by CNAF's subsidiaries: - - -------------------------------------------------------------------------------- Amount Of Building Owned and Occupied or Leased by CNA or its Location Subsidiaries Principal Usage - - -------------------------------------------------------------------------------- CNA 1,144,378 sq. ft.* Principal Executive Plaza Offices of CNAF 333 S. Wabash Chicago, Illinois 180 Maiden Lane 1,091,570* Property/Casualty New York, New York Insurance Offices 55 E. Jackson Blvd. 440,292* Principal Executive Chicago, Illinois Offices of CNAF 401 Penn Street 254,589* Property/Casualty Reading, Pennsylvania Insurance Offices 100 CNA Drive 251,363* Life Insurance Offices Nashville, Tennessee 7361 Calhoun Place 224,725** Life Insurance Offices Rockville, Maryland 200 S. Wacker Drive 265,727** Property/Casualty Chicago, Illinois Insurance Offices 1111 E. Broad St. 225,470** Property/Casualty Columbus, Ohio Insurance Offices 1110 Ward Avenue Honolulu, 186,687* Property/Casualty Hawaii Insurance Offices 3501 State Highway 66 183,184** Property/Casualty Neptune, New Jersey Insurance Offices 2405 Lucien Way 178,744** Property/Casualty Maitland, Florida Insurance Offices 333 Glen Street 164,032** Property/Casualty Glens Falls, New York Insurance Offices - - -------------------------------------------------------------------------------- Amount Of Building Owned and Occupied or Leased by CNA or its Location Subsidiaries Principal Usage - - -------------------------------------------------------------------------------- 1100 Cornwall Road 147,884** Property/Casualty Monmouth Junction, Insurance Offices New Jersey 600 North Pearl Street 139,151** Property/Casualty Dallas, Texas Insurance Offices * Represents property owned by CNAF or its subsidiaries. ** Represents property leased by CNAF or its subsidiaries. 10 ITEM 3. LEGAL PROCEEDINGS Information as to CNA's legal proceedings is set forth in Note F of the Consolidated Financial Statements of 1998 Annual Report to Shareholders, incorporated by reference in Item 8, herein. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 11
EXECUTIVE OFFICERS OF THE REGISTRANT POSITION AND OFFICES HELD FIRST BECAME WITH REGISTRANT OFFICER OF CNA NAME AGE PRINCIPAL OCCUPATION DURING PAST FIVE YEARS Laurence A. Tisch Chief Executive 76 * Co-Chairman of the Board of Loews Corporation. Officer, CNA President, Chief Executive Officer and Director of Financial CBS, Inc. until November 1995.Executive officer of Corporation the Registrant since 1974. Dennis H. Chookaszian Chairman of the 55 1975 Chairman of the Executive Committee of the Board and Chief Registrant. Until February 1999, Chairman of the Executive Board and Chief Executive Officer of CNA since Officer, CNA** September 1992. Executive officer of the Registrant since 1975. Philip L. Engel President, CNA*** 58 1977 President of CNA since September 1992. Prior thereto, Mr. Engel was Executive Vice President of CNA. Executive officer of the Registrant since 1992. Bernard L. Hengesbaugh Chairman of the 52 1980 Chairman of the Board and Chief Executive Officer Board and Chief of CNA since February 1999. Executive Vice Executive President and Chief Operating Officer of CNA Officer, CNA**** from February 1998 until February 1999. Senior Vice President of CNA since November 1990. Executive officer of the Registrant since 1992. W. James MacGinnitie Senior Vice 60 1997 Senior Vice President and Chief Financial Officer President and of CNA and of the Registrant since October 1997. Chief Financial From 1994 through 1997, Partner at Ernst & Officer Young LLP. Prior to that time, Principal with Tillinghast. Officers are elected and hold office until their successors are elected and qualified, and are subject to removal by the Board of Directors. *Mr. Tisch is not an officer of CNA. **Mr. Chookaszian resigned effective February 9, 1999. ***On March 25, 1999, Mr. Engel announced his intention to retire from his position as President on or about September 30, 1999. ****Mr. Hengesbaugh was elected Chairman of the Board and Chief Executive Officer of CNA effective February 9, 1999.
12 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS Incorporated herein by reference from page 118 of the 1998 Annual Report to Shareholders. ITEM 6. SELECTED FINANCIAL DATA Incorporated herein by reference from page 2 of the 1998 Annual Report to Shareholders. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Incorporated herein by reference from pages 11 through 57 of the 1998 Annual Report to Shareholders. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Incorporated herein by reference under the heading Market Risk in Management's Discussion and Analysis of Financial Condition and Results of Operations of the 1998 Annual Report to Shareholders on pages 46 through 50. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Balance Sheets - December 31, 1998 and 1997 Consolidated Statements of Operations - Year Ended December 3l, 1998, 1997 and 1996 Consolidated Statements of Stockholders' Equity - December 31, 1998, 1997 and 1996 Consolidated Statements of Cash Flows - Year Ended December 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements Independent Auditors' Report The above Consolidated Financial Statements, the related Notes to the Consolidated Financial Statements and the Independent Auditors' Report are incorporated herein by reference from pages 58 through 117 of the 1998 Annual Report to Shareholders. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 13 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information required in Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year. ITEM 11. EXECUTIVE COMPENSATION Information required in Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information required in Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information required in Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year. PART IV ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS AND REPORTS ON FORM 8-K Page Number ------ (a) 1. FINANCIAL STATEMENTS: A separate index to the Consolidated Financial Statements 13 is presented in Part II, Item 8.................................... (a) 2. FINANCIAL STATEMENT SCHEDULES: Schedule I Summary of Investments................................ 18 Schedule II Condensed Financial Information (Parent Company)...... 19 Schedule III Supplementary Insurance Information................... 23 Schedule V Valuation and Qualifying Accounts and Reserves........ 24 Schedule VI Supplementary Information Concerning Property/Casualty Insurance Operations.................................. 24 Other schedules are omitted because of the absence of conditions under which they are required or because the required information is provided in the Consolidated Financial Statements or notes thereto. Independent Auditors' Report....................................... 25 14 PART IV ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS AND REPORTS ON FORM 8-K (CONTINUED) (a) 3. EXHIBITS: Exhibit Number ------- Description of Exhibit ---------------------- (2) Plan of acquisition, reorganization, arrangement, liquidation or succession: Securities Purchase Agreement, dated as of December 6, 1994, by and between CNA Financial Corporation and The Continental Corporation (with exhibits thereto)(Exhibit 1 to Form 8-K dated December 9, 1994 incorporated herein by reference.)............. 2.1 Merger Agreement, dated as of December 6, 1994, by and among CNA Financial Corporation, Chicago Acquisition Corp. and The Continental Corporation (Exhibit 2 to Form 8-K dated December 9, 1994 incorporated herein by reference.)....................... 2.2 (3) Articles of incorporation and by-laws: Certificate of Incorporation of CNA Financial Corporation, as amended May 6,1998 (Exhibit 3.1 to Form S-8 filed on October 9, 1998 incorporated herein by reference.)................ 3.1 By-Laws of CNA Financial Corporation, as amended February 10, 1999. 3.2* (4) Instruments defining the rights of security holders, including indentures: CNA Financial Corporation hereby agrees to furnish to the Commission upon request copies of instruments with respect to long-term debt, pursuant to Item 601(b) (4) (iii) of Regulation S-K. -- (10) Material contracts: Continental Casualty Company "CNA" Annual Incentive Bonus Plan Provisions(Exhibit 10.1 to 1994 Form 10K incorporated herein by reference.)........................................................ 10.1 Continuing Services Agreement between CNA Financial Corporation and Dennis H. Chookaszian, dated February 9, 1999.................. 10.2* Employment Agreement between CNA Financial Corporation and Philip L. Engel, dated December 31, 1995(Exhibit 10.3 to 1995 Form 10-K incorporated herein by reference.)................. 10.3 Continuing Services Agreement between CNA Financial Corporation and Edward J. Noha, dated February 27, 1991 (Exhibit 6.0 to 1991 Form 8-K, filed March 18, 1991, incorporated herein by reference.). 10.4 CNA Employees' Retirement Benefit Equalization Plan, as amended through January 1, 1993 (Exhibit 10.4 to 1992 Form 10-K incorporated herein by reference.)........................... 10.5 CNA Employees' Supplemental Savings Plan, as amended through January 1, 1993 (Exhibit 10.6 to 1992 Form 10-K incorporated herein by reference.).............................................. 10.6 15 PART IV ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS AND REPORTS ON FORM 8-K (CONTINUED) (a) 3. EXHIBITS: Exhibit Number ------ Description of Exhibit ---------------------- (10) Material contracts (continued): Federal Income Tax Allocation Agreement dated February 29, 1980 between CNA Financial Corporation and Loews Corporation (Exhibit 10.2 to 1987 Form 10-K incorporated herein by reference.)..................................... 10.7 Agreement between Fibreboard Corporation and Continental Casualty Company, dated April 9, 1993 (Exhibit A to 1993 Form 8-K filed April 12, 1993 incorporated herein by reference.)..................................... 10.8 Settlement Agreement entered into on October 12, 1993 by and among Fibreboard Corporation, Continental Casualty Company, CNA Casualty of California, Columbia Casualty Company and Pacific Indemnity Company together the "Parties" (Exhibit 10.1 to September 30, 1993 Form 10-Q incorporated herein by reference.)............... 10.9 Continental-Pacific Agreement entered into October 12, 1993 between Continental Casualty Company and Pacific Indemnity Company (Exhibit 10.2 to September 30, 1993 Form 10-Q incorporated herein by reference.)............... 10.10 Global Settlement Agreement among Fibreboard Corporation, Continental Casualty Company, CNA Casualty Company of California, Columbia Casualty Company, Pacific Indemnity Company and the Settlement Class dated December 23, 1993 (Exhibit 10.11 to 1993 Form 10-K incorporated herein by reference.)................................................ 10.11 Glossary of Terms in Global Settlement Agreement, Trust Agreement, Trust Distribution Process and Defendant Class Settlement Agreement as of December 23, 1993 (Exhibit 10.12 to 1993 Form 10-K incorporated herein by reference.)........... 10.12 Fibreboard Asbestos Corporation Trust Agreement dated December 23, 1993 (Exhibit 10.13 to 1993 Form 10-K incorporated herein by reference.)................................................ 10.13 Trust Distribution Process - Annex A to the Trust Agreement as of December 23, 1993 (Exhibit 10.14 to 1993 Form 10-K incorporated herein by reference.)............................ 10.14 Defendant Class Settlement Agreement dated December 22, 1993 (Exhibit 10.15 to 1993 Form 10-K incorporated herein by reference.)................................................ 10.15 Escrow Agreement among Continental Casualty Company, Pacific Indemnity Company and The First National Bank of Chicago dated December 23, 1993(Exhibit 10.16 to 1993 Form 10-K incorporated herein by reference.).......................................... 10.16 Letter extending Employment Agreement between CNA Financial Corporation and Philip L. Engel, dated February 17, 1999....... 10.17* 16 PART IV ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS AND REPORTS ON FORM 8-K (continued) (a) 3. EXHIBITS: Exhibit Number -------- Description of Exhibit ---------------------- (10) Employment Agreement between CNA Financial Corporation and Bernard Hengesbaugh, dated February 9, 1999................. 10.18* (11) Computation of Net Income per Common Share.................. 11.1* (12) Statements regarding computation of ratios: Computation of Ratio of Earnings to Fixed Charges........... 12.1* Computation of Ratio of Net Income, As Adjusted, to Fixed Charges..................................................... 12.2* (13) 1998 Annual Report.......................................... 13.1* (21) Primary Subsidiaries of CNA................................. 21.1* (27) Financial Data Schedule..................................... 27* *Filed herewith (b) REPORTS ON FORM 8-K: On December 3, 1998, CNA Financial Corporation filed a report on Form 8-K that announced a senior management succession plan, under which Bernard L. Hengesbaugh was to succeed Dennis H. Chookaszian as chairman and chief executive officer of CNA. 17 SCHEDULE I CNA FINANCIAL CORPORATION SUMMARY OF INVESTMENTS
- - ------------------------------------------------------------------------------------------------------------------- December 31 1998 1997 ---------------------------------- ------------------------------ Fair Carrying Fair Carrying (In millions of dollars) Cost Value Value Cost Value Value - - ------------------------------------------------------------------------------------------------------------------- Fixed maturities available-for-sale: Bonds: United States government and government agencies and authorities-taxable... $ 9,507 $ 9,694 $ 9,694 $13,798 $13,920 $13,920 States, municipalities and political subdivisions-tax exempt............. 6,127 6,321 6,321 4,534 4,724 4,724 Foreign governments and political subdivisions........................ 1,543 1,545 1,545 998 998 998 Public utilities..................... 683 694 694 340 355 355 Convertibles and bonds with warrants attached............................ 1 1 1 3 2 2 All other corporate.................. 11,614 11,724 11,724 9,280 9,452 9,452 Redeemable preferred stocks.............. 36 94 94 67 97 97 ------ ------ ------ ------- ------ ------ Total fixed maturities available-for-sale 29,511 30,073 30,073 29,020 29,548 29,548 ------ ====== ------ ------- ====== ------ Equity securities available-for-sale: Common stocks: Banks, trusts and insurance companies 10 6 6 8 7 7 Industrial and other................. 724 1,659 1,659 559 672 672 Non-redeemable preferred stocks.......... 321 305 305 128 135 135 ------ ------ ------ ------ ------ ----- Total equity securities available-for-sale 1,055 $ 1,970 1,970 695 $ 814 814 ------ ======= ------ ------ ====== ------ Mortgage loans.............................. 57 57 80 80 Real estate................................. 5 5 5 5 Policy loans................................ 177 177 177 177 Other invested assets....................... 806 858 544 695 Short-term investments...................... 4,037 4,037 4,884 4,884 - - ------------------------------------------------------------------------------------------------------------------ TOTAL INVESTMENTS $35,648 $37,177 $35,405 $36,203 ==================================================================================================================
18 SCHEDULE II CNA FINANCIAL CORPORATION (PARENT COMPANY) CONDENSED FINANCIAL INFORMATION
FINANCIAL POSITION - - ------------------------------------------------------------------------------------------ December 31 1998 1997 (In millions of dollars) - - ------------------------------------------------------------------------------------------ ASSETS: Investments in subsidiaries..................................... $10,865 $ 9,770 Deferred income taxes........................................... 240 511 Notes receivable from affiliates................................ 514 205 Short-term investments.......................................... 3 174 Amounts due from affiliates..................................... 53 - Other........................................................... 5 4 ------- -------- Total assets............................................. $11,680 $10,664 ======= ======== LIABILITIES: Debt............................................................ $ 2,475 $ 1,972 Federal income taxes payable.................................... 48 108 Amounts due to affiliates....................................... - 106 Other........................................................... - 169 ------- ------- Total liabilities...................................... 2,523 2,355 STOCKHOLDERS' EQUITY: Net unrealized investment gains ................................ $ 991 $ 523 Other stockholders' equity...................................... 8,166 7,786 ------- ------- Total stockholders' equity............................... 9,157 8,309 - - ------------------------------------------------------------------------------------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $11,680 $10,664 ==========================================================================================
RESULTS OF OPERATIONS - - -------------------------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 (In millions of dollars) - - -------------------------------------------------------------------------------------------- REVENUES: Equity in income of subsidiaries before income tax: Operating (loss) income ......................................$ ( 54) $ 956 $1,089 Realized investment gains..................................... 697 742 610 Net investment income............................................ 25 12 13 Realized investment losses....................................... (2) (4) (5) --------- -------- ------- 666 1,706 1,707 --------- ------- ------- EXPENSES: Administrative and general expenses.............................. 189 217 223 Interest expense................................................. 148 131 135 Other............................................................ -- -- 4 --------- ------- ------- 337 348 362 --------- ------- ------- Income before income tax.................................. 329 1,358 1,345 Income tax expense............................................... 47 392 380 - - -------------------------------------------------------------------------------------------- NET INCOME $ 282 $ 966 $ 965 ============================================================================================ See accompanying Notes to Condensed Financial Information.
19 SCHEDULE II (continued) CNA FINANCIAL CORPORATION (PARENT COMPANY) CONDENSED FINANCIAL INFORMATION
STATEMENTS OF CASH FLOWS - - -------------------------------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31 1998 1997 1996 (In millions of dollars) - - -------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income...................................................................... $ 282 $ 966 $ 965 ----- ---- ----- Adjustments to reconcile net income to net cash flows from operating activities: Undistributed earnings of affiliates........................................ (159) (1,523) (828) Realized losses ........................................................... 2 4 5 Deferred income taxes....................................................... 47 144 352 Changes in: Federal income taxes....................................................... (60) 79 165 Other, net................................................................. (143) (352) (391) ----- ------- ------- TOTAL ADJUSTMENTS.......................................................... (27) (944) (697) ----- ------ ------- NET CASH FLOWS FROM OPERATING ACTIVITIES................................... 255 22 268 ----- ------ ------- CASH FLOWS FROM INVESTING ACTIVITIES: Change in short-term investments................................................ 11 (15) (2) Capital contribution to subsidiaries............................................ (257) -- -- Purchase of preferred stock of subsidiaries..................................... (305) -- -- Other........................................................................... -- (4) (5) ------ ----- ------- NET CASH FLOWS FROM INVESTING ACTIVITIES................................... (551) (19) (7) ------ ----- ------- CASH FLOWS FROM FINANCING ACTIVITIES: ............................................. Dividends paid to preferred shareholders........................................ (7) (6) (6) Proceeds from issuance of long-term debt........................................ 1,000 -- 248 Principal payments on long-term debt............................................ (490) -- (500) Issuance of cumulative exchangeable preferred stock............................. 200 -- -- Purchase of treasury stock...................................................... (102) -- -- Loans to subsidiaries........................................................... (305) -- -- ------ ------ ------- NET CASH FLOWS FROM FINANCING ACTIVITIES.................................... 296 (6) (258) ----- ----- ------- NET CASH FLOWS.............................................................. -- (3) 3 Cash at beginning of year.......................................................... -- 3 -- - - -------------------------------------------------------------------------------------------------------------- CASH AT END OF YEAR $ -- $ -- $ 3 =============================================================================================================== Supplemental disclosures of cash flow information: Cash (paid) received: Interest....................................................................$ (129) $ (134) $(141) Federal income taxes........................................................ (143) (95) 15 Non-cash transactions: NoteS receivable from officer stockholders' for sale of treasury stock...... (44) -- -- ================================================================================================================== See accompanying Notes to Condensed Financial Information.
20 SCHEDULE II (continued) CNA FINANCIAL CORPORATION (PARENT COMPANY) CONDENSED FINANCIAL INFORMATION NOTES TO CONDENSED FINANCIAL INFORMATION a. Basis of presentation The condensed financial information of CNA Financial Corporation (Parent Company) should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in the CNA Financial Corporation Annual Report to Shareholders. Investments in subsidiaries are accounted for using the equity method of accounting. Certain amounts applicable to prior years have been reclassified to conform to classifications followed in 1998. b. Debt ---------------------------------------------------------------------------- December 31 1998 1997 (In millions of dollars) - - ----------------------------------------------------------------------------- Variable Rate Debt: Commercial Paper......................................$ 500 $ 675 Credit Facility - CNAF................................ 235 400 Senior Notes: 8.875%, due March 1, 1998............................ -- 150 6.25%, due November 15, 2003......................... 249 249 6.50% , due April 15, 2005........................... 497 -- 6.75%, due November 15, 2006......................... 248 248 6.45%, due January 15, 2008.......................... 149 -- 6.60%, due December 15, 2008......................... 199 -- 6.95%, due January 15, 2018.......................... 148 -- 7.25% Debenture, due November 15, 2023.................. 247 247 1.0% Urban Development Action Grant, due May 7, 2019..... 3 3 - - ----------------------------------------------------------------------------- TOTAL $2,475 $1,972 ============================================================================= CNAF has a $795 million revolving credit facility that expires in May 2001. The amount available is reduced by CNAF's outstanding commercial paper borrowings. As of December 31, 1998, there was $60 million of unused borrowing capacity under the facility. The interest rate on the bank loans is based on the London Interbank Offered Rate (LIBOR), plus 16 basis points. Additionally, there is a facility fee of 9 basis points annually. The average interest rate on the bank loans under the credit facility at December 31, 1998, 1997 and 1996, was 5.49%, 6.16% and 5.72%, respectively. To offset the variable rate characteristics of the facility, CNAF entered into interest rate swap agreements with several banks having a total notional principal amount at December 31, 1998 and 1997 of $650 million and $950 million, respectively, which terminate from May 2000 to December 2000. These agreements provide that CNAF pay interest at a fixed rate, averaging 6.07% at December 31, 1998 and 6.20% at December 31, 1997 and 1996, respectively, in exchange for the receipt of interest at the three month LIBOR rate. The effect of these interest rate swaps was to increase interest expense by 21 SCHEDULE II (continued) CNA FINANCIAL CORPORATION (PARENT COMPANY) CONDENSED FINANCIAL INFORMATION NOTES TO CONDENSED FINANCIAL INFORMATION--(CONTINUED) approximately $2 million, $4 million and $7 million for the years ended December 31, 1998, 1997 and 1996, respectively. The weighted average interest rate on commercial paper at December 31, 1998 was 5.89% compared to 6.05% and 5.67% at December 31, 1997 and 1996, respectively. The commercial paper borrowings are fully supported by the committed credit facility. The weighted average interest rate (interest and facility fees) on the combined revolving credit facility, commercial paper borrowings and interest rate swaps was 6.36%, 6.35% and 6.28% at December 31, 1998, 1997 and 1996, respectively. In 1998, CNAF issued $1 billion of senior notes under a $1 billion Registration Statement on Form S-3 filed with the Securities and Exchange Commission on August 18, 1997. This shelf registration incorporated $250 million of securities remaining available for issuance from a prior shelf registration. Since filing the shelf registration, the Company has issued in four separate offerings senior notes with an aggregate principal amount of $1 billion. c. Management and administrative expenses CNAF has reimbursed, or will reimburse, its subsidiaries for general management and administrative expenses, unallocated loss adjustment expenses and investment expense of $187 million, $217 million and $223 million in 1998, 1997 and 1996, respectively. d. Capital contributions In 1998, CNAF contributed approximately $257 million to the capital of its subsidiaries. There were no contributions made by CNAF to the capital of its subsidiaries in 1997 or 1996. - - ------------------------------------------------------------------------------ 22
SCHEDULE III CNA FINANCIAL CORPORATION SUPPLEMENTARY INSURANCE INFORMATION - - ------------------------------------------------------------------------------------------------------------------- Gross Insurance Reserves ----------------------------------------- Claim Insurance Deferred And Future Policy- Net Net Claims and Acquisition Claim Policy Unearned holders' Premium Investment Policyholders' (In millions of dollars) Costs Expense Benefits Premiums Funds Revenue Income Benefits - - ------------------------------------------------------------------------------------------------------------------- DECEMBER 31, 1998 Agency Market Operations...$ - $ - $ - $ - $ - $ 5,247 $ 744 $4,431 Specialty Operations....... - - - - - 1,092 245 951 CNA Re..................... - - - - - 944 163 707 Global Operations.......... - - - - - 941 110 585 Risk Management............ - - - - - 823 144 909 Group Operations........... - - - - - 3,712 133 3,177 Life Operations............ - - - - - 684 525 871 Corporate.................. - - - - - (27) 82 127 Eliminations............... - - - - - (41) - (41) Consolidated............... 2,422 29,192 5,418 5,039 789 - - - ----------------------------------------------------------------------------------------- $2,422 $29,912 $ 5,418 $ 5,039 $ 789 $13,375 $2,146 $11,717 ======================================================================================== December 31, 1997 Agency Market Operations.$ - $ - $ - $ - $ - $ 5,092 $ 787 $ 3,871 Specialty Operations.... - - - - - 1,251 268 1,011 CNA Re.................. - - - - - 898 153 670 Global Operations....... - - - - - 854 117 490 Risk Management......... - - - - - 776 158 893 Group Operations........ - - - - - 3,903 117 3,375 Life Operations......... - - - - - 688 501 855 Corporate............... - - - - - 20 108 103 Eliminations............ - - - - - -- - - Consolidated............ 2,142 29,558 4,829 4,700 742 -- - - --------------------------------------------------------------------------------------- $2,142 $29,558 $4,829 $ 4,700 $ 742 $13,482 $2,209 $11,268 ======================================================================================== December 31, 1996 Agency Market Operations $ - $ - $ - $ - $ - $ 5,346 $ 828 $ 4,277 Specialty Operations.... - - - - - 1,217 273 1,092 CNA Re.................. - - - - - 944 161 694 Global Operations....... - - - - - 945 134 594 Risk Management......... - - - - - 572 179 567 Group Operations........ - - - - - 3,816 118 3,272 Life Operations......... - - - - - 654 485 838 Corporate............... - - - - - 53 98 59 Eliminations............ - - - - - (22) - (22) Consolidated............ 1,854 30,395 4,181 4,659 746 - - - -------------------------------------------------------------------------------------- $1,854 $30,395 $ 4,181 $4,659 $ 746 $13,525 $2,276 $11,371 ======================================================================================
SCHEDULE III (CONT.)
CNA FINANCIAL CORPORATION SUPPLEMENTARY INSURANCE INFORMATION - - ---------------------------------------------------------------- Amortization of Deferred Other Acquisition Operating Premiums (In millions of dollars) Costs Expenses Written* - - ---------------------------------------------------------------- DECEMBER 31, 1998 Agency Market Operations... $ 1,239 $ 491 $5,463 Specialty Operations....... 175 169 1,023 CNA Re..................... 252 57 907 Global Operations.......... 224 251 985 Risk Management............ 98 234 888 Group Operations........... 5 731 1,008 Life Operations............ 178 104 295 Corporate.................. 9 326 - Eliminations............... - - - Consolidated Operations.... - - - -------------------------------------- $2,180 $2,363 $10,569 ===================================== December 31, 1997 Agency Market Operations $1,242 $ 384 $5,085 Specialty Operations.... 247 149 1,267 CNA Re.................. 247 79 1,091 Global Operations....... 173 221 812 Risk Management......... 101 196 706 Group Operations........ - 680 963 Life Operations......... 120 147 247 Corporate............... 8 244 15 Eliminations............ - - - Consolidated Operations. - - - ----------------------------------- $2,138 $2,100 $10,186 ==================================== December 31, 1996 Agency Market Operations $1,183 $ 560 $5,473 Specialty Operations.... 232 79 1,200 CNA Re.................. 119 172 937 Global Operations....... 221 145 993 Risk Management......... 60 248 660 Group Operations........ (24) 674 1,037 Life Operations......... 61 144 188 Corporate............... 4 185 33 Eliminations............ - - - Consolidated Operations. - - - ------------------------------------- $1,856 $2,207 $10,611 ===================================== - - ------------------------------ *Premiums written relates to property/casualty companies only.
23
SCHEDULE V CNA FINANCIAL CORPORATION VALUATION AND QUALIFYING ACCOUNTS AND RESERVES - - --------------------------------------------------------------------------------------------- Balance Balance at Charged to Charged to at Beginning Costs and Other End of (In millions of dollars) of Period Expenses Amounts Deductions Period - - ---------------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31, 1998 Deducted from assets: Allowance for doubtful accounts: Receivables.....................$ 303 $ 35 $ -- $ 10 $ 328 ===== ===== ===== ===== ===== YEAR ENDED DECEMBER 31, 1997 Deducted from assets: Allowance for doubtful accounts: Receivables......................$ 277 $ 30 $ -- $ 4 $ 303 ===== ===== ===== ===== ===== YEAR ENDED DECEMBER 31, 1996 Deducted from assets: Allowance for doubtful accounts: Receivables......................$ 289 $ 34 $ -- $ 46 $ 277 ===== ===== ===== ===== ===== - - ----------------------------------------------------------------------------------------------
SCHEDULE VI CNA FINANCIAL CORPORATION SUPPLEMENTARY INFORMATION CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS - - ----------------------------------------------------------------------------- Consolidated Property/ Casualty Entities ------------------------ As of and for the Year Ended December 31 1998 1997 1996 (In millions of dollars) - - ---------------------------------------------------------------------------------------------------- Deferred acquisition costs.....................................$ 1,279 $ 1,162 $ 1,084 Reserves for unpaid claims and claim adjustment expenses....... 28,355 28,571 29,395 Discount deducted from claim and claim adjustment expense reserves above(based on interest rates ranging from 3.5% to 7.5%).................................................. 2,380 2,409 2,459 Unearned premiums.............................................. 5,039 4,700 4,659 Earned premiums................................................ 10,079 9,927 10,127 Net investment income.......................................... 1,731 1,790 1,881 Incurred claim and claim adjustment expenses related to current year................................................... 7,903 7,942 7,922 Incurred claim and claim adjustment expenses related to prior years..................................................... 263 (256) (91) Amortization of deferred acquisition costs...................... 2,042 2,017 1,843 Paid claim and claim expenses................................... 8,745 8,376 9,200 Net Premiums written............................................ 10,569 10,186 10,611 - - ---------------------------------------------------------------------------------------------------
24 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders CNA Financial Corporation We have audited the consolidated financial statements of CNA Financial Corporation (an affiliate of Loews Corporation) and subsidiaries as of December 31, 1998 and 1997, and for each of the three years in the period ended December 31, 1998 and have issued our report thereon dated February 10, 1999. Such consolidated financial statements and report are included in the Company's 1998 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the financial statement schedules of CNA Financial Corporation and subsidiaries listed in Item 14. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein. Deloitte & Touche LLP Chicago, Illinois February 10, 1999 25 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CNA Financial Corporation By S\LAURENCE A. TISCH -------------------------------------- Laurence A. Tisch Chief Executive Officer (Principal Executive Officer) By S\W. JAMES MACGINNITIE -------------------------------------- W. James MacGinnitie Senior Vice President and Chief Financial Officer Date: March 31, 1999 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. Signature Title | | | S\ANTOINETTE COOK BUSH Director | - - ------------------------------------ | Antoinette Cook Bush | | | S\DENNIS H. CHOOKASZIAN Director | - - ------------------------------------ | Dennis H. Chookaszian | | S\PHILIP L. ENGEL Director | Dated - - ------------------------------------ | Philip L. Engel | March 31, 1999 | S\ROBERT P. GWINN Director | - - ------------------------------------ | Robert P. Gwinn | | S\BERNARD L. HENGESBAUGH Director | - - ------------------------------------ | Bernard L. Hengesbaugh | 26 SIGNATURES--(continued) Signature Title | | S\Walter F. Mondale Director | - - ------------------------------- | Walter F. Mondale | | S\EDWARD J. NOHA Chairman of the Board | - - ------------------------------------ and Director | Edward J. Noha | | S\JOSEPH ROSENBERG Director | - - ------------------------------------ | Joseph Rosenberg | | S\RICHARD L. THOMAS Director | Dated - - ------------------------------------ | Richard L. Thomas | March 31, 1999 | S\JAMES S. TISCH Director | - - ----------------------------------- | James S. Tisch | | S\LAURENCE A. TISCH Chief Executive Officer| - - ------------------------------------ and Director | Laurence A. Tisch | | S\PRESTON R. TISCH Director | - - ------------------------------------ | Preston R. Tisch | | S\MARVIN ZONIS Director | - - ------------------------------------ | Marvin Zonis | 27 EXHIBIT 11.1 CNA FINANCIAL CORPORATION COMPUTATION OF NET INCOME PER COMMON SHARE =============================================================================== Year Ended December 31 1998 1997 1996 1995 1994 (In millions, except per share data) - - ------------------------------------------------------------------------------- Weighted average shares outstanding..............184.9 185.4 185.4 185.4 185.4 ===== ===== ===== ===== ===== Net income.......................................$ 282 $ 966 $ 965 $ 757 $ 36 Less preferred stock dividends................... 7 7 7 7 5 ----- ----- ----- ----- ----- Net income available to common stockholders...$ 275 $ 959 $ 958 $ 750 $ 31 ===== ===== ===== ===== ===== Earnings per share: Net income available to common stockholders...$1.49 $5.17 $5.17 $4.05 $0.17 ===== ===== ===== ===== ===== - - ------------------------------------------------------------------------------- 28 EXHIBIT 12.1 CNA FINANCIAL CORPORATION COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - - ------------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 1995 1994 (In millions of dollars, except ratios) - - ------------------------------------------------------------------------------- Income (loss) before income tax, as adjusted....$329 $1,358 $1,345 $1,042 $(134) Adjustments: Interest expense............................. 219 198 200 182 71 Interest element of operating lease rental... 47 34 32 47 19 ----- ----- ------ ------ ----- Earnings before fixed charges...................$595 $1,590 $1,577 $1,271 $ (44) ===== ===== ====== ====== ===== Fixed charges: Interest expense.............................$219 $ 198 $ 200 $ 182 $ 71 Interest element of operating lease rental... 47 34 32 47 19 ---- ------ ------ ------ ----- Total fixed charges.............................$266 $ 232 $ 232 $ 229 $ 90 ==== ====== ====== ====== ===== Ratio of earnings to fixed charges (1).......... 2.2 6.8 6.8 5.6 (0.5) - - ------------------------------------------------------------------------------- (1) For purposes of computing this ratio, earnings consist of income before income taxes plus fixed charges of consolidated companies. Fixed charges consist of interest and that portion of operating lease rental expense which is deemed to be an interest factor for such rentals. EXHIBIT 12.2 CNA FINANCIAL CORPORATION COMPUTATION OF RATIO OF NET INCOME, AS ADJUSTED, TO FIXED CHARGES - - ------------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 1995 1994 (In millions of dollars, except ratios) - - ------------------------------------------------------------------------------- Net income......................................$282 $ 966 $ 965 $757 $37 Adjustments: Interest expense, after tax.................. 143 129 130 119 46 Interest element of operating lease rental, after tax.................................... 30 22 21 30 12 ----- ----- ----- ----- ---- Net income, as adjusted.........................$455 $ 1,117 $1,116 $906 $95 ===== ====== ====== ===== ==== Fixed charges: Interest expense, after tax..................$143 $ 129 $ 130 $119 $46 Interest element of operating lease rental, after tax.................................... 30 22 21 30 12 ----- ----- ----- ----- ----- Total fixed charges.............................$173 $ 151 $ 151 $149 $58 ===== ======= ====== ===== ==== Ratio of net income, as adjusted, to fixed charges......................................... 2.6 7.4 7.4 6.1 1.6 - - ------------------------------------------------------------------------------- (1) For purposes of computing this ratio, net income, as adjusted, consists of net income plus fixed charges of consolidated companies, after tax. Fixed charges consist of after-tax interest and that portion of operating lease rental expense which is deemed to be an interest factor for such rentals. 29 EXHIBIT 21.1 PRIMARY SUBSIDIARIES OF CNA PLACE OF COMPANY INCORPORATION - - -------- -------------- AMS Services, Inc. Delaware American Casualty Company of Reading, Pennsylvania Pennsylvania CNA Casualty of California California CNA Reinsurance Company, Ltd. United Kingdom CNA Surety Corporation Delaware Columbia Casualty Company Illinois Commercial Insurance Company of Newark, N. J. New Jersey Continental Assurance Company Illinois Continental Casualty Company Illinois Firemen's Insurance Company of Newark, New Jersey New Jersey First Insurance Company of Hawaii Hawaii National Fire Insurance Company of Hartford Connecticut National-Ben Franklin Insurance Company of Illinois Illinois Pacific Insurance Company California The Buckeye Union Insurance Company Ohio The Continental Insurance Company New Hampshire The Fidelity and Casualty Company of New York New Hampshire Transcontinental Insurance Company New York Transcontinental Technical Services, Inc. Illinois 30 EXHIBIT 21.1 - (continued) PRIMARY SUBSIDIARIES OF CNA--(continued) PLACE OF COMPANY INCORPORATION - - ------- ------------- Transportation Insurance Company Illinois Valley Forge Insurance Company Pennsylvania Valley Forge Life Insurance Company Pennsylvania Western National Warranty Corporation Arizona All other subsidiaries, when aggregated, are not considered significant. 31 CNA FINANCIAL CORPORATION CNA PLAZA CHICAGO, ILLINOIS 60685 G-123177-A (98) EX-3.2 2 BY-LAWS BY-LAWS OF CNA FINANCIAL CORPORATION (As Amended Effective February 10, 1999) ARTICLE I. OFFICES. SECTION 1. The registered office shall be in the City of Wilmington, County of New Castle, State of Delaware. SECTION 2. The Corporation may also have offices at such other places both within and without the State of Delaware as the Board of Directors may from time to time determine or the business of the Corporation may require. ARTICLE II. MEETINGS OF STOCKHOLDERS. SECTION 1. Meetings of stockholders for any purpose may be held at such time and place, within or without the State of Delaware, as shall be stated in the notice of the meeting or in a duly executed waiver of notice thereof. SECTION 2. Annual meetings of stockholders, commencing with the year 1970, shall be held on the first Wednesday in May if not a legal holiday, and if a legal holiday, then on the next business day following, at 10:00 a.m., or at such other date and time as shall be designated from time to time by the Board of Directors and stated in the notice of the meeting, at which they shall elect by a plurality vote a Board of Directors, and transact such other business as may properly be brought before the meeting. Elections of Directors need not be by ballot. SECTION 3. Written notice of the annual meeting stating the place, date and hour of the meeting shall be given to each stockholder entitled to vote at such meeting not less than ten nor more than fifty days before the date of the meeting. SECTION 4. The officer who has charge of the stock ledger of the Corporation shall prepare and make, at least ten days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be opened to the examination of any stockholder, for the purpose germane to the meeting, during ordinary business hours, for a period of at least ten days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present. 1 SECTION 5. Special meetings of the stockholders, for any purpose or purposes, unless otherwise prescribed by statute or by the Certificate of Incorporation, may be called by the Chief Executive Officer or President and shall be called by the President or Secretary at the request in writing of a majority of the Board of Directors, or at the request in writing of stockholders owning not less than one-fifth of all shares issued and outstanding and entitled to vote on any proposal to be submitted to said meeting. Such request shall state the purpose or purposes of the proposed meeting. SECTION 6. Written notice of a special meeting stating the place, date and hour of the meeting and the purpose or purposes for which the meeting is called, shall be given not less than ten nor more than fifty days before the date of the meeting, to each stockholder entitled to vote at such meeting. SECTION 7. Business transacted at any special meeting of stockholders shall be limited to the purposes stated in the notice. SECTION 8. The holders of a majority of the stock issued and outstanding and entitled to vote thereat, present in person or represented by proxy, shall constitute a quorum at all meetings of the stockholders for the transaction of business except as otherwise provided by statute or by the Certificate of Incorporation. If, however, such quorum shall not be present or represented at any meeting of the stockholders, the stockholders entitled to vote thereat, present in person or represented by proxy, shall have power to adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present or represented. At such adjourned meeting at which a quorum shall be present or represented any business may be transacted which might have been transacted at the meeting as originally notified. If the adjournment is for more than thirty days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting. SECTION 9. When a quorum is present at any meeting, the vote of the holders of a majority of the stock having voting power present in person or represented by proxy shall decide any question brought before such meeting, unless the question is one upon which by express provision of the statutes or of the Certificate of Incorporation, a different vote is required, in which case such express provision shall govern and control the decision of such question. 2 SECTION 10. Each stockholder shall at every meeting of the stockholders be entitled to one vote in person or by proxy for each share of the capital stock having voting power held by such stockholder, but no proxy shall be voted on after three years from its date, unless the proxy provides for a longer period. SECTION 11. Whenever the vote of stockholders at a meeting thereof is required or permitted to be taken for or in connection with any corporate action, by any provision of the statutes, the meeting and vote of stockholders may be dispensed with if all of the stockholders who would have been entitled to vote upon the action if such meeting were held shall consent in writing to such corporate action being taken; or if the Certificate of Incorporation authorizes the action to be taken with the written consent of the holders of less than all of the stock who would have been entitled to vote upon the action if a meeting were held, then on the written consent of the stockholders having not less than such percentage of the total number of votes as may be authorized in the Certificate of Incorporation; provided that in no case shall the written consent be by the holders of stock having less than the minimum percentage of the total required by statute for the proposed corporate action, and provided that prompt notice must be given to all stockholders of the taking of corporate action without a meeting and by less than unanimous written consent. ARTICLE III. DIRECTORS. SECTION 1. The number of Directors which shall constitute the whole Board shall not be greater than thirteen nor less than eleven. Except as provided in Section 2 of this Article, the Directors shall be elected at the annual meeting of the stockholders, and each Director shall hold office until his successor is elected and qualified. Directors need not be stockholders. SECTION 2. The office of a Director shall become vacant if he dies or resigns by a writing signed by him and delivered to the Corporation, and the Board of Directors may declare vacant the office of a Director if he be declared of unsound mind by an order of Court or convicted of a felony, or for any other proper cause, of if, within sixty days after notice of his election as a Director, he does not accept such office either in writing or by attending a meeting of the Board of Directors. Vacancies and newly created directorships resulting from any increase in the authorized number of Directors may be filled by a majority of the Directors then in office, though less than a quorum, or by a sole remaining Director, and the Directors so chosen shall hold office until the next annual election and until their successors are duly elected and shall qualify, unless sooner displaced. If there are no Directors in office, then an election of Directors may be held in the manner provided by statute. If, at the time of filing any vacancy or any newly created directorship, the Directors then in office shall constitute less than a majority of the whole Board (as constituted immediately prior to any such increase), the Court of Chancery may, upon application of any stockholder or stockholders holding at least ten percent of the total number of the shares at the time outstanding having the right to vote for such Directors, summarily order an election to be held to fill any such vacancies or newly created directorships, or to replace the Directors chosen by the Directors then in office. 3 SECTION 3. The business of the Corporation shall be managed by its Board of Directors which may exercise all such powers of the Corporation and do all such lawful acts and things as are not by statute or by the Certificate of Incorporation or by these By-Laws directed or required to be exercised or done by the stockholders. MEETINGS OF THE BOARD OF DIRECTORS SECTION 4. The Board of Directors of the Corporation may hold meetings, both regular and special, either within or without the State of Delaware. The Directors may designate a Director as the Chairman of the Board of Directors. The Chairman of the Board of Directors shall not be an officer of the Corporation. SECTION 5. The first meeting of each newly elected Board of Directors shall be held at such time and place as shall be fixed by the vote of the stockholders at the annual meeting and no notice of such meeting shall be necessary to the newly elected Directors in order legally to constitute the meeting, provided a quorum shall be present. In the event of the failure of the stockholders to fix the time or place of such first meeting of the newly elected Board of Directors, or in the event such meeting is not held at the time and place so fixed by the stockholders, the meeting may be held at such time and place as shall be specified in a notice given as hereinafter provided for special meetings of the Board of Directors, or as shall be specified in a written waiver signed by all of the Directors. SECTION 6. Regular meetings of the Board of Directors may be held without notice at such time and at such place as shall from time to time be determined by the Board. 4 SECTION 7. Special meetings of the Board of Directors may be called by the Chief Executive Officer, the President or the Secretary, and shall be called upon the written request of any two or more Directors. Notice of the time and place of such meetings shall be served upon or telephoned to each Director at least 24 hours, or mailed (postage prepaid) or telegraphed (charges prepaid) to each Director at his address as shown on the books of the Corporation at least 48 hours, prior to the time of the meeting, and if such notice is mailed or telegraphed as above provided, the notice shall be deemed to have been given at the time it is deposited in the United States mail or with the telegraph office for transmission, as the case may be. SECTION 8. At all meetings of the Board six (6) Directors shall constitute a quorum for the transaction of business and the act of a majority of the Directors present at any meeting at which there is a quorum shall be the act of the Board of Directors, except as may be otherwise specifically provided by statute or by the Certificate of Incorporation. If a quorum shall not be present at any meeting of the Board of Directors, the Directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present. SECTION 9. Unless otherwise restricted by the Certificate of Incorporation or these By-Laws, any action required or permitted to be taken at any meeting of the Board of Directors or of any committee thereof may be taken without a meeting, if all members of the Board or committee, as the case may be, consent thereto in writing, and the writing or writings are filed with the minutes of proceedings of the Board or committee. COMMITTEES OF DIRECTORS SECTION 10. The Board of Directors may, by resolution passed by a majority of the whole Board, designate one or more committees, each committee to consist of two or more of the Directors of the Corporation. The Board may designate one or more Directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. Any such committee, to the extent provided in the resolution, shall have and may exercise the powers of the Board of Directors in the management of the business and affairs of the Corporation, and may authorize the seal of the Corporation to be affixed to all papers which may require it; provided, however, that in the absence or disqualification of any member of such committee or committees, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any such absent or disqualified member. Such committee or committees shall have such name or names as may be determined from time to time by resolution adopted by the Board of Directors. Unless otherwise provided by the Board of Directors, a majority of the members of any committee appointed by the Board of Directors pursuant to this Section shall constitute a quorum at any meeting thereof and the act of a majority of the members present at a meeting at which a quorum is present shall be the act of such committee. Any such committee shall, subject to any rules prescribed by the Board of Directors, prescribe its own rules for calling, giving notice of and holding meetings and its method of procedure at such meetings and shall keep a written record of all action taken by it. 5 SECTION 11. Each committee shall keep regular minutes of its meetings and report the same to the Board of Directors when required. SECTION 12. In the absence or disqualification of one or more members of any Committee, the member or members present at any meeting and not disqualified from voting, whether or not such member or members constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any such absent or disqualified member or members. COMPENSATION OF DIRECTORS SECTION 13. The Directors may be paid their expenses, if any, of attendance at each meeting of the Board of Directors and may be paid a fixed sum for attendance at each meeting of the Board of Directors or a stated fee as Director. No such payment shall preclude any Director from serving the Corporation in any other capacity and receiving compensation therefor. Members of special or standing committees may be allowed like compensation for attending committee meetings. ARTICLE IV. NOTICE. SECTION 1. Whenever, under the provisions of the statutes or of the Certificate of Incorporation or of these By-Laws, notice is required to be given to any Director or stockholder, it shall not be construed to mean personal notice, but such notice may be given in writing, by mail, addressed to such Director or stockholder, at his address as it appears on the records of the Corporation, with postage thereon prepaid, and such notice shall be deemed to be given at the time when the same shall be deposited in the United States mail. Notice to Directors may also be given by telegram or telephone. SECTION 2. Whenever any notice is required to be given under the provisions of the statutes or of the Certificate of Incorporation or of these By-Laws, a waiver thereof in writing, signed by the person or persons entitled to said notice, whether before or after the time stated therein, shall be deemed equivalent thereto. 6 ARTICLE V. OFFICERS. SECTION 1. The officers of the Corporation shall be chosen by the Board of Directors and shall be a Chief Executive Officer, Secretary and Chief Financial Officer. The Board of Directors may also choose a President and one or more Vice Presidents. The Board of Directors may designate one or more of the Vice Presidents as Senior Vice President or Executive Vice President and may use descriptive words or phrases to designate the standing, seniority or area of special competence of the Vice Presidents. Any number of offices may be held by the same person, unless the Certificate of Incorporation or these By-Laws otherwise provide. SECTION 2. The Board of Directors at its first meeting after each annual meeting of stockholders shall choose a Chief Executive Officer, a Chief Financial Officer and a Secretary. SECTION 3. The Board of Directors may appoint such other officers and agents as it shall deem necessary who shall hold their offices for such terms and shall exercise such powers and perform such duties as shall be determined from time to time by the Board. SECTION 4. The Board of Directors shall fix the compensation of the Chief Executive Officer and, unless otherwise established by the Board of Directors or a committee appointed by the Board of Directors, the Chief Executive Officer shall fix the compensation of any or all other officers of the Corporation. SECTION 5. The officers of the Corporation shall hold office until their successors are chosen and qualify. Any officer elected or appointed by the Board of Directors may be removed at any time by the affirmative vote of a majority of the Board of Directors. Any vacancy occurring in any office of the Corporation shall be filled by the Board of Directors. CHIEF EXECUTIVE OFFICER SECTION 6. The Chief Executive Officer shall be the chief executive officer of the Corporation and shall have general and active control of its business and affairs. He shall preside at the meetings of the stockholders and the Board of Directors, and may exercise any and all of the powers of a chief executive officer. The Chief Executive Officer shall have such other powers and duties as may be assigned to or vested in him from time to time by the Board of Directors or by the Executive Committee. SECTION 7. The Chief Executive Officer may execute bonds, mortgages and other contracts requiring a seal, under the seal of the Corporation, except where required or permitted by law to be otherwise signed and executed and except where the signing and execution thereof shall be expressly delegated by the Board of Directors to some other officer or agent of the Corporation. 7 THE PRESIDENT SECTION 8. The President, if one shall be chosen, shall have general supervision and direction of all other officers of the Corporation, subject to the direction of the Board of Directors, and shall carry into effect the orders of the Board of Directors and Chief Executive Officer of the Board of Directors. The President shall also have such other duties and powers as may be assigned to or vested in him from time to time by the Board of Directors or by the Executive Committee. THE VICE PRESIDENTS SECTION 9. The Vice Presidents shall assist the Chief Executive Officer, and shall perform such other duties as may from time to time be directed by the Board of Directors, the Chief Executive Officer or the President. THE SECRETARY AND ASSISTANT SECRETARY SECTION 10. The Secretary shall attend all meetings of the Board of Directors and all meetings of the stockholders and record all the proceedings of the meetings of the Corporation and of the Board of Directors in a book to be kept for that purpose and shall perform like duties for the standing committees when required. He shall give, or cause to be given, notice of all meetings of the stockholders and special meetings of the Board of Directors, and shall perform such other duties as may be prescribed by the Board of Directors or President, under whose supervision he shall be. He shall have custody of the corporate seal of the Corporation and he, or an assistant secretary, shall have authority to affix the same to any instrument requiring it and when so affixed it may be attested by his signature or by the signature of such assistant secretary. The Board of Directors may give general authority to any other officer to affix the seal of the Corporation and to attest the affixing by his signature. SECTION 11. The Assistant Secretary, or if there be more than one, the Assistant Secretaries in the order determined by the Board of Directors (or if there be no such determination, then in the order of their election), shall, in the absence of the Secretary or in the event of his inability or refusal to act, perform the duties and exercise the powers of the Secretary and shall perform such other duties and have such other powers as the Board of Directors may from time to time prescribe. 8 THE CHIEF FINANCIAL OFFICER AND ASSISTANT TREASURER SECTION 12. The Chief Financial Officer shall have the custody of the corporate funds and securities and shall keep full and accurate accounts of receipts and disbursements in books belonging to the Corporation and shall deposit all moneys and other valuable effects in the name and to the credit of the Corporation in such depositories as may be designated by the Board of Directors. SECTION 13. He shall disburse the funds of the Corporation as may be ordered by the Board of Directors, taking proper vouchers for such disbursements, and shall render to the President and the Board of Directors, at its regular meetings, or when the Board of Directors so requires, an account of all his transactions as treasurer and of the financial condition of the Corporation. SECTION 14. If required by the Board of Directors, he shall give the Corporation a bond (which shall be renewed every six years) in such sum and with such surety or sureties as shall be satisfactory to the Board of Directors for the faithful performance of the duties of his office and for the restoration to the Corporation, in case of his death, resignation, retirement or removal from office, of all books, papers, vouchers, money and other property of whatever kind in his possession or under his control belonging to the Corporation. SECTION 15. The Assistant Treasurer, or if there shall be more than one, the Assistant Treasurers in the order determined by the Board of Directors (or if there be no such determination, then in the order of their election), shall, in the absence of the Chief Financial Officer or in the event of his inability or refusal to act, perform the duties and exercise the powers of the Treasurer and shall perform such other duties and have such other powers as the Board of Directors may from time to time prescribe. ARTICLE VI. CERTIFICATES OF STOCK. SECTION 1. Except as otherwise provided in the Certificate of Incorporation, every holder of stock in the Corporation shall be entitled to have a certificate, signed by, or in the name of the Corporation by, the Chief Executive Officer, the President or a Vice President and the Chief Financial Officer or an Assistant Treasurer, or the Secretary or an Assistant Secretary of the Corporation, certifying the number of shares owned by him in the Corporation. 9 SECTION 2. If the Corporation shall be authorized to issue more than one class or more than one series of any class, the designations, preferences and relative, participating, optional or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights shall be set forth in full or summarized on the face or back of the certificate which the Corporation shall issue to represent such class or series of stock, provided that, except as otherwise provided in Section 202 of the General Corporation Law of Delaware, in lieu of the foregoing requirements, there may be set forth on the face or back of the certificate which the Corporation shall issue to represent such class or series of stock, a statement that the Corporation will furnish without charge to each stockholder who so requests the designations, preferences and relative, participating, optional or other special rights of each class of stock or series thereof and the qualifications, limitations or restrictions of such preferences and/or rights. SECTION 3. Where a certificate is countersigned (1) by a transfer agent other than the Corporation or its employees, or, (2) by a registrar other than the Corporation or its employees, the signatures of the officers of the Corporation may be facsimiles. In case any officer who has signed or whose facsimile signature has been placed upon a certificate shall have ceased to be such officer before such certificate is issued, it may be issued by the Corporation with the same effect as if he were such officer at the date of issue. LOST CERTIFICATES SECTION 4. The Board of Directors may direct a new certificate or certificates to be issued in place of any certificate or certificates theretofore issued by the Corporation alleged to have been lost, stolen or destroyed, upon the making of an affidavit of the fact by the person claiming the certificate of stock to be lost, stolen or destroyed. When authorizing such issue of a new certificate or certificates, the Board of Directors may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate or certificates, or his legal representative, to advertise the same in such manner as it shall require and/or to give the Corporation a bond in such sum as it may direct as indemnity against any claim that may be made against the Corporation with respect to the certificate alleged to have been lost, stolen or destroyed. TRANSFER OF STOCK SECTION 5. Upon surrender to the Corporation or the transfer agent of the Corporation of a certificate for shares duly endorsed or accompanied by proper evidence of succession, assignment or authority to transfer, it shall be the duty of the Corporation to cause to be issued a new certificate to the person entitled thereto, cancel the old certificate and record the transaction upon its books. 10 FIXING RECORD DATE SECTION 6. In order that the Corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or to express consent to corporate action in writing without a meeting, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the Board of Directors may fix, in advance, a record date, which shall not be more than sixty nor less than ten days before the date of such meeting, nor more than sixty days prior to any other action. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting. REGISTERED STOCKHOLDERS SECTION 7. The Corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends, and to vote as such owner, and to hold liable for calls and assessments a person registered on its books as the owner of shares, and shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by the laws of Delaware. ARTICLE VII. GENERAL PROVISIONS. DIVIDENDS SECTION 1. Dividends upon the capital stock of the Corporation, subject to the provisions of the Certificate of Incorporation, if any, may be declared by the Board of Directors, or a duly constituted Committee thereof, at any regular or special meeting, pursuant to law. Dividends may be paid in cash, in property, or in shares of the capital stock, subject to the provisions of the Certificate of Incorporation. SECTION 2. Before payment of any dividend, there may be set aside out of any funds of the Corporation available for dividends such sum or sums as the Directors from time to time, in their absolute discretion, think proper as a reserve or reserves to meet contingencies, or for equalizing dividends, or for repairing or maintaining any property of the Corporation, or for such other purpose as the Directors shall think conducive to the interest of the Corporation, and the Directors may modify or abolish any such reserve in the manner in which it was created. 11 ANNUAL STATEMENT SECTION 3. The Board of Directors shall present at each annual meeting, and at any special meeting of the stockholders when called for by vote of the stockholders, a full and clear statement of the business and condition of the Corporation. CHECKS SECTION 4. All checks or demands for money and notes of the Corporation shall be signed by such officer or officers or such other person or persons as the Board of Directors may from time to time designate. FISCAL YEAR SECTION 5. The fiscal year of the Corporation shall be fixed by resolution of the Board of Directors. SEAL SECTION 6. The corporate seal shall have inscribed thereon the name of the Corporation, the year of its organization and the words "Corporate Seal, Delaware." The seal may be used by causing it or a facsimile thereof to be impressed or affixed or reproduced or otherwise. ARTICLE VIII. AMENDMENTS. SECTION 1. These By-Laws may be altered or repealed at any regular meeting of the stockholders or of the Board of Directors or at any special meeting of the stockholders or of the Board of Directors if notice of such alteration or repeal be contained in the notice of such special meeting. ARTICLE IX. MISCELLANEOUS. SECTION 1. Unless otherwise ordered by the Board of Directors, the Chief Executive Officer or the President, or any Vice President, or the Secretary or the Chief Financial Officer in person or by proxy or proxies appointed by any of them shall have full power and authority on behalf of the Corporation to vote, act and consent with respect to any shares of stock issued by other corporations which the Corporation may own or as to which the Corporation otherwise has the right to vote, act or consent. SECTION 2. In the event the protective conditions or restrictions of any outstanding series of Preferred Stock, fixed by the Board of Directors pursuant to the authority conferred upon the Board of Directors by the Certificate of Incorporation and Section 151 of Title 8 of the Delaware Code of 1953, are inconsistent with any provision of these By-Laws, such provision shall be deemed to be amended to remove any inconsistency. SECTION 3. Business Combinations with interested Stockholders. Pursuant to the provisions of Section 203(a)(2) of the General Corporation Law of Delaware, the Corporation, by action of the Board, expressly elects not to be governed by Section 203 of the General Corporation Law of Delaware, dealing with the business combinations with interested stockholders. Notwithstanding anything to the contrary in these By-Laws, the provisions of this Section may not be further amended by the Board except as may be specifically authorized by the General Corporation Law. 12 Article X. INDEMNIFICATION 1. The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative(other than an action by or in the right of the Corporation) by reason of the fact that he is or was a Director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had no reasonable cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that the person did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the Corporation, and, with respect to any criminal action or proceeding, had reasonable cause to believe that his conduct was unlawful. 2. The Corporation shall indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that he is or was a Director, officer, employee or agent of the Corporation, or is or was serving at the request of the Corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against expenses (including attorneys' fees) actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the Corporation unless and only to the extent that the Court of Chancery of the State of Delaware or the court in which such action or suit was brought shall determine upon application that despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery of the State of Delaware or such other court shall deem proper. 3. To the extent that any person referred to in paragraphs 1 and 2 of this Article TEN has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to therein or in defense or any claim, issue or matter therein, he shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by him in connection therewith. 13 4. Any indemnification under paragraphs 1 and 2 of this Article TEN, (unless ordered by a court) shall be made by the Corporation only as authorized in the specific case upon a determination that indemnification of the Director, officer, employee or agent is proper in the circumstances because he has met the applicable standard of conduct set forth in paragraphs 1 and 2 of this Article TEN. Such determination shall be made (a) by the Board of Directors by a majority vote of a quorum (as defined in the By-Laws of the Corporation) consisting of Directors who were not parties to such action, suit or proceeding, or (b) if such quorum is not obtainable, or, even if obtainable a quorum of disinterested Directors so directs, by independent legal counsel in a written opinion, or (c) by the stockholders. 5. Expenses incurred in defending a civil or criminal action, suit or proceeding may be paid by the Corporation in advance of the final disposition of such action, suit or proceeding as authorized by the Board of Directors in the manner provided in paragraph one of this Article TEN upon receipt of an undertaking by or on behalf of the Director, officer, employee or agent to repay such amount if it shall ultimately be determined that he is not entitled to be indemnified by the Corporation as provided in this Article TEN. 6. The indemnification and advancement of expenses provided by or granted pursuant to the other provisions of this Article TEN shall not be deemed exclusive of any other rights to which those indemnified may be entitled under any statute, by-law, agreement, vote of stockholders or disinterested Director or otherwise, both as to action in his official capacity and as to action in another capacity while holding such office. 7. The Corporation shall have power to purchase and maintain insurance on behalf of any person who is or was a Director, officer, employee or agent of the Corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against any liability asserted against him and incurred by him in any such capacity, or arising out of his status as such, whether or not the Corporation would have the power to indemnify him against such liability under the provisions of this Article TEN. 8. For purposes of this Article references to "other enterprises" shall include employee benefit plans; references to "fines" shall include any excess taxes assessed on a person with respect to any employee benefit plan; and references to "serving at the request of the Corporation" shall include any service as a director, officer, employee or agent of the Corporation which imposes duties on or involves services by such director, officer, employee or agent with respect to an employee benefit plan, its participants or beneficiaries; and a person who acted in good faith and in a manner he reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner "not opposed to the best interests of the Corporation" as referred to in this Article. 9. The indemnification and advancement of expenses provided by, or granted pursuant to this Article TEN shall continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person. 14 EX-10.2 3 CONTINUING SERVICE AGREEMENT CONTINUING SERVICE AGREEMENT This CONTINUING SERVICE AGREEMENT ("Agreement") is made as of February 9, 1999 ("Signing Date") by and between CNA Financial Corporation, a Delaware corporation ("Corporation"), and Dennis H. Chookaszian ("Executive"). WHEREAS, Executive has been employed by the Corporation for more than twenty-three years, has served as the Chairman of the Board and Chief Executive Officer of the principal insurance subsidiaries of the Corporation ("CNA") since 1992 and has provided valuable service to the Corporation over the term of his employment; and WHEREAS, Executive and the Corporation have entered into an Employment Agreement, dated December 31, 1995, governing the terms and conditions of Executive's employment ("Employment Agreement"); and WHEREAS, in order to facilitate an orderly management succession, Executive has agreed to retire as Chairman and Chief Executive Officer of CNA effective as of February 9, 1999, and to retire as an employee effective as of the Effective Date (as defined in Section 1 hereof) and, to the extent mutually agreeable to the Corporation's board of directors and Executive, to serve as the Chairman of the Executive Committee of the Corporation's board of directors beginning on February 10, 1999; and WHEREAS, the Corporation desires to avail itself of Executive's experience in executing an orderly transition of the management of the Corporation and the continued involvement of Executive in the business of the Corporation following Executive's retirement and relinquishment of his present position by engaging and retaining Executive to provide certain services to the Corporation with respect to the business of the Corporation and CNA to the extent mutually agreeable to the Chief Executive Officer of CNA and Executive; NOW, THEREFORE, in consideration of the foregoing and the mutual provisions contained herein, Executive and the Corporation, intending to be legally bound, hereby agree as follows: 1. Services to be Provided. A. Consulting Services. During the Service Period (as defined below), Executive shall be available to provide such services to the Corporation as the Chief Executive Officer of CNA may reasonably request. Such services may include, by way of illustration, advice and assistance with respect to (a) general corporate and organizational matters, (b) development and marketing of products, (c) customer and distribution force relations (including, but not limited to, promotional appearances and speeches, (d) strategic directions and business unit strategies, (e) cost reduction and organizational efficiencies, (f) insurance industry and trade organizational matters, or (g) service on the Corporation's board of directors. The foregoing notwithstanding, Executive shall not be required to perform any specific services, to provide services at any specific location, or to be present at the Corporation's offices during any specific periods, rather Executive shall perform only such services and only on such terms as shall be mutually agreeable to Executive and the Chief Executive Officer of CNA. All such services shall be provided as an independent contractor and not as an employee. Executive agrees that, on the Signing Date, he will sign and deliver to the Corporation a resignation letter substantially in the form of Exhibit A hereto. 1 B. Board Services. Executive shall be elected Chairman of the Executive Committee of the Corporation's board of directors on February 10, 1999. If elected to serve and if Executive agrees to serve on the board of directors of the Corporation, Executive agrees to waive any and all fees, compensation, and remuneration of any kind which he may otherwise be entitled to receive as a director of the Corporation; provided, however, that the foregoing waiver shall not affect his right to defense and indemnification with respect to claims to the extent provided in the Corporation's by-laws; and further, provided, that such waiver shall not extend to any fees, compensation, and remuneration to which he may be entitled to receive as a director of any subsidiary or affiliate of the Corporation. C. Assistance with Claims. Executive agrees that, during the Service Period, he will be available, on a reasonable basis, to assist the Corporation and its subsidiaries and affiliates in the prosecution or defense of any claims, suits, litigation, arbitrations, investigations, or other proceedings, whether pending or threatened ("Claims") that may be made or threatened by or against the Corporation or any of its subsidiaries or affiliates. Executive agrees, unless precluded by law, to promptly inform the Corporation if he is requested (i) to testify or otherwise become involved in connection with any Claim against the Corporation or any subsidiary or affiliate or (ii) to assist or participate in any investigation (whether governmental or private) of the Corporation or any subsidiary or affiliate or any of their actions, whether or not a lawsuit has been filed against the Corporation or any of its subsidiaries or affiliates relating thereto. D. Service Period. The "Service Period" shall be the period beginning April 1, 1999 (the "Effective Date") and ending on the Cessation Date, which shall be September 19, 2008 or such earlier date determined in accordance with this Agreement. The "Cessation Date" shall be the Cessation Date elected by Executive by advance written notice to Corporation, if earlier than September 19, 2008. 2. Pre-Effective Date Compensation. For the period January 1, 1999 through March 31, 1999, Executive shall be paid Base Salary in the amount of $700,000 (i.e., at a rate of $2,800,000 per annum. Executive shall be paid $900,000 in settlement of his award under the Corporation's Incentive Compensation Plan for 1998, subject to the approval of the Incentive Compensation Committee of the Corporation's board of directors, with such amount to be paid at the time specified in the plan (which is expected to be on or about March 8, 1999). Executive agrees that such payment is in full and final settlement and satisfaction of all rights he has to receive payments under the Corporation's Incentive Compensation Plan for fiscal year 1998. The Executive shall not be eligible to receive a payment under the Incentive Compensation Plan for 1999. 3. Compensation. Subject to the provisions of this Agreement, and in consideration of the services and duties agreed to be rendered and performed by Executive under Section 1 hereof, for holding himself available to render those services, and for the covenants contained in Section 4 hereof, the Corporation hereby covenants and agrees to provide for the payment of the compensation (including benefits) specified in this Section 3, without payment of additional compensation, except as otherwise mutually agreed. The Corporation shall, however, reimburse Executive for his reasonable out-of-pocket expenses, including travel expenses, incurred in connection with the provision of such services subject to the approval of Chief Executive Officer of CNA. 2 A. Service Period Compensation. (i) For the period beginning on the Effective Date and continuing thereafter during the Service Period until the Cessation Date, Executive shall be paid a Consulting Fee, at a rate equal to the difference between $2,722,708 per year and the sum of the Deemed Qualified Retirement Plan Benefit and the Deemed Retirement Equalization Plan Benefit (as defined below). The Consulting Fee shall be payable in substantially equal monthly installments, with such amounts to be wire transferred by the Corporation to an account in the name of Executive maintained at a Chicago bank selected by the Corporation. (By way of illustration, as of the Signing Date, the Consulting Fee is projected to be at the rate of $2,080,236 per year for the period commencing as of the Effective Date and ending on Executive's 62nd birthday, and at the rate of $2,084,334 per year for the period commencing as of Executive's 62nd birthday.) (ii) For the avoidance of doubt, it is recited here that, during the Service Period, Executive shall be considered to be retired from the Corporation on the Effective Date for purposes of determining his eligibility to receive benefits under the Qualified Retirement Plan and the Retirement Equalization Plan (as defined below). For purposes of this Agreement, the "Deemed Qualified Retirement Plan Benefit" shall be the benefit from the CNA Employees' Retirement Plan (the "Qualified Retirement Plan") in the form of a 50% joint and surviving spouse annuity commencing as of the Effective Date, with such amounts to be payable in accordance with the provisions of that plan. (By way of illustration, as of the Signing Date, such benefit is projected to be at the rate of $35,158 per year.) For purposes of this Agreement, the "Deemed Retirement Equalization Plan Benefit" shall be the benefit from the CNA Employees' Retirement Benefit Equalization Plan (the "Retirement Equalization Plan") in the form of a 50% joint and surviving spouse annuity commencing as of the Effective Date, with such amounts to be payable in accordance with the provisions of that plan. (By way of illustration, as of the Signing Date, such benefit is projected to be at the rate of $607,314 per year for the period commencing as of the Effective Date and ending on Executive's 62nd birthday, and at the rate of $603,216 per year for the period commencing as of Executive's 62nd birthday.) For purposes of determining the Deemed Qualified Retirement Plan Benefit and the Deemed Retirement Equalization Plan Benefit, the identity of Executive's spouse shall be determined as of the Effective Date. 3 B. Death of Executive. If Executive's death occurs during the Service Period, the date of death shall be the "Cessation Date," the Service Period shall end, and the next following Sections (i) and (ii) shall apply: (i) For the period beginning on the date following Executive's death and continuing until September 19, 2008, inclusive, Executive's estate shall be entitled to supplemental survivor benefit payments at the rate equal to: (a) $1,300,000 per year; reduced by (b) the Deemed Qualified Retirement Plan Benefit and the Deemed Retirement Equalization Plan Benefit deemed to be payable with respect the Executive's surviving spouse (and, purposes of calculating the deemed benefits, the identity of Executive's spouse shall be determined as of the Effective Date). Such supplemental survivor benefits shall be payable in substantially equal monthly installments, with such amounts to be wire transferred to an account in the name of Executive's estate (or such other beneficiary as determined in accordance with Section 5B hereof) maintained at a Chicago bank selected by the Corporation. (ii) In lieu of the benefit otherwise payable under the Retirement Equalization Plan, benefits shall be payable with respect to Executive under the Retirement Equalization Plan (or, in the discretion of the Corporation, under another non-qualified plan or arrangement maintained by the Corporation); with the amount of the benefit (if any) payable under this Section (ii) equal to the aggregate survivor benefits that would be provided under the Qualified Retirement Plan and Retirement Equalization Plan, determined based on provisions of those plans relating to survivor benefits, taking into account any elections applicable to Executive under such plans, and with the determination of the identity of Executive's spouse to be made immediately prior to the Effective Date; and determined as though (A) Executive's employment by the Corporation continued during the Service Period and ended on the Cessation Date; and (B) during the period of Executive's employment with the Corporation, he received compensation at the rate of $2,800,000 per annum. C. Pension After Service Period. If the "Cessation Date" occurs other than by reason of Executive's death (as described in Section B next above), then, in lieu of the benefit otherwise payable under the Retirement Equalization Plan, Executive shall be entitled to a benefit under the Retirement Equalization Plan (or, in the discretion of the Corporation, under another non-qualified plan or arrangement maintained by the Corporation), in an amount equal to: 4 (i) the aggregate benefit that would be provided under the Qualified Retirement Plan and Retirement Equalization Plan, determined as though (I) Executive's employment by the Corporation continued during the Service Period and ended on the Cessation Date; and (II) during the period of Executive's employment with the Corporation, he received compensation at the rate of $2,800,000 per annum (provided that, for purposes of this Section (i), the identity of Executive's spouse shall be made as of the Effective Date); reduced by (ii) the Deemed Qualified Retirement Plan Benefit. D. Deferral. (i) For each calendar year in the Service Period, Executive may elect, by filing an irrevocable written "Participation Election" with the Corporation prior to the beginning of such calendar year (in such form as the Corporation may reasonably require) to have an amount (an "Elective Allocation") credited to an account maintained on his behalf by the Corporation (the "Book Account"). For each month for which a Consulting Fee is paid, such amount shall be equal to the percentage of $216,666.67 (i.e., 1/12 of $2,600,000), not to exceed 16% of such amount, in whole multiples of 1% of such amount, with the same percentage applicable to each month within a year, all as elected by Executive in the Participation Election for the year; provided that there shall be a corresponding reduction in the amount of the Consulting Fee otherwise payable to Executive in accordance with Section 3A(i) hereof for that month (with the reduction to be applied to the amount otherwise payable in accordance with Section 3A(i) hereof). For the portion of the Service Period beginning on the Effective Date and ending December 31, 1999, Executive shall be deemed to have elected, in accordance with this Section (i), to have an Elective Allocation equal to 16% of $216,666.67 for each month through December 31, 1999. (ii) For each month for which Elective Allocation is to be credited to the Book Account in accordance with Section 3D(i), the Book Account shall be credited with an additional amount (the "Matching Allocation") equal to 70% of the Elective Allocation for that month; provided that for purposes of determining the amount of the Matching Allocation, any portion of the Elective Allocation for the month that exceeds 6% of $216,666.67 shall be disregarded. (iii) Amounts shall be credited to the Book Account at the time determined under the rules applicable to the crediting of amounts attributable to salary reduction under the CNA Employees' Supplemental Savings Plan (the "Supplemental Plan"). For any period during which amounts are credited to the Book Account, they shall be credited with interest at the interest rates applicable to accounts maintained under the Supplemental Plan for the respective period. Executive's entitlement to distribution with respect to the amount credited to the Book Account shall be determined in accordance with the rules that apply to distributions under the Supplemental Plan, and determined as though Executive's employment with the Corporation terminated on the Cessation Date. The provisions of this Section D shall be administered by the committee responsible for administering the Supplemental Plan, in accordance with rules applicable to that plan. 5 E. Benefits. (i) Health and Life. For the avoidance of doubt, it is recited here that, during the Service Period, Executive shall be considered to be retired from the Corporation on the Effective Date for purposes of determining his eligibility to receive coverage under the Corporation's retiree health and retiree life insurance arrangements. However, if there is a material reduction in the type or amount of benefits provided under the retiree health arrangements during the Service Period, the Corporation shall provide supplemental health coverage to Executive during the Service Period so that his coverage during the Service Period is not adversely affected by such reduction in the generally applicable retiree health coverage. At the Cessation Date, Executive (or, if applicable, his surviving spouse determined as of the Effective Date) shall have the right to convert such coverages to personal coverage at his sole cost and expense (or, if applicable, at the sole cost of his surviving spouse), subject to the restrictions on conversion applicable to such coverage. (ii) Office Space. During the Service Period, the Corporation will provide Executive with office space (consistent with the space provided to Executive on the Signing Date), parking space, together with the services of a secretary, appropriate to his status hereunder. (iii) Car and Driver. During the Service Period, a car and driver of the Corporation will be made available to Executive for Corporation business purposes, but only to the extent such car and driver are not, in the sole discretion of the Chief Executive Officer of CNA, otherwise reserved or used for other business purposes. (iv) Clubs. During the Service Period, Executive shall be designated by the Corporation as eligible to use the Corporation's membership in the Economics Club and the Executives Club. 4. Covenants. A. Confidentiality. Executive agrees that, during the Service Period, and at all times thereafter, he shall continue to hold in a fiduciary capacity for the benefit of the Corporation all secret or confidential information, knowledge or data relating to the Corporation and any other business or entity in which at any relevant time the Corporation holds greater than a 10% equity (voting or non-voting) interest (an "Affiliate") that shall have been obtained by Executive during his employment by or affiliation with the Corporation or during the Service Period and that shall not be public knowledge other than by acts of Executive or his representative ("Confidential Material"). Executive shall not, without the prior written consent of the Chief Executive Officer of CNA, communicate or divulge any Confidential Material to anyone other than the Corporation and those designated by it. 6 B. Competition. Executive hereby agrees that, until the Cessation Date, he will not, directly or indirectly, without the prior written approval of the Chief Executive Officer of CNA, enter into any business relationship (either as principal, agent, board member, officer, consultant, stockholder, employee or in any other capacity) with any business or other entity that at any relevant time competes in any respect with any of the principal businesses of the Corporation or with any of the principal businesses of any Affiliate (a "Competitor"); provided, however, that such prohibited activity shall not include the ownership of less than 5% of the voting securities of any publicly traded corporation regardless of the business of such corporation. Upon the written request of Executive, the Chief Executive Officer of CNA will determine whether a business or other entity constitutes a "Competitor" for purposes of this Section B; provided that the Chief Executive Officer of CNA may require Executive to provide such information as the Chief Executive Officer determines to be necessary to make such determination; and further provided that the current and continuing effectiveness of such determination may be conditioned on the accuracy of such information, and on such other factors as the Chief Executive of CNA may determine. C. Solicitation. Executive agrees that during the Service Period (or if Cessation Date occurs prior to September 19, 2008, for the period beginning on the Signing Date and ending on the six-month anniversary of the Cessation Date), he will not employ, offer to employ, engage as a consultant, or form an association with any person who is then, or who during the preceding one year was, an employee of the Corporation or any Affiliate, nor will he assist any other person in soliciting for employment or consultation any person who is then, or who during the preceding one year was, an employee of the Corporation or any Affiliate. D. Non-Interference. Executive agrees that during the Service Period (or if Cessation Date occurs prior to September 19, 2008, for the period beginning on the Signing Date and ending on the twelve-month anniversary of the Cessation Date), he will not disturb or attempt to disturb any business relationship or agreement between either the Corporation or an Affiliate and any other person or entity. E. Effect of Breach. Executive acknowledges that his violation of the foregoing covenants of this Section 4 could cause the Corporation irreparable harm and he agrees that the Corporation shall be entitled to injunctive relief restraining Executive from actual or threatened breach of the covenants and that if bond is required to be posted in order for the Corporation to secure such relief said bond need only be in a nominal amount. Subject to Section F next below, the right of the Corporation to seek injunctive relief shall be in addition to any other remedies available to the Corporation with respect to an alleged or threatened breach. F. Limitation on Remedies. The Corporation shall not be entitled to suspend payments otherwise due to Executive by reason of Executive's violation of Sections 4A, 4B, 4C, or 4D hereof (whether before or after a judgment is obtained by the Corporation against Executive). The Corporation shall not be entitled to set off against the amounts payable to Executive under this Agreement any amounts owed to the Corporation by Executive. Nothing in this Section F shall limit the Corporation's remedies in the case of Executive's violation of this Agreement, except as otherwise specifically provided in this Section F. 7 G. Effect of Covenants. Nothing in Sections 4A, 4B, 4C, or 4D hereof shall be construed to adversely affect the rights that the Corporation would possess in the absence of the provisions of such sections. 5. Miscellaneous. A. Other Agreements. This Agreement shall be effective on the later of the Signing Date or the approval of this Agreement by the board of directors of the Corporation pursuant to Section 5H hereof. Prior thereto, the terms and conditions of Executive's employment with the Corporation shall be governed by the Employment Agreement. Except as otherwise expressly provided herein, this Agreement constitutes the entire agreement between Executive and the Corporation and supersedes all prior agreements and understandings, written or oral, including, but not by way of limitation, the Employment Agreement. B. Successors. This Agreement is personal to Executive and may not be assigned by Executive without the consent of the Corporation. However, to the extent that rights or benefits under this Agreement otherwise survive Executive's death, Executive's heirs and estate shall succeed to such rights and benefits pursuant to Executive's will or the laws of descent and distribution; provided that Executive shall have the right at any time and from time to time, by notice delivered to the Corporation, to designate or to change the beneficiary or beneficiaries with respect to such benefits. This Agreement may be assigned to a successor to all or substantially all of the business or assets of the Corporation, but only if such successor expressly agrees to assume and perform this Agreement in the same manner and to the same extent that the Corporation would be required to perform it in the absence of such assignment. C. Arbitration of All Disputes. Any controversy or claim arising out of or relating to this Agreement (or the breach thereof) shall be settled by final, binding and non-appealable arbitration in Chicago, Illinois by three arbitrators. Except as otherwise expressly provided in this Section C, the arbitration shall be conducted in accordance with the rules of the American Arbitration Association (the "Association") then in effect. One of the arbitrators shall be appointed by the Corporation, one shall be appointed by Executive, and the third shall be appointed by the first two arbitrators. If the first two arbitrators cannot agree on the third arbitrator within 30 days of the appointment of the second arbitrator, then the third arbitrator shall be appointed by the Association. This Section C shall not be construed to limit the Corporation's right to obtain relief under Section 4E hereof with respect to any matter or controversy subject to Section 4E hereof, and, pending a final determination by the arbitrator with respect to any such matter or controversy, the Corporation shall be entitled to obtain any such relief by direct application to state, federal or other applicable court, without being required to first arbitrate such matter or controversy. D. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of Illinois, without reference to the principles of conflict laws. 8 E. Amendment. This Agreement may only be amended by written agreement executed by the parties hereto or their respective successors or legal representatives. F. Notices. Notices and all other communications provided for in this Agreement shall be in writing and shall be delivered personally or sent by registered or certified mail, return receipt requested, postage prepaid (provided that international mail shall be sent via overnight or two-day delivery), or sent by facsimile or prepaid overnight courier to the parties at the addresses set forth below (or such other addresses as shall be specified by the parties by like notice). Such notices, demands, claims and other communications shall be deemed given: (i) in the case of delivery by overnight service with guaranteed next day delivery, the next day or the day designated for delivery; (ii) in the case of certified or registered U.S. mail, five days after deposit in the U.S. mail; or (iii) in the case of facsimile, the date upon which the transmitting party received confirmation of receipt by facsimile, telephone or otherwise; provided, however, that in no event shall any such communications be deemed to be given later than the date they are actually received. Communications that are to be delivered by the U.S. mail or by overnight service or two-day delivery service are to be delivered to the addresses set forth below: If to Executive: Dennis H. Chookaszian 1100 Michigan Avenue Wilmette, IL 60091 If to the Corporation: CNA Financial Corporation CNA Plaza Chicago, IL 60685 Attn: Corporate Secretary or to such other address as either party shall furnished to the other party in writing in accordance with the provisions of this Section F. G. Severability. The invalidity or unenforceability of any provision of this Agreement will not affect the validity or enforceability of any other provision of this Agreement, and this Agreement shall be construed as if such invalid or unenforceable provision were omitted (but only to the extent such provision can not be appropriately reformed or modified). 9 H. Approval by Board. The board of directors of the Corporation shall consider approval of this Agreement at its next meeting occurring after the complete execution of this Agreement. The effectiveness of the Corporation's execution of this Agreement is contingent on the Agreement being approved by a majority of the board of directors of the Corporation (excluding Executive) at the time specified in this Section H, and the Agreement shall be void if such approval is not given. The Corporation shall provide written notice to Executive of the approval or disapproval of the agreement by the Corporation's board of directors. IN WITNESS WHEREOF, Executive has hereunto set his hand and, subject to Section 5H hereof, the Corporation has caused this Agreement to be executed on its behalf, all as of the Signing Date. Attest: CNA Financial Corporation S/MARY RIBIKAWSKIS By: S\JONATHON KANTOR - - ----------------------------- ----------------------------------------- Assistant Secretary Its: Senior Vice President, General Counsel and Secretary S/DENNIS H. CHOOKASZIAN ------------------------------------------ Dennis H. Chookaszian 10 ANNEX A LETTER OF RESIGNATION Board of Directors CNA Financial Corporation CNA Plaza Chicago, Illinois 60685 Dear Sirs: Effective February 9, 1999, in accordance with the provisions of the Service Agreement between CNA Financial Corporation (the "Corporation") and me dated February 9, 1999 (the "Continuing Service Agreement"), I hereby resign from all positions (including, without limitation, any position as a member of any board of directors) with the Corporation (subject to my remaining on the Board of Directors of the Corporation in accordance with the provisions of the Service Agreement, and subject to my remaining an employee of the Corporation until March 31, 1999 in accordance with the provisions of the Service Agreement), and any other business or entity in which the Corporation holds greater than a 10% equity (voting or non-voting) interest, including, without limitation, resignation as an underwriter for CNA Lloyd's of Texas, and resignation from the boards of directors of the following: American Casualty Company of Reading Pennsylvania Boston Old Colony Insurance Company CNA Casualty of California CNA Casualty of Illinois CNA Foundation CNA Reinsurance Company CNA Structured Settlements, Inc. Continental Assurance Company Columbia Casualty Company Commercial Insurance Company of Newark, New Jersey Continental Casualty Company Continental Reinsurance Corporation Firemen's Insurance Company of Newark, New Jersey Galway Insurance Company Hedge Financial Corporation Hedge Financial Products, Inc. Hedge Investor Services, Inc. Kansas City Fire and Marine Insurance Company National Fire Insurance Company of Hartford National-Ben Franklin Insurance Company of Illinois Niagara Fire Insurance Company North Pearl Management, Inc. 11 Pacific Insurance Company Settlement Options, Inc. South Street Insurance Brokers, Inc. The Buckeye Union Insurance Company The Continental Corporation The Continental Insurance Company The Continental Insurance Company of New Jersey The Fidelity and Casualty Company of New York The Glens Falls Insurance Company The Mayflower Insurance Company, Ltd. Transportation Insurance Company Valley Forge Insurance Company Valley Forge Life Insurance Company In the event that the Chief Executive Officer of CNA (as defined in the Continuing Service Agreement) requests that I do so, I agree to tender promptly my resignation as: (a) director of the American Insurance Association, (b) director of the Insurance Services Office, (c) director of the American Council of Life Insurance, (d) director of the Council of Insurance Company Executives, (e) trustee and director of the Foundation for Health Enhancement, and (f) a director, officer, trustee, and member of and any organization with respect to which my holding such position may be viewed as representing the interests of the Corporation or CNA. Very truly yours, S/DENNIS H. CHOOKASZIAN Dennis H. Chookaszian 12 EX-10.17 4 LETTER EXTENDING EMPLOYMENT AGREEMENT Mr. Philip L. Engel CNA Financial Corporation 333 S. Wabash Avenue Chicago, IL 60685 Dear Phil: You and CNA Financial Corporation (the "Company") entered into an employment agreement dated December 31, 1995 (the "Agreement"). The third paragraph of Paragraph Eighth of the Agreement (the "Non-Renewal Provisions") specifies the terms that will apply if the Agreement is not extended or renewed at the end of its term on December 31, 1998. Because the Agreement was not extended or renewed, and your employment is continuing in 1999, the provisions of Paragraph Seventh and the provisions of the first and second paragraphs of Paragraph Eighth of the Agreement do not apply, and the Non-Renewal Provisions will apply. Your employment with the Company in 1999 will be subject to the following items (1) through (5): 1. Period of Employment. Under the Non-Renewal Provisions of the Agreement, your employment with the Company is to automatically terminate on March 31, 1999 if the Agreement is not renewed by that date. You and the Company have agreed that the automatic termination date will be deferred until September 30, 1999, and this letter confirms that the Agreement is amended by substituting the date "September 30, 1999" for the date "March 31, 1999" in each place the latter date appears in the Non-Renewal Provisions. 2. Coverage under Plans. By letter dated January 19, 1999 (the "Prior Letter"), we confirmed the understanding and agreement of you and of the Company that, during the portion of 1999 while you are employed by the Company, the terms of the Agreement that governed your benefits and perquisites prior to 1999 will continue to apply. For purposes of determining your right to benefits and perquisites (including, without limitation, benefits under the CNA Employees' Retirement Benefit Equalization Plan and the CNA Employees' Supplemental Savings Plan), the annual rate of combined salary and bonus deemed to be payable to you while you are employed by the Company during 1999 will be the sum of your salary (as provided in item (3) of this letter) and bonus (as provided in item (5) of this letter) for 1999. Further, matching contributions credited to your account under the CNA Employees' Supplemental Savings Plan (including those credited by reason of the preceding sentence) will be included in determining your benefits under the CNA Employees' Retirement Benefit Equalization Plan. For the avoidance of doubt, it is recited here that the amounts payable to you under items 3, 4, and 5 below are pensionable. 1 3. Salary Rate. Notwithstanding the Non-Renewal Provisions of the Agreement and the provisions of the Prior Letter, your salary will be at the rate of $800,000 per year for the period beginning January 1, 1999 and continuing until your termination of employment with the Company. Beginning February 19, 1999, your salary payments will reflect the rate of $800,000 per year. However, because the $800,000 annual salary rate is less than the rate specified in the Prior Letter, you have been paid until February 5, 1999 salary in excess of the amount due to you under this letter. The salary payments in excess of the $800,000 annual salary rate made between January 1, 1999 and February 5, 1999 (the "Excess Salary") will be repaid to the Company by making substantially equal reductions to the salary payments otherwise due you under this letter for the period beginning February 19, 1999 and ending September 30, 1999. If such amounts are insufficient to fully repay the Excess Salary, any remaining unrepaid Excess Salary will be repaid to the Company by an offset against and reduction of amounts otherwise due to you from the Company. 4. 1998 Bonus. You will be paid $300,000 in settlement of your award under the Company's Incentive Compensation Plan for 1998, which payment has been approved by the Incentive Compensation Committee of the Company's board of directors (the "Committee"), with such amount to be paid at the time specified in the plan (which is expected to be on or about March 8, 1999); provided that payment of any such amount will be subject to any applicable deferral elections made by you. You have agreed that such payment is in full and final settlement and satisfaction of all rights you have to receive payments under the Company's Incentive Compensation Plan for fiscal year 1998. 5. 1999 Bonus. You will be entitled to a bonus award for calendar year 1999, in an amount equal to the lesser of $600,000 or 0.3% of the Net Income of the Company and its subsidiaries (as defined below) for 1999, subject to a pro rata reduction to reflect the portion of 1999 following your date of termination with the Company. The bonus award described in this paragraph shall be payable in a cash lump sum as soon as practicable after the end of 1999, and shall be made after the Committee determines the amount to which you are entitled. You will not be entitled to any bonus award under this paragraph if your employment with the Company terminates prior to September 30, 1999 for Cause (as defined in the Agreement) or your voluntary resignation. However, if your employment with the Company terminates prior to September 30, 1999 for any other reason, the bonus award described in this paragraph shall be $600,000 (regardless of the Net Income), subject to a pro rata reduction to reflect the portion of 1999 following your date of termination with the Company, and shall be payable as soon as practicable (but not more than 30 days) after your termination of employment. 2 You will be entitled to an additional bonus award for calendar year 1999, in an amount equal to the lesser of $300,000 or 0.3% of the Net Income of the Company and its subsidiaries for 1999. The bonus award described in this paragraph shall be payable in a cash lump sum as soon as practicable after the end of 1999, and shall be made after the Committee determines the amount to which you are entitled. However, if your employment with the Company terminates prior to September 30, 1999 for any reason, the bonus award described in this paragraph shall be $300,000 (regardless of the Net Income), and shall be payable as soon as practicable (but not more than 30 days) after your termination of employment. For the avoidance of doubt, it is recited that the bonus amounts described in this paragraph and the preceding paragraph are to be determined in accordance with the applicable terms of the respective paragraph without any discretionary adjustment. For purposes of determining the bonus under this item 5, the term "Net Income" of the Company and its subsidiaries for 1999 shall mean the after tax Net Income of the Company and all of its subsidiaries for 1999 as reflected on the companies' audited consolidated financial statements for such year as filed with the Security and Exchange Commission less an amount equal to the "Net Realized Investment Gains" included in Net Income as reported in the audited consolidated financial statements, but increased by an amount equal to the "Net Realized Investment Losses" included in Net Income as reported in the audited financial statements. The foregoing notwithstanding, (I) the Net Income for 1999 shall be determined without taking into account any entry intended to reflect the cumulative effect in prior periods of any change in accounting principles used in preparing current period financial statements, and (II) the amount of Net Income for 1999 shall be determined without including any adjustments provided by SOP 97-3 (i.e., as though SOP 97-3 were inapplicable to any aspect of such determination). If this letter reflects your understanding of the terms of your employment with the Company, please indicate your agreement by signing and returning a copy of this letter to the undersigned. Very truly yours, CNA Financial Corporation By: S/JONATHON KANTOR ----------------------------------- Its: Senior Vice President, General Counsel and Secretary Accepted and agreed to this 17th day of February, 1999. S/PHILIP L. ENGEL - - ------------------------------ Philip L. Engel 3 EX-10.18 5 EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (the "Agreement") is made as of the 9th day of February, 1999 (the "Signing Date"), by and between CNA Financial Corporation, a Delaware corporation (the "Company"), and Bernard Hengesbaugh ("Executive"); WITNESSETH: WHEREAS, Executive currently serves as the Chief Operating Officer of the principal subsidiaries of the Company (i.e., the CNA insurance companies, hereinafter the "CNA Companies"), and, commencing as of February 9, 1999, the Company desires to promote Executive to the position of Chairman and Chief Executive Officer of the CNA Companies, and Executive desires to be employed in that position, all under the terms and subject to the conditions set forth below: NOW, THEREFORE, in consideration of the foregoing premises and the promises and covenants herein, the parties hereto agree as follows: 1. Employment Term. The Company and Executive agree that the Company shall continue to employ Executive to perform the duties of Executive Vice President and Chief Operating Officer of the CNA Companies for the period commencing January 1, 1999 (the "Effective Date"). Effective as of February 9, 1999, Executive shall cease to be the Executive Vice President and Chief Operating Officer of the CNA Companies, and shall be elected as Chairman and Chief Executive Officer of the CNA Companies on the terms and subject to the conditions set forth herein for a term continuing through and until December 31, 2000 or such earlier date as of which Executive's employment is terminated in accordance with Section 6 hereof. 2. Duties of Executive. (a) Executive shall assume the duties and responsibilities of the Chief Executive Officer of the CNA Companies as of February 9, 1999. As Chief Executive Officer, Executive shall have responsibility for the day to day operations of the CNA Companies and for development and implementation of the CNA Companies' business plans and strategies. Executive shall report to the Board of Directors of the Company (the "Board"). It is the anticipation of the parties that, subject to the right vested by law in the stockholders and directors, respectively, to elect directors and officers, Executive shall be elected to the Board on February 9, 1999, and Executive shall be elected and shall serve as a member of the Board of Directors of each of the CNA Companies, and shall serve as the Chairman of the Board of Directors of each of the CNA Companies, and if so elected Executive agrees to serve on such boards in such capacity without additional compensation. 1 CNA FINANCIAL CORPORATION - - -------------------------- (b) Executive shall diligently and to the best of his abilities assume, perform, and discharge the duties and responsibilities of Chairman and Chief Executive Officer of the CNA Companies, as well as such other specific duties and responsibilities as the Board shall assign or designate to Executive from time to time. Executive shall devote substantially all of his working time to the performance of his duties as set forth herein and shall not, without the prior written consent of the Board, accept other employment or render or perform other services, nor shall he have any direct or indirect ownership interest in any other business which is in competition with the business of the Company or the CNA Companies, other than in the form of publicly traded securities constituting less than five percent (5%) of the outstanding securities of a corporation (determined by vote or value) or limited partnership interests constituting less than five percent (5%) of the value of any such partnership. The foregoing shall not preclude Executive from engaging in charitable, professional, and personal investment activities, provided that, in the judgment of the Board, such activities do not materially interfere with his performance of his duties and responsibilities hereunder. 3. Compensation. (a) The Company shall pay to Executive, commencing December 3, 1998 and continuing for the period he is employed by the Company hereunder, an annual base salary of NINE HUNDRED FIFTY THOUSAND AND NO ONE HUNDREDS DOLLARS ($950,000.00), payable not less frequently than monthly (the "Base Compensation"). Such salary shall be reviewed not less frequently than annually by the Board with a view to making such adjustments as the Board deems equitable and appropriate based on Executive's performance and the overall profitability and revenue growth of the CNA Companies, provided that no such adjustment shall be made which would reduce Executive's annual Base Compensation to less than $950,000.00 without his consent. (b) Executive shall be entitled to an Incentive Compensation Award, in accordance with the CNA Financial Corporation Incentive Compensation Plan for Certain Executive Officers (the "Incentive Compensation Plan"). The amount of the Incentive Compensation Award shall be based on the performance of the Company and its subsidiaries for the calendar years 1999 and 2000, respectively, and the award for each year shall be payable in a cash lump sum as soon as practicable after the end of the year, but in no event prior to the date on which the Committee, as that term is defined in the Incentive Compensation Plan (the "Committee"), certifies the amount, if any, which has been earned for the year. The amount of the Incentive Compensation Award for Executive shall be determined in accordance with the following: (i) The amount of the Incentive Compensation Award for the calendar year 1999 shall be determined as follows: A preliminary determination of the amount of the Incentive Compensation Award payable to Executive with respect to calendar year 1999 shall be made by: (I) dividing the lesser of (A) the Net Income for the 1999 calendar year or (B) $100 million by (C) $100 million, and multiplying the resulting percentage by $950,000; 2 (II) dividing the lesser of (A) the Net Income for the calendar year in excess of $200 million for the calendar year or (B) $300 million by (C) $300 million, and multiplying the resulting percentage by 200% of $950,000; and (III) adding the products of (I) and (II). (ii) The amount of the Incentive Compensation Award for the calendar year 2000 shall be determined as follows: A preliminary determination of the amount of the Incentive Compensation Award payable to Executive with respect to calendar year 2000 shall be made by: (I) dividing the lesser of (A) the Net Income for the 2000 calendar year or (B) $200 million by (C) $200 million, and multiplying the resulting percentage by $950,000; (II) dividing the lesser of (A) the Net Income for the calendar year in excess of $200 million for the calendar year or (B) $300 million by (C) $300 million, and multiplying the resulting percentage by 200% of $950,000; and (III) adding the results of (I) and (II). (iii) The actual amount of the Incentive Compensation Award payable to Executive with respect to a calendar year shall be determined each year by the Incentive Compensation Committee based on Executive's overall performance, but in all events the amount of the Incentive Compensation Award shall not be less than 90% nor more than 100% of the preliminary determination of the Incentive Compensation Award under paragraphs (I) and (II) next above. (iv) For purposes of this paragraph (b), the term "Net Income" shall have the meaning ascribed to it in the Incentive Compensation Plan; provided that, for the avoidance of doubt, it is recited here that the term "Net Income" of the Company and its subsidiaries for any calendar year shall mean the after tax Net Income of the Company and all of its subsidiaries for the calendar year as reflected on the companies' audited consolidated financial statements for such year as filed with the Security and Exchange Commission less an amount equal to the "Net Realized Investment Gains" included in Net Income as reported in the audited consolidated financial statements, but increased by an amount equal to the "Net Realized Investment Losses" included in Net Income as reported in the audited financial statements. The foregoing notwithstanding, (I) the Net Income shall be determined without taking into account any entry intended to reflect the cumulative effect in prior periods of any change in accounting principles used in preparing current period financial statements, and (II) the amount of Net Income for 1999 shall be determined without including any adjustments provided by SOP 97-3 (i.e., as though SOP 97-3 were inapplicable to any aspect of such determination). 3 4. Other Benefits. Executive shall be entitled to participate in the various benefit plans, programs or arrangements established and maintained by the Company from time to time and applicable to senior executives of the Company such as, but not by way of limitation, vacation pay, health and major medical insurance, dental insurance, life insurance, long-term disability insurance, both qualified and supplemental retirement or savings plans, and long-term incentive compensation plans, and to receive all fringe benefits made available to Grade 96 employees of the Company. Executive's entitlement to participate in any such plan, program or arrangement shall, in each case, be subject to the terms and conditions thereof, subject to the following: (a) In determining the amount of Executive's retirement benefit under the CNA Employees' Retirement Benefit Equalization Plan or any other supplemental retirement plan or program in which Executive may participate, Executive's compensation or pensionable earnings shall be deemed to include all Incentive Compensation Awards or other incentive compensation payable to Executive (with such amounts to be includible at the time they would otherwise be paid in the absence of any elective deferral by Executive). (b) The Company maintains the CNA Employees' Supplemental Savings Plan (the "Supplemental Plan"), which currently permits participants to make elective deferrals of certain compensation (the "Eligible Compensation"), not to exceed 16% of the Eligible Compensation. Further, the Supplemental Plan currently provides for an additional Company allocation equal to 70% of the amount electively deferred by the participant under the plan, not to exceed 6% of the participant's Eligible Compensation. For purposes of determining the maximum amount which may be deferred under the Supplemental Plan, and for purposes of determining the amount of the matching allocation, Executive's "Eligible Compensation" shall include all Incentive Compensation Awards or other incentive compensation payable to Executive (with such amounts to be includible at the time they would otherwise be paid to Executive in the absence of any elective deferral by Executive). 5. Expense Reimbursement. Executive shall be entitled to reimbursement by the Company for all reasonable and customary travel and other business expenses incurred by Executive in carrying out his duties under this Agreement, in accordance with the general reimbursement policies adopted by the Company from time to time. Executive shall report all such expenditures not less frequently than monthly accompanied by adequate records and such other documentary evidence as required by the Company or by Federal or state tax statutes or regulations governing the substantiation of such expenditures. 4 6. Termination of Employment. Executive's employment with the Company hereunder shall continue until the earlier of December 31, 2000 or the date on which his employment is terminated pursuant to this Section 6. Either party may terminate Executive's employment with the Company by written notice to the other party effective as of the date specified in such notice and Executive's employment shall automatically terminate in the event of Executive's death. Upon termination of Executive's employment under this Agreement, the rights of the parties under this Agreement shall be determined pursuant to this Section 6. 6.1 Death and Disability. In the event of the death of Executive or, at the Company's election, in the event of his Permanent Disability (as defined below) during the term of this Agreement and while Executive is in the employ of the Company, Executive's employment shall terminate; provided, however, that: (a) The Company shall pay to Executive or his personal representatives, heirs or beneficiaries as the case may be, (i) any unpaid Base Compensation, including credited but unused vacation pay accrued up to the date of such termination, (ii) any unpaid Incentive Compensation Award described in paragraph 3(b) with respect to the calendar year prior to Executive's death or Permanent Disability, and (iii) a pro-rata portion of the amount of the Incentive Compensation Award earned for the calendar year in which the termination occurs determined by multiplying the Incentive Compensation Amount earned for the period through the end of the calendar year of termination (as determined by actual performance through the end of that year) by the number of days in the calendar year prior to the date of termination and dividing such product by 365. (b) The rights of Executive or his personal representatives, heirs or beneficiaries under any benefit plan, program or arrangement in which he was participating at the time of his termination, including any benefits which shall have accrued and vested under the terms of any plan, program or arrangement described in Section 4, and his right under any long-term incentive compensation plan, shall remain unaffected and shall be determined by the applicable terms of such plans, programs or arrangements. For purposes of this Agreement, the term "Permanent Disability" means a physical or mental condition of Executive which, as determined by the Board in its sole discretion based on all available medical information, is expected to continue indefinitely and which renders Executive incapable of performing any substantial portion of the services contemplated hereunder. 6.2 Termination For Cause by the Company. In the event that Executive shall engage in any conduct which the Board, in good faith, shall determine to be fraudulent, a substantial breach of any material provision of this Agreement, willful malfeasance or gross negligence, or inconsistent with the dignity and character of a senior executive of the Company, and only if such conduct is determined by the Board, acting in good faith, to have a material adverse effect on the business of the Company (defined herein as "Cause"), the Company shall have the right to terminate Executive's employment with the Company by written notice to Executive effective as of the date of such notice. Upon such termination, the Company shall have no further obligations under this Agreement other than for the payment of any unpaid Base Compensation accrued through the date of termination, any unpaid Incentive Compensation Award described in paragraph 3(b) with respect to the calendar year prior to the date of such termination, and unused vacation time accrued prior to the date of such termination. 5 6.3 Termination for Convenience by the Company. In the event Executive's employment is terminated by the Company for any reason not described in subsections 6.1 or 6.2 above, the obligations of the parties hereto shall be deemed discharged, provided, however, that: (a) The Company shall pay to Executive or his personal representatives, heirs, or beneficiaries, as the case may be, (i) any unpaid Base Compensation, including credited but unused vacation pay accrued up to the date of such termination, (ii) any unpaid Incentive Compensation Award described in paragraph 3(b) with respect to the calendar year prior to the date of such termination, and (iii) termination payments at the annual rate equal to: (I) three (3); multiplied by (II) Executive's annual rate of Base Compensation as in effect immediately prior to his date of termination; with such termination payment to be made in substantially equal installments, not less frequently than monthly, for a period of thirty-six (36) months following such termination. (b) The rights of Executive or his personal representatives, heirs, or beneficiaries under any benefit plan, program or arrangement in which he participated at the time of such termination, including any benefits which shall have accrued and vested under the terms of any plan described in Section 4, and his rights under any long-term incentive compensation plan, shall remain unaffected and be determined by the applicable terms of such plans, programs or arrangements. (c) In the event any payments made to Executive under this subsection 6.3 shall be found to constitute an "excess parachute payment" within the meaning of section 280(G) of the Internal Revenue Code or other payment subject to a federal excise tax, the Company shall pay to Executive, in addition to any payment obligation under (a) or (b) above, an amount equal to the amount of such excise tax, plus a tax gross-up payment in the amount of the aggregate additional federal, state, and local income, excise or other taxes payable by Executive with respect to the receipt of such excise tax payment. 6.4 Termination For Good Reason by Executive. (a) In the event that Executive's employment is terminated by Executive for "good reason," the Company's obligations shall be the same as they would have been, and Executive shall receive the same payments and other benefits that he would have received, had the Company terminated his employment pursuant to subsection 6.3. 6 (b) For purposes of this Agreement, the term "good reason" mean (i) any material diminution in Executive's duties and responsibilities as Chairman or Chief Executive Officer or authority or title or (ii) any material change in the Base Compensation or the Incentive Compensation Award payable to Executive in violation of Section 3, or any material change in Executive's rights under any long-term incentive compensation plan established by the Incentive Compensation Committee in violation of Section 3. 6.5 Voluntary Resignation by Executive. In the event that Executive's employment is terminated by Executive other than pursuant to subsection 6.4 or as a direct result of his death or Permanent Disability (as described in subsection 6.1), the Company shall have no further obligation under this Agreement other than in the payment of any accrued but unpaid Base Compensation, any unpaid Incentive Compensation Award described in paragraph 3(b) with respect to the calendar year prior to the date of such termination, and unused vacation time. 6.6 Failure to Extend Agreement. In the event that this Agreement has not been extended or renewed by mutual agreement at the end of its term on December 31, 2000 and the employment of Executive continues, then such employment shall constitute an employment at will from month to month. During Executive's employment following December 31, 2000, (i) he shall receive salary at the annual rate of 400% of his annual Base Compensation as of December 31, 2000; (ii) the terms of this Agreement that governed Executive's benefits and perquisites prior to January 1, 2001 will continue to apply, and will be in addition to Executive's salary specified in clause (i) above; (iii) Executive shall be entitled to payment with respect to the Incentive Compensation Award for calendar year 2000 to the extent provided by this Agreement, but Executive will not be entitled to an Incentive Compensation Award for calendar year 2001. If the Company terminates Executive's employment following December 31, 2000, or if the Company and Executive shall not have mutually agreed to the terms of, and entered into, a new employment prior to March 31, 2001, then Executive's employment shall terminate on April 1, 2001, and the Company's obligations shall be the same as they would have been, and Executive shall receive the same payments and other benefits that he would have received, had the Company terminated his employment pursuant to subsection 6.3, provided, however, that the termination payments otherwise payable in accordance with paragraph 6.3(a)(iii) shall be at an annual rate equal to: (I) three (3); multiplied by (II) Executive's annual rate of Base Compensation as of December 31, 2000; and such termination payments shall be made in substantially equal installments, not less frequently than monthly, for a period of thirty-six (36) months following such termination. 7 7. Confidentiality. Executive agrees that, while he is employed by the Company, and at all times thereafter, he shall continue to hold in a fiduciary capacity for the benefit of the Company all secret or confidential information, knowledge or data relating to the Company and any other business or entity in which at any relevant time the Company holds greater than a 10% equity (voting or non-voting) interest (an "Affiliate") that shall have been obtained by Executive during his employment by or affiliation with the Company and that shall not be public knowledge other than by acts of Executive or his representative ("Confidential Material"). Executive shall not, without the prior written consent of the Chairman of the Board, communicate or divulge any Confidential Material to anyone other than the Company and those designated by it. 8. Competition. Executive hereby agrees that, while he is employed by the Company, and for a period of 24 months following the date of his termination of employment with the Company for any reason, he will not, directly or indirectly, without the prior written approval of the Chairman of the Board, enter into any business relationship (either as principal, agent, board member, officer, consultant, stockholder, employee or in any other capacity) with any business or other entity that at any relevant time competes in any respect with any of the principal businesses of the Company or with any of the principal businesses of any Affiliate (a "Competitor"); provided, however, that such prohibited activity shall not include the ownership of less than 5% of the voting securities of any publicly traded corporation regardless of the business of such corporation. Upon the written request of Executive, the Chairman of the Board will determine whether a business or other entity constitutes a "Competitor" for purposes of this Section 8; provided that the Chairman of the Board may require Executive to provide such information as the Chairman of the Board determines to be necessary to make such determination; and further provided that the current and continuing effectiveness of such determination may be conditioned on the accuracy of such information, and on such other factors as the Chairman of the Board may determine. 9. Solicitation. Executive agrees that while he is employed by the Company, and for a period of 36 months following his termination of employment with the Company for any reason, he will not employ, offer to employ, engage as a consultant, or form an association with any person who is then, or who during the preceding one year was, an employee of the Company or any Affiliate, nor will he assist any other person in soliciting for employment or consultation any person who is then, or who during the preceding one year was, an employee of the Company or any Affiliate. 10. Non-Interference. Executive agrees that while he is employed by the Company, and for a period of 36 months following his termination of employment with the Company for any reason, he will not disturb or attempt to disturb any business relationship or agreement between either the Company or an Affiliate and any other person or entity. 8 11. Assistance with Claims. Executive agrees that, while he is employed by the Company, and for a reasonable period (not less than 36 months) thereafter, he will be available, on a reasonable basis, to assist the Company and its subsidiaries and affiliates in the prosecution or defense of any claims, suits, litigation, arbitrations, investigations, or other proceedings, whether pending or threatened ("Claims") that may be made or threatened by or against the Company or any of its subsidiaries or affiliates. Executive agrees, unless precluded by law, to promptly inform the Company if he is requested (i) to testify or otherwise become involved in connection with any Claim against the Company or any subsidiary or affiliate or (ii) to assist or participate in any investigation (whether governmental or private) of the Company or any subsidiary or affiliate or any of their actions, whether or not a lawsuit has been filed against the Company or any of its subsidiaries or affiliates relating thereto. 12. Return of Materials. Executive shall, at any time upon the request of the Company, and in any event upon the termination of his employment with the Company, for whatever reason, immediately return and surrender to the Company all originals and all copies, regardless of medium, of property belonging to the Company or the CNA Companies, created or obtained by Executive as a result of or in the course of or in connection with his employment with the Company regardless of whether such items constitute Proprietary Information, provided that Executive shall be under no obligation to return written materials acquired from third parties which are generally available to the public. Executive acknowledges that all such materials are, and will remain, the exclusive property of the Company and the CNA Companies. 13. Effect of Breach. Executive acknowledges that his violation of the covenants set forth in Sections 7, 8, 9, 10, and 12 could cause the Company irreparable harm and he agrees that the Company shall be entitled to injunctive relief restraining Executive from actual or threatened breach of the covenants and that if bond is required to be posted in order for the Company to secure such relief said bond need only be in a nominal amount. The right of the Company to seek injunctive relief shall be in addition to any other remedies available to the Company with respect to an alleged or threatened breach. 14. Limitation on Remedies. The Company shall not be entitled to suspend payments otherwise due to Executive by reason of Executive's violation of Sections 7, 8, 9, 10, and 12 (whether before or after a judgment is obtained by the Corporation against Executive). The Corporation shall not be entitled to set off against the amounts payable to Executive under this Agreement any amounts owed to the Corporation by Executive. Nothing in this Section 14 shall limit the Company's remedies in the case of Executive's violation of this Agreement, except as otherwise specifically provided in this Section 14. 9 15. Effect of Covenants. Nothing in Sections 7, 8, 9, 10, 11, and 12 shall be construed to adversely affect the rights that the Company would possess in the absence of the provisions of such Sections. 16. Revision. The parties hereto expressly agree that in the event that any of the provisions, covenants, warranties or agreements in this Agreement are held to be in any respect an unreasonable restriction upon Executive or are otherwise invalid, for whatsoever cause, then the court or arbitrator so holding is hereby authorized to (a) reduce the territory to which said covenant, warranty or agreement pertains, the period of time in which said covenant, warranty or agreement operates or the scope of activity to which said covenant, warranty or agreement pertains or (b) effect any other change to the extent necessary to render any of the restrictions contained in this Agreement enforceable. 17. Severability. Each of the terms and provisions of this Agreement is to be deemed severable in whole or in part and, if any term or provision of the application thereof in any circumstances should be invalid, illegal or unenforceable, the remaining terms and provisions or the application thereof to circumstances other than those as to which it is held invalid, illegal or unenforceable, shall not be affected thereby and shall remain in full force and effect. 18. Binding Agreement; Assignment. This Agreement shall be binding upon the parties hereto and their respective heirs, successors, personal representatives and assigns. the Company shall have the right to assign this Agreement to any successor in interest to the business, or any majority part thereof, of the Company or any joint venture or partnership to which the Company is a joint venturer or general partner which conducts substantially all of the Company's business. Executive shall not assign any of his obligations or duties hereunder and any such attempted assignment shall be null and void. 19. Controlling Law; Jurisdiction. This Agreement shall be governed by, interpreted and construed according to the laws of the State of Illinois (without regard to conflict of laws principles). 20. Arbitration of All Disputes. Any controversy or claim arising out of or relating to this Agreement (or the breach thereof) shall be settled by final, binding and non-appealable arbitration in Chicago, Illinois by three arbitrators. Except as otherwise expressly provided in this Section 20, the arbitration shall be conducted in accordance with the rules of the American Arbitration Association (the "Association") then in effect. One of the arbitrators shall be appointed by the Company, one shall be appointed by Executive, and the third shall be appointed by the first two arbitrators. If the first two arbitrators cannot agree on the third arbitrator within 30 days of the appointment of the second arbitrator, then the third arbitrator shall be appointed by the Association. This Section 20 shall not be construed to limit the Company's right to obtain relief under Section 13 with respect to any matter or controversy subject to Section 13 and, pending a final determination by the arbitrator with respect to any such matter or controversy, the Company shall be entitled to obtain any such relief by direct application to state, federal or other applicable court, without being required to first arbitrate such matter or controversy. 10 21. Entire Agreement. Except as otherwise expressly set forth herein, and except with respect to the letter from the Company to Executive dated February 9, 1999 and describing the one-time cash payment to Executive, this Agreement contains the entire agreement of the parties with regard to the subject matter hereof, supersedes all prior agreements and understandings, written or oral, and may only be amended by an agreement in writing signed by the parties thereto. 22. Additional Documents. Each party hereto shall, from time to time, upon request of the other party, execute any additional documents which shall reasonably be required to effectuate the purposes hereof. 23. Incorporation. The introductory recitals hereof are incorporated in this Agreement and are binding upon the parties hereto. 24. Failure to Enforce. The failure to enforce any of the provisions of this Agreement shall not be construed as a waiver of such provisions. Further, any express waiver by any party with respect to any breach of any provision hereunder by any other party shall not constitute a waiver of such party's right to thereafter fully enforce each and every provision of this Agreement. 25. Survival. Except as otherwise set forth herein, the obligations contained in this Agreement shall survive the termination, for any reason whatsoever, of Executive's employment with the Company. 26. Headings. All numbers and headings contained herein are for reference only and are not intended to qualify, limit or otherwise affect the meaning or interpretation of any provision contained herein. 27. Notices. Notices and all other communications provided for in this Agreement shall be in writing and shall be delivered personally or sent by registered or certified mail, return receipt requested, postage prepaid (provided that international mail shall be sent via overnight or two-day delivery), or sent by facsimile or prepaid overnight courier to the parties at the addresses set forth below (or such other addresses as shall be specified by the parties by like notice). Such notices, demands, claims and other communications shall be deemed given: (a) in the case of delivery by overnight service with guaranteed next day delivery, the next day or the day designated for delivery; (b) in the case of certified or registered U.S. mail, five days after deposit in the U.S. mail; or (c) in the case of facsimile, the date upon which the transmitting party received confirmation of receipt by facsimile, telephone or otherwise; provided, however, that in no event shall any such communications be deemed to be given later than the date they are actually received. Communications that are to be delivered by the U.S. mail or by overnight service or two-day delivery service are to be delivered to the addresses set forth below: If to the Company: CNA Financial Corporation CNA Plaza Chicago, IL 60685 Attn: Corporate Secretary If to Executive: Bernard Hengesbaugh 202 Thompson Drive Wheaton, IL 60187 or to such other address as either party shall furnished to the other party in writing in accordance with the provisions of this Section 27. 28. Gender. The masculine, feminine or neuter pronouns used herein shall be interpreted without regard to gender, and the use of the singular or plural shall be deemed to include the other whenever the context so requires. 11 IN WITNESS WHEREOF, the parties hereto have executed this Agreement on the date and year first above written. CNA FINANCIAL CORPORATION By: S/JIM MACGINNITIE - - ------------------------ Title:Senior Vice President and Chief Executive Officer S/BERNARD HENGESBAUGH - - ------------------------ BERNARD HENGESBAUGH CNA Administrative Offices CNA Plaza Chicago, Illinois 60685 312-822-5000 Transfer Agent and Registrar First Chicago Trust Company of New York P.O. Box 2500 Jersey City, New Jersey 07303-2500 INDEPENDENT AUDITORS Deloitte & Touche LLP 180 North Stetson Avenue Chicago, Illinois 60601 EX-13.1 6 1998 ANNUAL REPORT CNA FINANCIAL CORPORATION 1998 ANNUAL REPORT CNA PROFILE - - ----------------------------------------------------------------------------- CNA Financial Corporation is a holding company whose primary subsidiaries consist of property/casualty and life insurance companies. Collectively these subsidiaries are CNA. CNA is one of the largest writers of commercial property/casualty insurance and one of the ten largest insurance organizations in the United States. - - ----------------------------------------------------------------------------- CNA serves businesses and individuals with a broad range of insurance and other risk management products and services. Insurance products include property and casualty coverages; life, accident and health insurance; and pension products and annuities. CNA services include risk management, information services, health care management and claims administration. CNA products and services are marketed through agents, brokers, general agents and direct sales. CNA Financial Corporation, with 1998 revenues of $17.1 billion, assets of $62.4 billion and stockholders' equity of $9.2 billion, is the holding company of Continental Casualty Company, incorporated in 1897, Continental Assurance Company, incorporated in 1911, and The Continental Corporation, which is the holding company of The Continental Insurance Company, incorporated in 1853. CNA Financial Corporation stock is traded primarily on the New York Stock Exchange and, as of December 31, 1998, was approximately 85 percent owned by Loews Corporation. CNA FINANCIAL CORPORATION ------------------------- CNA TABLE OF CONTENTS - - ----------------------------------------------------------------------------- 1998 2 FINANCIAL HIGHLIGHTS 4 LETTER FROM CNA FINANCIAL CORPORATION CHAIRMAN EDWARD J. NOHA 6 LETTER FROM CNA CHAIRMAN AND CEO BERNARD L. HENGESBAUGH 9 FINANCIAL SECTION CONTENTS 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 58 CONSOLIDATED FINANCIAL STATEMENTS 117 INDEPENDENT AUDITORS' REPORT 118 COMMON STOCK INFORMATION 119 CORPORATE DIRECTORY CNA FINANCIAL CORPORATION ------------------------- FINANCIAL HIGHLIGHTS - - --------------------------------------------------------------------------- Results of Operations and Financial Condition
- - ----------------------------------------------------------------------------------------------------------------- As of and for the Year Ended December 31 1998 1997 1996 1995* 1994 - - ----------------------------------------------------------------------------------------------------------------- (In millions of dollars, except per share data and ratios) RESULTS OF OPERATIONS - - ----------------------------------------------------------------------------------------------------------------- Revenues $17,074 $17,072 $16,988 $14,700 $11,000 ==================================================================================================== Net operating (loss) income (152) 488 578 463 187 Net realized investment gains (losses) 434 478 387 294 (151) - - ----------------------------------------------------------------------------------------------------------------- NET INCOME $ 282 $ 966 $ 965 $ 757 $ 36 ================================================================================================================= EARNINGS PER SHARE - - ----------------------------------------------------------------------------------------------------------------- Net operating (loss) income $ (0.86) $ 2.59 $ 3.08 $ 2.46 $ 0.98 Net realized investment gains (losses) 2.35 2.58 2.09 1.59 (0.81) - - ----------------------------------------------------------------------------------------------------------------- NET INCOME $ 1.49 $ 5.17 $ 5.17 $ 4.05 $ 0.17 ================================================================================================================== FINANCIAL CONDITION - - ------------------------------------------------------------------------------------------------------------------ Invested assets $37,177 $36,203 $35,412 $35,886 $29,943 Total assets 62,359 61,675 60,455 60,360 44,320 Reserves 40,438 39,829 39,981 40,803 28,938 Debt 3,160 2,897 2,765 3,026 914 Stockholders' equity 9,157 8,309 7,060 6,736 4,546 Book value per common share 47.89 44.01 37.27 35.52 23.71 Return on average stockholders' equity 3.2% 12.6% 14.0% 13.4% 0.7% - - ------------------------------------------------------------------------------------------------------------------ STATUTORY SURPLUS - - ------------------------------------------------------------------------------------------------------------------ Property/casualty companies** $ 7,593 $ 7,123 $ 6,349 $ 5,696 $ 3,367 Life companies 1,109 1,224 1,163 1,128 1,056 ================================================================================================================== * RESULTS OF OPERATIONS DATA INCLUDES THE CONTINENTAL CORPORATION SINCE ITS ACQUISITION ON MAY 10, 1995. ** SURPLUS INCLUDES EQUITY OF PROPERTY/CASUALTY COMPANIES OWNERSHIP IN LIFE INSURANCE SUBSIDIARIES.
CNA FINANCIAL CORPORATION -------------------------- 2 - - ------------------------------------------------------------------------------ Financial Position This page of CNA Financial Corporation's annual report has four bar graphs which illustrate the trend in revenues, assets, stockholders' equity and book value per common share from 1988 through 1998. CNA FINANCIAL CORPORATION (1988-1998) ($ in billions except per share data) |-----------------------|----------|---------|---------------|---------------| |Measurement Period | | | Stockholders'| Book Value Per| | (Fiscal Year Covered | Revenues | Assets | Equity | Common Share* | |-----------------------|----------|---------|---------------|---------------| |FYE 12/31/88...........| 8.3 | 25.9 | 3.6 | 18.29 | |FYE 12/31/89...........| 9.1 | 30.9 | 4.2 | 21.58 | |FYE 12/31/90...........| 9.9 | 34.7 | 4.5 | 23.41 | |FYE 12/31/91...........| 11.1 | 39.2 | 5.1 | 26.75 | |FYE 12/31/92...........| 10.8 | 39.7 | 4.8 | 25.02 | |FYE 12/31/93...........| 11.0 | 41.9 | 5.4 | 28.22 | |FYE 12/31/94...........| 11.0 | 44.3 | 4.5 | 23.71 | |FYE 12/31/95...........| 14.7 | 60.4 | 6.7 | 35.52 | |FYE 12/31/96...........| 17.0 | 60.5 | 7.1 | 37.27 | |FYE 12/31/97...........| 17.1 | 61.7 | 8.3 | 44.01 | |FYE 12/31/98...........| 17.1 | 62.4 | 9.2 | 47.89 | |-----------------------|----------|---------|---------------|---------------| *Previous years have been restated for 3 for 1 stock split that occured on 5/98. CNA FINANCIAL CORPORATION --------------------------- 3 A LETTER TO OUR SHAREHOLDERS - - ----------------------------------------------------------------------------- 1998 FROM CNA FINANCIAL CORPORATION CHAIRMAN EDWARD J. NOAH CNA Financial Corporation reported lower earnings in 1998. Net income for the year was $282 million, or $1.49 per share, compared with net income of $966 million, or $5.17 per share, in 1997. Excluding after-tax restructuring and other related charges of $169 million in 1998, net income was $451 million, or $2.40 per share. Net realized investment gains for 1998 were $434 million, or $2.35 per share, compared with net realized gains of $478 million, or $2.58 per share, for 1997. Consolidated revenues were approximately $17.1 billion in both 1998 and 1997. Net operating income for 1998, excluding after-tax restructuring and other related charges, was $17 million, or $0.05 per share, compared with $488 million, or $2.59 per share, for 1997. Key factors that affected net income included intensely competitive marketplace conditions, a change in estimate of prior year reserves of $270 million, restructuring and related costs of $169 million after tax, increased catastrophe costs of $140 million, and decreased investment income of $40 million. All these factors underscore the importance of CNA's conservative financial strategies and solid financial base. At year-end 1998, CNA's total assets amounted to $62.4 billion. Stockholders' equity was $9.2 billion, up 10% from the previous year. Book value per share increased 9% to $47.89. In our investment portfolio, 93 percent of our fixed maturity holdings were in investment-grade bonds. In addition, we began a capital enhancement plan to place additional capital in one of the property/casualty pools. During the fourth quarter, we began these efforts with a $200 million public debt offering and $200 million of preferred stock purchased by Loews, our majority shareholder. Also of note, CNA implemented an officer stock ownership plan during the fourth quarter. The senior officers purchasing the stock do so voluntarily and are fully at risk for their holdings. Strong participation in the plan further demonstrates management's confidence in the direction of CNA and its prospects for the long term. Along with its solid financial foundation, CNA continued to build on a strong leadership team. In a succession plan announced in 1998 and completed earlier this year, Bernard L. Hengesbaugh, former executive vice president and chief operating officer, succeeded Dennis H. Chookaszian as chairman and chief executive officer. Mr. Hengesbaugh has already demonstrated his leadership, industry knowledge and CNA FINANCIAL CORPORATION ------------------------- 4 - - ------------------------------------------------------------------------------- 1998 organizational capabilities as chief operating officer and in his previous position as head of our successful Specialty Operations. We look forward to working with him in his new role. Mr. Chookaszian was elected chairman of the Executive Committee of the Board of CNA Financial Corporation. Preston R. Tisch, who had served as chairman of the Executive Committee for the past 25 years, will continue to serve as a committee member. We appreciate Mr. Chookaszian's contributions during 23 years of service to CNA, and we will benefit greatly from his continued counsel. Looking to the future, we see an insurance environment being transformed by consolidation, convergence of financial services, globalization and intense competition. In this tumultuous arena, we are fully focused on improved earnings and continued growth of shareholder value. With its solid financial position and strong leadership, CNA is well positioned to continue its record of integrity, growth of long-term value, and commitment to customers, employees and business partners. On behalf of the board of directors, I thank you for your commitment and ongoing support. Sincerely, S/EDWARD J. NOHA Edward J. Noha Chairman of the Board CNA Financial Corporation CNA FINANCIAL CORPORATION --------------------------- 5 A LETTER TO OUR SHAREHOLDERS - - ---------------------------------------------------------------------------- 1998 FROM CNA CHAIRMAN AND CHIEF EXECUTIVE OFFICER BERNARD L. HENGESBAUGH The financial results you see in this report underscore two indisputable facts. First, the conditions in the insurance marketplace have never been more competitive. And second, our operating performance is unacceptable to CNA management and our board. CNA began implementing strategies this year to improve operating performance and we will continue to concentrate our full management attention on improving the Company's bottom line. These strategies include expense reduction and restructuring, exiting non-core businesses, and working with key distribution partners to achieve adequate rates in middle-market property/casualty business. Together, these efforts are designed to build on CNA's strong franchise value by focusing on core businesses and becoming a provider of choice in our selected markets. Early last year, we began a companywide drive to achieve best-in-class expense levels. We stepped up our efforts at mid-year with the launch of an 18-month restructuring plan, under which each of the business and support areas accelerated their efforts to provide higher quality services on a more efficient operating platform. The restructuring activities resulted in charges of $246 million pre-tax during the last half of the year, with an additional $100 million to $150 million pre-tax in restructuring-related costs anticipated during 1999. When fully implemented, the plan is expected to produce pre-tax annual savings in excess of $300 million. CNA continued a process of focusing all its resources on businesses with the ability to sustain profitable, long-term growth. We no longer believe that certain businesses have long-term profit potential for CNA. For this reason, we exited the agriculture and certain employer health insurance businesses in 1998. Early this year, we exited the entertainment insurance market. Our third major strategy for improved operating performance relates to our book of middle-market property/casualty insurance. In recent years, competitive pressure has driven pricing in workers' compensation and other key lines to unreasonable levels. During the last half of 1998, CNA reviewed its pricing and underwriting standards. Now, in partnership with key agents and brokers, CNA is working aggressively to improve price adequacy. We are addressing the issue on a case by case basis, and are fully prepared to walk away from business if the market continues to underprice. While the strategies for improved operating performance are critical, they do not tell the whole story of CNA's 1998 results. Several lines of business continued to perform well, including surety, directors & officers liability, nonmedical professional liability, warranty, individual life, long-term care and others. CNA UniSource, our start-up Professional Employer Organization, ranks among CNA FINANCIAL CORPORATION -------------------------- 6 - - ------------------------------------------------------------------------------ 1998 the nation's fastest growing PEOs. In addition, we achieved our goal of reaching Year 2000 computer readiness of all internal application systems by December 1, 1998. While some work continues in 1999, the technology platform is well prepared to support CNA operations as we move into the next century. Looking to the rest of 1999, we anticipate another year of difficult market conditions. Our efforts to improve operating performance will continue to focus squarely on the fundamentals of our business. In our businesses that are performing well, we will continue to improve earnings through underwriting discipline, efficient operations and strong distribution relationships. We will complete our expense reduction and restructuring efforts, and we will carry this approach forward by emphasizing continuous improvement. We will continue our middle-market strategy at full speed. Although much of the work will be done this year, we expect that the positive impact on our operating results will not be fully realized until the year 2000. Many accounts do not come up for renewal until later in 1999, and with some accounts, it will take several renewal cycles of disciplined underwriting to achieve the right price levels. Finally, we will continue to challenge all our businesses on the basis of their ability to sustain profitable, long-term growth. In that regard, we have introduced a new approach to reporting CNA results. In this report, we are providing financial data and discussion of each of our major business segments. You will see this approach in the Management's Discussion and Analysis section. We believe that segment reporting will provide a clearer picture of the way we manage our businesses, as well as the progress that we are making in each segment. In summary, CNA is focused on improving profitability in the near term, while continuing to manage for long-term value. In a difficult insurance environment, we believe CNA is on the right track. We have the people, the strategies, the business relationships and the financial strength to emerge as the most improved player over the next few years. Thank you for your continuing confidence in CNA, and I look forward to sharing our progress with you in next year's report. Sincerely, S/BERNARD L. HENGESBAUGH Bernard L. Hengesbaugh Chairman and Chief Executive Officer CNA CNA FINANCIAL CORPORATION ------------------------- 7 CNA FINANCIAL SECTION CONTENTS - - ---------------------------------------------------------------------------- 1998 11 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 58 CONSOLIDATED BALANCE SHEETS 60 CONSOLIDATED STATEMENTS OF OPERATIONS 61 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY 62 CONSOLIDATED STATEMENTS OF CASH FLOWS 64 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 117 INDEPENDENT AUDITORS' REPORT 118 COMMON STOCK INFORMATION 119 CORPORATE DIRECTORY CNA FINANCIAL CORPORATION ------------------------- 9 CNA MANAGEMENT'S DISCUSSION AND ANALYSIS - - ---------------------------------------------------------------------------- Consolidated Operations INTRODUCTION The following discussion highlights significant factors influencing the results of operations and financial condition of CNA Financial Corporation (CNAF). CNAF together with its subsidiaries is referred to as CNA or the Company. This discussion should be read in conjunction with the consolidated financial statements and the related notes, appearing on pages 58 through 116, and the five-year summary of selected financial highlights appearing on page 2. The discussion also includes an overview of each of the Company's seven operating segments, the products offered, the customers served, the distribution channels used and an analysis of operating results. Since distinct investment portfolios are not maintained for each insurance segment, the discussion of investment results, including investment income and realized investment gains, is on a consolidated basis and begins on page 40. The 1998 provisions for restructuring and other related charges are discussed along with consolidated operations. - - ----------------------------------------------------------------------------- CONSOLIDATED OPERATIONS BUSINESS OVERVIEW CNA is one of the largest insurance organizations in the United States and, based on 1997 net written premium, is the third largest property/casualty company and the thirty-second largest life insurance company. CNA's overall goal is to create long-term enterprise value by pursuing a strategy of profitable growth in the market segments in which it operates. CNA conducts its operations through seven operating segments that are briefly described below: AGENCY MARKET OPERATIONS - provides small to mid-size businesses as well as individuals a wide range of property/casualty products distributed through one of the broadest independent agency networks in the U.S. SPECIALTY OPERATIONS - provides a broad array of professional, financial and specialty property/casualty products and services distributed through brokers, managing general agencies and independent agencies. CNA RE - serves as a property/casualty reinsurer, offering primarily traditional treaty reinsurance, with developing positions in facultative and financial reinsurance. GLOBAL OPERATIONS - provides marine, property/casualty, surety, warranty and specialty products to both domestic and international customers. RISK MANAGEMENT - serves the property/casualty needs of large domestic commercial businesses, offering customized, solution based strategies to address risk management. CNA FINANCIAL CORPORATION ------------------------- 11 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ------------------------------------------------------------------------------ Consolidated Operations (cont.) GROUP OPERATIONS - provides a broad array of group life and health insurance products and services to employers, affinity groups and other entities that buy as a group. Group operations also provides reinsurance for group and individual life and health insurers. LIFE OPERATIONS - provides financial protection to individuals through a full product line of insurance, including term life, universal life and long term care as well as annuities and viatical settlements. Life Operations also provides retirement products and administration services to pension plans and other institutional buyers. These operating segments reflect the way in which CNA distributes its products to the marketplace and the way in which it manages operations and makes business decisions. A more detailed description of each segment is included later in this discussion. Corporate results consist of interest expense on corporate borrowings, certain run-off insurance operations, asbestos claims related to Fibreboard Corporation, financial guarantee insurance contracts, and certain non-insurance operations, principally the operations of Agency Management Systems, Inc. (AMS), an information technology and agency software development subsidiary. CNA FINANCIAL CORPORATION -------------------------- 12 - - ----------------------------------------------------------------------------- Consolidated Operations (cont.) OPERATING RESULTS: The following chart summarizes the consolidated operating results for each of the last three years. CONSOLIDATED OPERATIONS - - ---------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - ----------------------------------------------------------------------------- (In millions of dollars) OPERATING REVENUES (EXCLUDING REALIZED INVESTMENT GAINS/LOSSES): Premiums $13,375 $13,482 $13,525 Net investment income 2,146 2,209 2,276 Other 858 628 568 - - ----------------------------------------------------------------------------- Total operating revenues (excluding realized investment gains/losses) 16,379 16,319 16,369 Restructuring and other related charges 246 - - Benefits and other expenses 16,465 15,689 15,619 - - ----------------------------------------------------------------------------- Operating (loss) income before income tax (332) 630 750 Income tax benefit (expense) 200 (132) (163) - - ----------------------------------------------------------------------------- Net operating (loss) income (excluding realized investment gains/losses) (132) 498 587 Realized investment gains, net of tax 434 478 387 Minority interest (20) (10) (9) - - ----------------------------------------------------------------------------- NET INCOME $ 282 $ 966 $ 965 ============================================================================= REVENUES Total operating revenues, which consist of premium, net investment income, and other revenues, were $16.4 billion, $16.3 billion and $16.4 billion for the years ended December 31, 1998, 1997 and 1996, respectively. Premiums and other operating revenues, exclusive of net investment income and net realized investment gains, are discussed and analyzed in the context of the discussions of each of the business segments that follow. Benefits and other operating expenses are also discussed at the segment level. Premiums for 1998 declined by $107 million when compared with 1997. This decrease is primarily due to intense price competition facing the commercial lines insurance market. Premiums for 1997 declined by $43 million when compared with 1996. This decrease is primarily due to reductions in premiums from involuntary markets and competitive conditions in the commercial lines insurance market. NET INVESTMENT INCOME Net investment income was $2.1 billion, $2.2 billion and $2.3 billion for 1998, 1997 and 1996, respectively. Net investment income for 1998 decreased by $63 million when compared with 1997. This decrease is primarily attributable to a lower average level of assets invested in interest-bearing securities in 1998 as compared with 1997. See discussion on investments on page 40. CNA FINANCIAL CORPORATION ------------------------- 13 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ------------------------------------------------------------------------------ Consolidated Operations (cont.) Net investment income for 1997 decreased by $67 million when compared with 1996. This decrease is primarily due to lower interest rates in 1997 as compared with 1996. REALIZED INVESTMENT GAINS/LOSSES The Company's investment portfolio is managed to maximize after-tax investment return while minimizing credit risk with investments concentrated in high quality securities to support its insurance underwriting results. As a result of this investment philosophy, the Company may sell, and has sold, securities from time to time to take advantage of market conditions. Investment gains realized from these sales can be a significant component of the overall investment portfolio performance and the Company's net income. In 1998, realized investment gains, net of tax, amounted to $434 million in 1998 as compared with $478 million and $387 million in 1997 and 1996, respectively. See discussion of investments on page 40. RESTRUCTURING AND OTHER RELATED CHARGES BACKGROUND During 1998, the Company initiated a comprehensive review of several of its business operations and corporate functions to identify opportunities to restructure those operations and/or eliminate processes and employee positions. The objectives of these reviews were to develop detailed plans to increase operating efficiencies by better use of technology and streamlining of decision-making, and to exit businesses that were not contributing to the achievement of corporate financial objectives, the net results of which are expected to be a better focus on the customer and the realization of cost savings. COMPANY PLAN The Company finalized and approved a restructuring plan (the "Plan") in August 1998. In connection with the Plan, the Company incurred various expenses that were recorded in the third and fourth quarters of 1998. These restructuring and other related charges primarily related to the following activities: planned reductions in the workforce; the consolidation of certain processing centers; the exiting of certain businesses and facilities; the termination of related lease obligations; and the writeoff of certain assets related to these activities. The Plan contemplates a gross reduction in workforce of 4,500 employees, resulting in a planned net reduction of 2,400 employees. According to the Plan, the various activities and workforce reductions should be completed by the end of 1999. Once the Plan is fully executed, it is expected that there will be cost savings of approximately $300 to $350 million on an annualized basis. INCOME STATEMENT CHARGES The pretax restructuring and other related charges were comprised of the following costs and expenses: a) costs and benefits related to planned employee terminations of $98 million, of which $53 million related to severance and outplacement costs, $24 million related to other employee transition related costs, principally parallel processing and $21 million related to benefit plan curtailment losses; b) writedown of certain assets to their fair value of $74 million, of which $59 million related to a writedown of an intangible asset, and $15 million related to adjustments for abandoned leasehold improvements and other related fixed assets associated with leases that were terminated as part of the restructuring plan; c) lease termination costs of $42 million; and d) losses incurred on the exiting of certain businesses of $32 million. CNA FINANCIAL CORPORATION -------------------------- 14 - - ------------------------------------------------------------------------------ Consolidated Operations (cont.) The Company recorded $220 million of these restructuring and other related charges in the third quarter of 1998. Other charges such as parallel processing costs, relocation costs, and retention bonuses, did not qualify for accrual at the end of the third quarter under generally accepted accounting principles and are being expensed as incurred. In the fourth quarter of 1998, $26 million of these charges were recorded. Based on the Company's current estimates, it is expected that the Company will record an additional $100 million to $150 million, pre-tax, of these costs over approximately the next twelve months. Such costs are expected to be reported as uses of operating cash. AGENCY MARKET OPERATIONS The 1998 pre-tax restructuring and other related charges for Agency Market Operations totaled approximately $96 million. The charges included employee severance and outplacement costs of $34 million related to the planned net reduction in the workforce of approximately 1,200 employees. Approximately $29 million of lease termination costs were also incurred in connection with the consolidation of four regional offices into two zone offices and a reduction of the number of claim processing offices from 24 to 8. The Agency Market Operations charges also included benefit plan costs of $12 million, parallel processing charges of $7 million, and $5 million of other fixed asset writedowns. Other charges, including travel, relocation and other transition-related activity, which were expensed as incurred, totaled approximately $9 million. Through December 31, 1998, approximately 364 Agency Market Operation employees, the majority of whom were loss adjusters and office support staff, had been released at a cost of $8 million. RISK MANAGEMENT The 1998 pre-tax restructuring and other related charges for Risk Management totaled approximately $88 million. The charges included lease termination costs associated with the consolidation of claim offices in 36 market territories that totaled approximately $8 million. In addition, employee severance and outplacement costs relating to the planned net reduction in workforce of approximately 200 employees were approximately $10 million and the writedown of fixed and intangible assets totaled approximately $64 million. Parallel processing and other charges totaled approximately $6 million. The charges related to fixed and intangible assets were primarily due to a writedown of an intangible asset (goodwill) related to a business that had been acquired several years earlier. As part of the Company's periodic reviews of asset recoverability and as a result of several adverse events, the Company concluded, based on its discounted cash flow analysis completed in the third quarter of 1998, that a $59 million writeoff was necessary. The adverse events contributing to this conclusion included operating losses from the business, the loss of several significant customers whose business volume within this operation contributed a large portion of the revenue base, and substantial changes in the overall market demand for the services offered by this operation which, in turn, had negative effects on the prospects for achieving the profitability levels necessary to recover the intangible asset. Through December 31, 1998, approximately 152 Risk Management employees had been released at a cost of $2 million. The majority of the employees were adjusters and office support staff. CNA FINANCIAL CORPORATION -------------------------- 15 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ------------------------------------------------------------------------------ Consolidated Operations (cont.) GROUP OPERATIONS The 1998 pre-tax restructuring and other related charges for Group Operations totaled approximately $39 million. The charges included approximately $29 million of costs related to the Company's decision to exit the Employer Health and Affinity lines of business. These costs represent the Company's estimate of losses in connection with fulfilling the remaining obligations under contracts related to these lines. Earned premiums for these lines of business approximated $400 million in 1998. The 1998 charges also included employee severance and outplacement costs of approximately $7 million related to the planned net reduction in workforce of approximately 400 employees. Charges for lease termination costs and fixed asset writedowns totaled $3 million. Through December 31, 1998, approximately 56 Group Operations employees had been released at a cost of $1 million. The majority of the employees were claims and sales support staff. OTHER SEGMENTS For the other segments of the Company, pre-tax restructuring and other related charges totaled approximately $23 million for 1998. Charges related primarily to the closing of leased facilities ($3 million) and employee severance and outplacement costs related to planned net reductions of 600 employees in the current workforce and benefit costs associated with those reductions ($13 million). In addition, there were $4 million in charges related to the writedown of certain assets and $3 million related to the exiting of certain businesses. Through December 31, 1998, approximately 270 employees of these other segments, most of whom were underwriters and office support staff, had been released at a cost of $3 million. CORPORATE Corporate results consist of interest expense on corporate borrowings, certain run-off insurance operations, asbestos claims related to Fibreboard Corporation, financial guarantee insurance contracts, and certain non-insurance operations, principally the operations of Agency Management Systems, Inc. (AMS), an information technology and agency software development subsidiary. Operating losses for 1998 increased by $124 million compared with 1997. This increase is primarily attributed to a net unfavorable change in loss development on asbestos claims related to Fibreboard Corporation of approximately $70 million, an increase in pre-tax operating losses attributable to AMS of $20 million and a decrease in investment income and an increase in interest expense totaling $29 million. Operating losses for 1997 increased by $94 million from 1996. This increase was primarily attributable to a net unfavorable change in loss development on run-off operations and financial guarantee insurance contracts of $77 million. The remaining increase was due to increased operating losses from AMS of approximately $12 million, and other items aggregating $5 million. A discussion of consolidated investment results can be found on page 40. CNA FINANCIAL CORPORATION ------------------------- 16 CNA SEGMENT OVERVIEWS AND ANALYSIS - - --------------------------------------------------------------------------- 1998 AGENCY MARKET OPERATIONS 18 SPECIALTY OPERATIONS 22 CNA RE 25 GLOBAL OPERATIONS 27 RISK MANAGEMENT 31 GROUP OPERATIONS 34 LIFE OPERATIONS 37 CNA FINANCIAL CORPORATION -------------------------- MANAGEMENT'S DISCUSSION AND ANALYSIS - - ---------------------------------------------------------------------------- Agency Market Operations BUSINESS OVERVIEW Agency Market Operations builds on the Company's long and successful relationship with the independent agency distribution system to market a broad range of property/casualty insurance products and services to both businesses and individuals. Business products include workers' compensation, commercial packages, general liability and commercial auto, as well as a variety of creative risk management services. Products for individuals are primarily personal auto and homeowners insurance. In addition, Agency Market Operations recently launched a professional employer organization, CNA UniSource, which provides various employer-related services. Agency Market Operations includes four groups. COMMERCIAL INSURANCE Commercial Insurance (CI) provides traditional property/casualty insurance products such as workers' compensation, general and product liability, property, commercial auto and umbrella coverage to businesses with less than $1 million in annual premiums. The majority of CI customers are small and medium-sized businesses. CI is among the market leaders in applying industry segmentation techniques to design products and services tailored to the needs of its targeted customer groups. In early 1998, CI completed an extensive review of its business and developed a new, more effective platform that positions CI as a world class competitor for the next century. The basis for the platform is to move decision-making authority and resources closer to our customers. That platform consists of 40 branches, located throughout the U.S., providing customer support in the areas of underwriting, loss control and sales. A new processing center will be responsible for premium processing and accounting for all 40 branches, and will incorporate a call center for increased customer service. Eight claim service centers, located throughout the U.S., will provide customers and claimants with improved service through more specialized claim handling and easier claim reporting. The improved efficiencies are expected to result in decreased expenses in underwriting and claims through the implementation of new technology, process redesign and centralization. In addition, CI recognizes that an even lower cost platform is necessary to be successful in the small commercial marketplace. CI has developed underwriting and sales tools that automate the underwriting process, enabling agents to handle applications, verify eligibility, price and issue policies at the point of sale. PERSONAL INSURANCE Personal Insurance (PI) sells primarily personal auto and homeowners coverages and also offers excess liability, separate scheduled property, boat-owners and other recreational vehicle insurance. These coverages are sold primarily as a package product. In addition, PI is developing capabilities that support employer group marketing through independent agencies. E&S E&S provides specialized insurance and other financial products for a wide array of commercial and personal lines customers. Risks covered by E&S are generally viewed as highly perilous and less predictable in exposure than those covered CNA FINANCIAL CORPORATION ------------------------- 18 - - ---------------------------------------------------------------------------- Agency Market Operations (cont.) by the more traditional insurance markets. By combining superior insurance and financial expertise with a detailed understanding of customer operations and future direction, E&S is able to create and implement innovative business solutions that are valued by the customer. In addition, E&S actively seeks business partners who can supplement CNA resources and enhance value for the customer. CNA UNISOURCE CNA UniSource is a professional employer organization that provides integrated products and services to business owners and their employees. Products and services include payroll processing, human resource services, and access to workers' compensation and employee benefit insurance. The primary sales force is comprised of independent insurance agencies that are also contracted with the CI branches. Payroll processing and human resource services can also be provided on an unbundled basis. At December 31, 1998, CNA UniSource was licensed in 35 states and the District of Columbia. It expects to be licensed in ten additional states by mid-1999. Currently 325 clients, representing over 13,000 employees, receive employer-related services from CNA UniSource's 25 service offices. Continued growth of enrolled employees is anticipated over the next several years. CNA FINANCIAL CORPORATION ------------------------- 19 MANAGEMENT'S DISCUSSION AND ANALYSIS - - -------------------------------------------------------------------------- Agency Market Operations (cont.) OPERATING RESULTS - - --------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - --------------------------------------------------------------------------- (In millions of dollars) Premiums $5,247 $ 5,092 $ 5,346 Other revenue 39 50 13 Restructuring and other related charges (96) - - Benefits and expenses (6,070) (5,491) (6,020) - - --------------------------------------------------------------------------- Underwriting loss (880) (349) (661) Investment income 744 787 828 Non-insurance revenues 68 - - Non-insurance expenses (91) (6) - - - --------------------------------------------------------------------------- Operating (loss) income before income tax (159) 432 167 Income tax benefit (expense) 105 (106) (13) - - --------------------------------------------------------------------------- Net operating (loss) income (54) 326 154 Realized investment gains, net of tax 171 187 133 - - --------------------------------------------------------------------------- NET INCOME $ 117 $ 513 $ 287 =========================================================================== SUMMARY: Agency Market Operations' 1998 results were significantly impacted by competitive pricing in commercial insurance lines, catastrophe losses and net loss reserve strengthening. In addition, 1998 results also reflected significant restructuring and other related charges. PREMIUMS: Premiums for 1998 increased by $155 million, or approximately 3%, as compared with 1997. Premiums for CI increased $94 million and was primarily attributable to premiums from involuntary risks. Excluding involuntary risks, premiums in CI decreased by approximately $165 million due to the continued soft market conditions throughout the commercial insurance industry. Agency Market Operations' participation in involuntary risks is mandatory and generally a function of its share of the voluntary market by line of insurance in each state. The increase in involuntary risk premiums in 1998 as compared with 1997 was $259 million and is largely a function of the 1997 involuntary risk premiums being reduced by a revision of prior years' estimated premiums. The decrease in involuntary risk premiums in 1997 stemmed from a greater willingness on the part of the voluntary market, including Agency Market Operations, to write these types of coverages. This willingness was precipitated by improved loss experience trends in the involuntary market. Premiums for PI grew $61 million in 1998. Contributing to the growth was the strong product identity of the Personal Package policy, a personal insurance product providing a wide range of available coverage options and the convenience of single policy delivery and combined billing. The decrease in premiums of $254 million in 1997 as compared with 1996 was primarily due to a decrease in premiums of approximately $425 million related to CI involuntary risks, as previously discussed, offset by increases in workers' compensation premiums. CNA FINANCIAL CORPORATION ------------------------- 20 - - --------------------------------------------------------------------------- Agency Market Operations (cont.) UNDERWRITING AND NON-INSURANCE RESULTS: Underwriting results for 1998 declined by $531 million as compared with 1997. Contributing to this decline were net changes in reserve development, restructuring and other related charges and catastrophe losses. The increase in underwriting losses for 1998 is due primarily to an increase in benefits and expenses of $579 million in 1998 as compared with 1997, as well as restructuring and other related charges of $96 million (discussed on page 15), partially offset by the aforementioned increase in premiums in 1998 of $155 million. Benefits and expenses increased due to reserve development and increased catastrophe losses in 1998. Net reserve development in 1998 was $168 million as compared with favorable reserve development of $276 million in 1997. Management strengthened reserves in 1998 primarily in response to deteriorating claim experience for asbestos and other mass tort exposures. Reserves were also increased for construction defect claims and for workers' compensation reinsurance bureaus. In 1997, actions were taken to mitigate further exposure from construction defect liabilities that arose almost exclusively out of exposures underwritten in California. In 1998, catastrophe losses were $131 million higher than the 1997 losses of $68 million. Underwriting results for 1997 improved by $312 million compared with 1996. This improvement was primarily due to a net favorable change in loss reserve development of $258 million, lower catastrophe losses of $158 million when compared to the prior year, and improved benefits and expenses of approximately $113 million associated with the $254 million decrease in premiums for 1997 discussed above. The favorable change in loss reserve development was due principally to favorable loss development in 1997 of $276 million, comprised of $492 million in favorable development in involuntary risks, primarily workers' compensation, and $80 million of favorable loss development in PI lines offset in part by unfavorable development in CI lines of $296 million. The favorable loss development in involuntary risks in 1997 was attributable to better than expected results in workers' compensation and private passenger automobile lines stemming from improved frequency and severity in these lines. Non-insurance results are attributable to CNA UniSource. Non-insurance operations experienced a loss of $23 million for 1998, an increase of $17 million when compared with 1997. This increase is due to the start-up nature of CNA UniSource as it develops the volume necessary for generating profits. A discussion of consolidated investment results can be found on page 40. CNA FINANCIAL CORPORATION ------------------------- 21 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ----------------------------------------------------------------------------- Specialty Operations BUSINESS OVERVIEW Specialty Operations provides a broad array of professional, financial and specialty property/casualty products and services through a network of brokers, managing general agencies and independent agencies. Specialty Operations provides creative solutions for managing the risks of its clients, including architects, engineers, lawyers, healthcare professionals, financial intermediaries and corporate directors and officers. Specialty Operations is composed of three principal groups. CNA PRO CNA Pro is the largest provider of professional liability insurance and risk management services for non-medical professionals and service firms in the U.S. CNA Pro's customers include four targeted professions: architects & engineers, lawyers, accountants and real estate agents and brokers. In addition, CNA Pro is focusing on a diversified group of growing professions including staffing services and consultants. Product distribution is primarily through program administrators, although large law firms and the diversified professions are served through independent insurance brokers. HEALTHPRO HealthPro offers a comprehensive set of specialized insurance products and clinical risk management consulting services designed to assist health care providers in managing the quality-of-care risks associated with the delivery of health care. Key customer segments include individual and small group purchasers of malpractice insurance, as well as large corporate buyers of malpractice, directors & officers, and errors & omissions coverages related to managed care. Caronia Corporation, acquired during 1997, also provides third-party claims administration for medical professional liability insureds. FINANCIAL INSURANCE Financial Insurance offers a comprehensive selection of governance liability, fidelity, credit, residual value and other financial peril insurance products. These products provide coverage for large and small corporate clients and not-for-profit organizations. Governance liability (including directors & officers, errors & omissions, and employment practices liability) and fidelity products are distributed on a national basis through approximately 3,000 independent brokers and agents. Credit, residual value and other financial peril products are distributed on a national basis through a variety of channels including brokers, agents and direct sales. OTHER OPERATIONS A start-up venture, Hedge Financial Products, was formed in 1997 to focus on securitization of insurance risk and the embedding of financial protections within traditional insurance programs. CNA FINANCIAL CORPORATION ------------------------- 22 - - ---------------------------------------------------------------------------- Specialty Operations (cont.) OPERATING RESULTS - - ----------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - ----------------------------------------------------------------------- (In millions of dollars) Premiums $ 1,092 $ 1,251 $ 1,217 Other revenue 17 11 - Retructuring and other related charges (5) - - Benefits and expenses (1,277) (1,398) (1,403) - - ----------------------------------------------------------------------- Underwriting loss (173) (136) (186) Investment income 245 268 273 Non-insurance revenues 10 3 - Non-insurance expenses (18) (9) - - - ----------------------------------------------------------------------- Operating income before income tax 64 126 87 Income tax expense (6) (31) (15) - - ----------------------------------------------------------------------- Net operating income 58 95 72 Realized investment gains, net of tax 57 63 44 - - ----------------------------------------------------------------------- NET INCOME $ 115 $ 158 $ 116 ======================================================================== SUMMARY: In 1998, Specialty Operations (Specialty) continued to produce strong overall operating results. However, results trended downward as rate competition stiffened and loss reserves for medical malpractice were strengthened. Intense competition in Specialty's markets has resulted in lower premium rates, despite expanded forms of coverage and higher coverage limits. Specialty remains committed to conservative underwriting practices in this difficult environment. This has resulted in little premium growth in the segment's core financial insurance, medical malpractice and professional liability businesses. In addition, Specialty has decided to exit the agricultural and entertainment insurance businesses after determining that these markets did not offer acceptable long-term profitability. PREMIUMS: Premiums in 1998 decreased by $159 million, or approximately 13%, compared with 1997. The decrease was largely attributable to an approximate $100 million reduction in premiums caused by management's decision to exit the agricultural insurance market. The remaining decline in premiums in 1998 was due to increased price competition and management's resolve not to accept inadequately priced business. Premiums in 1997 were 2.8% higher than 1996, reflecting modest growth in the period. Specialty's commitment to prudent underwriting and responsible pricing are expected to continue to limit premium growth until general market pricing improves. CNA FINANCIAL CORPORATION ------------------------- 23 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ------------------------------------------------------------------------------ Speciality Operations (cont.) UNDERWRITING AND NON-INSURANCE RESULTS: Results for 1998 reflect an underwriting loss of $173 million compared with an underwriting loss of $136 million in 1997. The increase in underwriting losses in 1998 of $37 million was primarily attributable to the aforementioned decrease in premiums of $159 million, offset in part by a decrease in benefits and expenses of $121 million in 1998 as compared with 1997. The decrease in benefits and expenses was comprised of reduced losses and operating expenses of approximately $222 million relating primarily to the aforementioned exit of the agricultural insurance lines of business, as well as decisions not to write inadequately priced business. These decreases were partially offset by a net unfavorable change in reserve development of $112 million. The increase in unfavorable loss reserve development in 1998 was due principally to adverse claim experience in the medical malpractice insurance line of business. The improvement in underwriting results in 1997 of $50 million as compared with 1996 was primarily attributable to the increase in premiums of $34 million as well as net favorable change in reserve development of $76 million, offset by increases in losses and operating expenses related to premium growth. The non-insurance operations incurred pre-tax operating losses of $8 million and $6 million in 1998 and 1997, respectively. These losses were primarily attributable to the start-up activities of Hedge Financial Products. A discussion of consolidated investment results can be found on page 40. CNA FINANCIAL CORPORATION ------------------------- 24 - - ----------------------------------------------------------------------------- CNA Re BUSINESS OVERVIEW CNA Re operates globally as a reinsurer in the broker market, offering both treaty and facultative products through major offices in London and Chicago. CNA Re's operations include the business of CNA Reinsurance Company, Limited (CNA Re U.K.), a U.K. company, and U.S. operations based in Chicago. Major products are traditional treaty reinsurance, with developing positions in facultative and financial reinsurance. CNA Re also participates in Lloyd's of London through a corporate syndicate, Syndicate 1229, as well as investments in several similar syndicates. Headquartered in London with offices in Amsterdam, Milan, Singapore and Zurich, CNA Re U.K. writes both London market and other European business. As one of the largest reinsurers in this market, CNA Re maintains an A+ (Good) rating from Standard and Poor's and an A (Excellent) rating from A.M. Best. CNA Re writes U.S. and international treaty and professional liability business, including medical malpractice, errors & omissions and directors & officers coverages. Based in Chicago, the U.S. operations of CNA Re provide products to the North and South American markets. Treaty products include working layer property, working layer casualty, property catastrophe, workers' compensation, products liability, general liability, professional liability, specialty and excess and surplus lines. In addition, financial reinsurance products are offered as well as property and casualty facultative reinsurance. OPERATING RESULTS - - ------------------------------------------------------------------------ Year Ended December 31 1998 1997 1996 - - ------------------------------------------------------------------------ (In millions of dollars) Premiums $ 944 $ 898 $ 944 Other revenue 3 - - Restructuring and other related charges (1) - - Benefits and expenses (1,012) (993) (983) - - ------------------------------------------------------------------------- Underwriting loss (66) (95) (39) Investment income 163 153 161 Non-insurance revenues 2 7 7 Non-insurance expenses (4) (3) (2) - - ------------------------------------------------------------------------- Operating income before income tax 95 62 127 Income tax expense (27) (11) (38) - - ------------------------------------------------------------------------- Net operating income 68 51 89 Realized investment gains, net of tax 27 34 21 - - ------------------------------------------------------------------------- NET INCOME $ 95 $ 85 $ 110 ========================================================================= CNA FINANCIAL CORPORATION -------------------------- 25 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ------------------------------------------------------------------------------ CNA Re (cont.) SUMMARY: CNA Re experienced an increase in profitability in 1998 due principally to net favorable reserve development partially offset by an increase in catastrophe losses. PREMIUMS: Premiums in 1998 increased by $46 million, or approximately 5%, compared with 1997. The increase in 1998 premiums over 1997 is primarily a function of adverse premium development of prior year estimates recorded in 1997. Premiums decreased $46 million, or approximately 5%, in 1997 as compared with 1996. The decrease in premiums in 1997 included an unfavorable change in estimates of prior year premiums of $88 million, offset in part by growth in treaty reinsurance business. The prior year movement can be largely attributed to the competitive insurance marketplace and its effect on CNA Re's clients, who have not met their own estimated premium targets. These shortfalls have had an effect upon CNA Re's proportional reinsurance book. UNDERWRITING RESULTS: The improvement in underwriting results of $29 million in 1998, as compared with 1997, is comprised of an $80 million net favorable change in estimates of prior year premiums and related commissions, as well as an improvement in underwriting expense of $10 million. These increases were partially offset by increased catastrophe losses of $37 million due principally to hurricane activity in 1998, and a $21 million net unfavorable change in loss reserve development. The decrease in underwriting expenses in 1998 as compared with 1997 is principally due to the start-up costs associated with expansion into facultative reinsurance and the establishment of branch offices abroad during 1997. Underwriting losses increased $56 million in 1997 as compared with 1996. This increase is primarily due to the $46 million decrease in premiums discussed above, an increase in current year loss experience, an increase in underwriting expenses of $33 million and a decrease in catastrophe losses of $20 million. The increase in underwriting expenses was primarily due to the start-up costs discussed above. A discussion of consolidated investment results can be found on page 40. CNA FINANCIAL CORPORATION ------------------------- 26 - - --------------------------------------------------------------------------- Global Operations BUSINESS OVERVIEW Global Operations provides products and services to U.S.-based customers, customers expanding overseas and foreign customers. Product distribution is primarily through brokers and independent agents. The major product lines include marine, commercial and contract surety, warranty and specialty products, as well as commercial property and casualty. Global Operations is composed of five principal groups. MARINE Marine Office of America Corp. (MOAC), a leading provider of ocean marine insurance in the U.S., offers hull, cargo, primary and excess marine liability, offshore energy, marine claims and recovery products and services. Business is sold through national brokers, regional marine specialty brokers and independent agencies. These distributors work closely with MOAC's 10 branch offices located throughout the U.S. On June 30, 1998, CNA completed the acquisition of Maritime Insurance Co., Ltd. in the U.K. and its Canadian subsidiary, Eastern Marine Underwriters (EMU), strengthening CNA's position as a global marine insurer. Management expects growth to come from leveraging the relationships with CNA's domestic producers and providing customers with services and products throughout the world. SURETY On October 1, 1997, Global Operations completed the merger of CNA's surety operations with Capsure Holdings Corp.'s subsidiaries, Western Surety Company and Universal Surety of America to form CNA Surety Corporation (CNA Surety). CNA owns approximately 61% of CNA Surety. CNA Surety, traded on the New York Stock Exchange (SUR), is the largest publicly traded provider of surety bonds, with approximately 9% of that market. Among its U.S. competitors, CNA Surety has the most extensive distribution system and one of the most diverse surety product lines, offering small, medium and large contract and commercial surety bonds. CNA Surety provides surety and fidelity bonds in all 50 states through a combined network of approximately 37,000 independent agencies. Management expects growth to come from CNA Surety's broad product line and distribution network and cross-selling opportunities. WARRANTY CNA Warranty, Inc. (Warranty), is the fourth largest warranty underwriter in the U.S., providing extended service contracts, warranties and related insurance products that protect the consumer or business from the financial burden associated with the breakdown, under-performance or maintenance of a product. Warranty's key market segments consist of vehicle, retail, home, commercial and original equipment manufacturer. Each market segment distributes its product via a sales force employed or contracted through a program administrator. CNA FINANCIAL CORPORATION ------------------------- 27 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ----------------------------------------------------------------------------- Global Operations (cont.) In 1998, Warranty expanded into the home warranty segment with the acquisition of a 90% interest in Home Security of America, Inc., one of the largest home warranty administrators in the U.S. Warranty expects growth from cross marketing efforts with other CNA businesses, increasing product distribution via the CNA agency force and introducing several warranty products in the international marketplace. INTERNATIONAL International is responsible for coordinating and managing the direct business of the foreign operations of CNA. The business identifies and capitalizes on strategic indigenous opportunities outside the U.S. by continuing to build its own capabilities and by initiating acquisitions, strategic alliances and start-up operations that allow for expansion into targeted markets. In addition, International provides U.S.-based customers that are expanding their operations overseas with a single source for their commercial insurance needs. To this end, International has placed underwriters within Commercial Insurance branches. International currently oversees foreign operations in Europe, Latin America, Canada and Asia. In Europe, CNA formed CNA Insurance Company (Europe) Limited (CIE) in 1996, which is based in London. CIE has since opened offices in France, Germany, the Netherlands and Denmark. Through its network of offices, International intends to build on the successes of several CNA specialty products (including warranty, personal accident and financial lines insurance) and introduce those products across Europe. In Latin America, International acquired a 70% interest in Omega A.R.T. in 1997, the third largest workers' compensation company in Argentina. International plans to expand its presence within the region with additional insurance products. In Canada, CNA Canada, formed in 1998, sells a broad array of property/casualty and specialty insurance products through brokers and managing general agents. The short to mid-term growth opportunities for International are in the more mature foreign insurance markets, such as Europe and Canada, and in the marketing of specialty insurance products. In the longer term, emphasis will be on the emerging insurance markets in Latin America and Asia. FIRST INSURANCE COMPANY OF HAWAII First Insurance Company of Hawaii, Ltd. (FICOH) is the oldest domestic insurer in the state of Hawaii, dating back to 1911. FICOH is also the largest commercial insurance company and the third largest property/casualty insurance company in the state. FICOH offers commercial and personal lines solely in the state of Hawaii. Distributed through independent agencies, the business mix is approximately 65% commercial and 35% personal. CNA owns 60% of FICOH and foresees growth opportunities through collaborative partnerships with other CNA businesses. CNA FINANCIAL CORPORATION ------------------------- 28 - - ------------------------------------------------------------------------------ Global Operations (cont.) OPERATING RESULTS - - -------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - -------------------------------------------------------------------------- (In millions of dollars) Premiums $ 941 $ 854 $ 945 Other revenue 5 1 - Restructuring and other related charges (1) - - Benefits and expenses (1,007) (857) (929) - - -------------------------------------------------------------------------- Underwriting (loss) income (62) (2) 16 Investment income 110 117 134 Non-insurance revenues 77 28 34 Non-insurance expenses (64) (27) (31) - - -------------------------------------------------------------------------- Operating income before income tax 61 116 153 Income tax expense (18) (35) (44) - - -------------------------------------------------------------------------- Net operating income 43 81 109 Realized investment gains, net of tax 17 20 21 Minority interest (25) (29) (9) - - -------------------------------------------------------------------------- NET INCOME $ 35 $ 72 $ 121 ========================================================================== SUMMARY: Global Operations' 1998 underwriting results were adversely impacted primarily by unfavorable development in discontinued pools and associations and marine asbestos reserves. Recent decisions made are intended to achieve, sustain, and augment the established standard of underwriting profitability. Actions included placing International underwriters in selected Commercial Insurance branches and establishing indigenous overseas organizations. Establishment of these organizations was accelerated as a result of the acquisitions of Maritime and Omega A.R.T. Actions also included the strategic expansion of the successful Surety and Warranty businesses and a decision to allow FICOH to reinvest its earnings enabling it to grow over 70% since 1996. Lastly, MOAC exited non-core lines and unprofitable domestic pools, and is now focused exclusively on the ocean marine market. PREMIUMS: Premiums in 1998 increased by $87 million, or approximately 10%, compared with 1997. This increase was primarily attributable to the effects of the recent acquisitions and mergers. Omega contributed $48 million, Maritime contributed $37 million and Surety's business increased $80 million in 1998 reflecting the first full year of Capsure premiums as well as leveraging the expanded product line and distribution channels. Warranty had an increase in premiums in 1998 of $27 million as compared with 1997. This increase was primarily due to growth in Western National, an automobile warranty business, which has seen broad market acceptance of its products and services. Additionally, International premiums increased by $25 million primarily attributable to growth in Canadian operations. CNA FINANCIAL CORPORATION ------------------------- 29 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ------------------------------------------------------------------------------ Global Operations (cont.) Partially offsetting the growth through acquisitions was the sale of a $47 million book of business. In addition, premiums decreased $84 million in 1998 due to MOAC's strategic decision in 1997 to exit unprofitable non-core lines by inland marine, commercial property, boiler and machinery and commercial auto physical damage. Consequently, MOAC is now focused exclusively on its historic core competencies of ocean marine business, upon which the franchise was originally built. Premiums decreased $91 million in 1997 when compared with 1996. The decision to exit unprofitable pools and associations decreased voluntary pool premiums by $180 million in 1997. In addition, an unwillingness to accept inadequate pricing reduced MOAC's premiums by $62 million in 1997. Decisions to expand Global's International franchise and growth in Surety, Warranty and FICOH helped offset these declines by collectively generating growth of $151 million. UNDERWRITING AND NON-INSURANCE RESULTS: Global Operations' underwriting results declined in 1998 by $60 million as compared with 1997. The decrease is attributable to the aforementioned growth in premiums which was more than offset by increased benefits and expenses of $150 million. The increase in benefits and expenses is due to a net unfavorable change in loss development of $64 million, increased expenses of $65 million and higher catastrophe losses of $21 million. The change in net unfavorable development of $64 million is comprised of approximately $111 million of unfavorable year-over-year change related to Surety, MOAC and discontinued pools, offset in part by favorable year-over-year change of approximately $47 million related principally to the CNA International and Warranty business. The increase in expenses is principally due to higher costs associated with the growth in premiums. The decline in underwriting income of $18 million in 1997 as compared with 1996 was attributable to the aforementioned decrease in premiums of $91 million, offset in part in a decrease in benefits and expenses of approximately $72 million. The decrease in benefits and expenses in 1997 when compared with 1996 was principally the result of a net favorable change in loss reserve development of approximately $55 million, of which approximately $43 million was attributable to voluntary pools. Included in the underwriting results above were net underwriting losses of $12 million related to the book of business which was sold by year-end 1997. Additionally, MOAC's underwriting losses increased by $17 million in 1997 and are reflected in the decrease noted above. This increase in underwriting losses was a result of large losses in MOAC's property and inland marine book of business. These underwriting losses precipitated management's decision to exit these non-core lines of business. Non-insurance income is primarily attributable to the Western National automobile warranty business as well as results for Home Security of America, a 90% owned subsidiary purchased in 1998. Profit margins in these businesses are improving as the current infrastructure is positioned to handle larger volumes of business. A discussion of consolidated investment results can be found on page 40. CNA FINANCIAL CORPORATION ------------------------- 30 - - ---------------------------------------------------------------------------- Risk Management BUSINESS OVERVIEW Risk Management (RM) markets and sells insurance products and services to large U.S.-based companies. These customers have a minimum of $1 million or more in casualty claims each year. It is estimated that there are approximately 8,500 targeted companies within this market segment. RM is one of 11 significant competitors and has a very strong reputation and presence, particularly as a writer of casualty insurance lines. RM includes two groups. RISK TRANSFER Risk Transfer writes casualty and property lines of insurance. The casualty insurance business focuses on workers' compensation, commercial auto liability, general liability through traditional and innovative financial risk products, and excess coverage needs. The excess products provide umbrella, excess workers' compensation and high excess coverages. Capacity has been increased for the excess products to address the casualty needs of the global customer. Over the last two years, domestic and global property capabilities have been increased, providing primary, inland marine and excess property facilities. Global property includes a strategic alliance with Protection Mutual to address the needs of the highly protected risk customer. Global property also includes Northrock, a wholly owned subsidiary of CNA, offering property excess of loss insurance coverages. RSKCo SM Formed in 1998, RSKCo SM provides total risk management services (integrated and single component) related to claims, loss control, cost management and information services to the commercial insurance marketplace. The broad range of RSKCo's SM capabilities includes: CLAIM SERVICES: Services that allow customers to select from a single source the desired level of service-from an integrated claims package to any component service. LOSS CONTROL: Pre-loss prevention services include industrial hygiene, laboratory, ergonomics, field consulting and training, property, environmental and transportation loss control. Driver training is provided through Smith System Driver Improvement Institute, Inc., a wholly owned subsidiary of CNA. COST MANAGEMENT: Post-loss cost control services through case management, medical bill review, preferred provider organizations and other unique partnerships to reduce lost work days through rapid response, quality care and effective coordination. INFORMATION SERVICES: Data access, reporting tools, information and benchmarking analysis, consulting and custom reporting services. CNA FINANCIAL CORPORATION ------------------------- 31 MANAGEMENT'S DISCUSSION AND ANALYSIS - - --------------------------------------------------------------------------- Risk Management (cont.) OPERATING RESULTS - - ------------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - ------------------------------------------------------------------------------- (In millions of dollars) Premiums $ 823 $ 776 $ 572 Benefits and expenses (1,021) (976) (649) - - ------------------------------------------------------------------------------- Underwriting loss (198) (200) (77) Investment income 144 158 179 Non-insurance revenues 230 194 222 Non-insurance restructuring and other related charges (88) - - Non-insurance other expenses (224) (214) (226) - - ------------------------------------------------------------------------------- Operating (loss) income before income tax (136) (62) 98 Income tax benefit (expense) 48 25 (24) - - ------------------------------------------------------------------------------- Net operating (loss) income (88) (37) 74 Realized investment gains, net of tax 31 37 29 - - ------------------------------------------------------------------------------- NET (LOSS) INCOME $ (57) $ - $ 103 =============================================================================== SUMMARY: RM's 1998 net loss was $57 million, down from breakeven in 1997. The primary reason for the decrease was an $88 million restructuring and other related charges. In 1998, RSKCo SM, a new total risk management services company, was created. The new service organization will realize significant operating efficiencies necessary to compete in a market place demanding comprehensive, efficient service delivery. PREMIUMS: Premiums in 1998 increased by $47 million, or approximately 6%, as compared with 1997. The increase is due to growth of $30 million in the property facility business, that was introduced in the latter part of 1997, underlying momentum in Risk Management's core primary casualty business, and new business growth. Premiums in 1997 increased $204 million as compared with 1996. This increase was primarily due to RM's significant increase in market share among the Fortune 500-size companies, particularly in the casualty business that increased $85 million, growth of $20 million in the property facility business, $60 million of incremental premium 1997 renewal accounts that moved from large deductible insurance programs to guaranteed cost programs and $54 million of favorable premium development. UNDERWRITING RESULTS: Underwriting losses remained consistent in 1998 with the aforementioned increase in premiums of $47 million being offset by a like increase in benefits and expenses as customers moved to guaranteed cost business. CNA FINANCIAL CORPORATION ------------------------- 32 - - ---------------------------------------------------------------------------- Risk Management (cont.) Restructuring and other related charges in 1998, as discussed on page 15, totaled $88 million. The 1997 underwriting loss deterioration of $123 million was primarily the result of the aforementioned increase in premium of $204 million, offset by increased benefits and expenses of $327 million. The increase in benefits and expenses in 1997 when compared with 1996 was principally the result of a net unfavorable change in reserve development of $253 million, increased losses on premium growth of approximately $124 million, offset by favorable changes in policyholders dividends of approximately $50 million. Total expenses, excluding loss and loss adjustment expense, decreased by $10 million during the 3 year period ended December 31, 1998, while premiums grew by 44% for the same period. A discussion of consolidated investment results can be found on page 40. CNA FINANCIAL CORPORATION ------------------------- 33 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ---------------------------------------------------------------------------- Group Operations BUSINESS OVERVIEW Group Operations provides a broad array of group life and health insurance products and services to employers, affinity groups and other entities that purchase insurance as a group. Its products and services are primarily distributed through brokers. In addition, Group Operations provides health insurance to postal and other federal employees, retirees and their families; managed care and self-funded medical excess insurance; medical provider network management and administration services; and reinsurance for life and health insurers. Group Operations includes five principal groups. SPECIAL BENEFITS Special Benefits provides group term life insurance, short and long term disability, statutory disability, long term care and accident products. Products are marketed through a nationwide operation of 31 sales offices, third party administrators, managing general agents and insurance consultants. PROVIDER MARKETS Provider Markets is comprised of two major businesses and a third now under development. CNA Health Partners provides comprehensive managed care services to employers and healthcare provider networks including network development and management, medical management, claims administration, consulting services and management services. Currently under development is a Management Services Organization that will provide a complete set of managed care services to health care provider organizations that are managing capitated risks. Services will include medical management, claims administration, consulting services and management services. Group Reinsurance writes assumed reinsurance on health, life and other related products written on a group basis, as well as excess risk coverages related to health care. LIFE REINSURANCE Life Reinsurance reinsures individual life and health products marketed by other life insurance companies throughout North America. Sales are through an internal sales force. FEDERAL MARKETS Federal Markets is the second largest provider of health insurance benefits to postal and other federal employees under the Federal Employees Health Benefit Plan (FEHBP). In addition to insuring over one million members, Federal Markets is responsible for all claim management activities under the plan, such as large case management, hospital and provider bill negotiations, systems, fraud detection activities, vendor contracts and federal government relations. HEALTH BENEFITS Health Benefits markets direct mail specialty products such as accidental death and dismemberment, term life and dental insurance to bank customers and federal employees. CNA FINANCIAL CORPORATION -------------------------- 34 - - ---------------------------------------------------------------------------- Group Operations (cont.) OPERATING RESULTS - - -------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - -------------------------------------------------------------------------- (In millions of dollars) Revenues: Premiums $3,712 $ 3,903 $3,816 Investment income 133 117 118 Other 24 17 8 - - -------------------------------------------------------------------------- Total operating revenues 3,869 4,037 3,942 Restructuring and other related charges 39 - - Claims and benefits and other operating expenses 3,913 4,055 3,922 - - -------------------------------------------------------------------------- Operating (loss) income before income tax (83) (18) 20 Income tax benefit (expense) 35 10 (3) - - --------------------------------------------------------------------------- Net operating (loss) income (48) (8) 17 Realized investment gains, net of tax 29 28 21 - - --------------------------------------------------------------------------- NET (LOSS) INCOME $ (19) $ 20 $ 38 =========================================================================== SUMMARY: In 1998, Group Operations experienced a reduction in profitability as a result of restructuring and other related charges associated with exiting certain businesses and the continued challenging market conditions in group health lines. PREMIUMS: Premiums decreased by approximately 5% or $191 million, in 1998 as compared with 1997. The decrease was attributable, in part, to a $166 million decrease in the medical lines of coverage in Health Benefits, resulting from the decision to exit certain markets. Additionally, due to changes in coverage terms, FEHBP premiums decreased by $90 million. These decreases were offset, in part, by premium growth of $65 million across all other lines of business. During 1997, premiums grew by $87 million as compared with 1996. Premium growth was experienced in Special Benefits, driven by strong sales to employee benefit plans, and in Health Benefits, attributable to sales of credit card accidental death and dismemberment and other non-medical insurance products; other growth was from sales and renewal increases on employer medical plans. Partially offsetting these increases were decreases in the Group Reinsurance premiums, resulting from the termination of some small group medical quota share treaties. CNA FINANCIAL CORPORATION ------------------------- 35 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ------------------------------------------------------------------------------ Group Operations (cont.) OPERATING RESULTS: Pre-tax operating income in 1998 deteriorated by $65 million as compared with 1997. The decrease is primarily due to restructuring and other related charges of $39 million for Group Operations, as discussed on page 16. In addition, increased losses of $30 million on accident coverages contributed to the operating loss. The increased losses resulted from both adverse claim developments and unusually high claim activity in the traditional accident insurance line. During 1998, CNA decided to exit the insured comprehensive medical portion of the employer and affinity markets and a majority of this inforce business was sold effective January 1, 1999. Earned premiums for these lines of business approximated $400 million in 1998. The $38 million decline in pre-tax operating results from 1996 to 1997 was driven primarily by deteriorating group medical claim experience, including increased losses of about $40 million in Health Benefits (employer and affinity health), and $10 million of increased losses on medical stop loss and reinsured group medical in Provider Markets. Offsetting these declines, Special Benefits' results improved by about $20 million due to improved experience under both long-term care and life coverages. A discussion of consolidated investment results can be found on page 40. CNA FINANCIAL CORPORATION ------------------------- 36 - - ---------------------------------------------------------------------------- Life Operations BUSINESS OVERVIEW Life Operations provides financial protection to individuals through a full product line of term life insurance, universal life insurance, long term care insurance, annuities and other products. Life Operations also provides retirement services to institutions in the form of various investment products and administration services. Life Operations has several distribution relationships and partnerships including managing general agencies, other independent agencies working with CNA life sales offices, a network of brokers and dealers and various other independent insurance consultants. Life Operations has three principal groups. INDIVIDUAL LIFE Individual Life offers primarily level premium term life insurance, universal life insurance and related products. New sales of term life have placed CNA as either first or second in the market in each of the last three years. RETIREMENT SERVICES Retirement Services markets investment and annuity products to both the retail and institutional markets. LONG TERM CARE Long Term Care products provide reimbursement for covered nursing home and home health care expenses incurred due to physical or mental disability. OTHER OPERATIONS Other Life Operations businesses include pre-need insurance, viatical settlements and a developing business in the international arena. CNA FINANCIAL CORPORATION ------------------------- 37 MANAGEMENT'S DISCUSSION AND ANALYSIS - - -------------------------------------------------------------------------- Life Operations (cont.) OPERATING RESULTS - - --------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - --------------------------------------------------------------------------- (In millions of dollars) Revenues: Premiums $ 684 $ 688 $ 654 Investment income 525 501 485 Other 115 105 106 - - --------------------------------------------------------------------------- Total operating revenues 1,324 1,294 1,245 Restructuring and other related charges 7 - - Claims and benefits and other operating expenses 1,153 1,107 1,028 - - --------------------------------------------------------------------------- Operating income before income tax 164 187 217 Income tax expense (58) (66) (74) - - --------------------------------------------------------------------------- Net operating income 106 121 143 Realized investment gains, net of tax 82 124 102 - - --------------------------------------------------------------------------- NET INCOME $ 188 $ 245 $ 245 =========================================================================== SUMMARY: Life Operations continued to experience good profitability in 1998, although results were lower than 1997 and 1996. The primary reasons for the reduction were lower realized gains, less favorable mortality experience in 1998, reduced income from decreased pension deposits and lower available margins on those sales. PREMIUMS: Direct premiums have continued to show strong growth over the last three years. Premium revenues, however, decreased slightly in 1998 to $684 million from $688 million in 1997, principally due to the increased use of reinsurance for individual term life insurance products. Premium revenues increased $34 million in 1997 as compared with 1996 premium revenues of $654 million, primarily due to an increase in individual term life premiums. Individual Life premium revenues were $321 million in 1998, as compared with $373 million in 1997. The reason for this decrease in premiums was the increased use of reinsurance. The current program includes a 90% coinsurance treaty covering policies issued from mid-1994 to mid-1996 and 75% coinsurance on policies issued after September, 1997. Individual Life premium revenues increased from $313 million in 1996 to $373 million in 1997, primarily as a result of growth in individual term life premiums. Individual Life insurance premiums, on a direct basis, were $754 million in 1998, an increase of $111 million from 1997 premiums of $643 million. Premiums increased $148 million in 1997 from 1996 premiums of $495 million. This trend reflects CNA's strong market presence in term insurance. CNA FINANCIAL CORPORATION -------------------------- 38 - - ------------------------------------------------------------------------------ Life Operations (cont.) Retirement Services premium revenues increased slightly in 1998 to $177 million as compared with $174 million in 1997. Premium revenues increased $24 million in 1997 from $150 million in 1996. Total sales volume for Retirement Services, which reflects deposits and other income which are not included in the premiums above, declined from $1,410 million in 1996 to $1,042 million in 1997 to $998 million in 1998. The decreased sales volume is primarily due to the discontinuation of fixed individual annuities and the lower volume of guaranteed investment contracts sold in institutional markets. Long Term Care premium revenues increased $27 million to $137 million over the two year period ended December 31, 1998. Long Term Care sales volume increased $102 million to $299 million over the two year period ended December 31, 1998. A discussion of consolidated investment results can be found on page 40. CNA FINANCIAL CORPORATION ------------------------- 39 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ----------------------------------------------------------------------------- Investments Investments: - - ------------ Net investment income, in the table below, was approximately $2.1 billion, $2.2 billion and $2.3 billion for the years ended December 31, 1998, 1997 and 1996 respectively. Lower net investment income can be attributed to a lower average level of assets invested in interest-bearing securities in 1998 as compared with 1997. The decrease in 1997 as compared with 1996 is primarily due to a decline in investment yields in the bond market. The bond segment of the investment portfolio yielded 6.4% in 1998 compared with 6.4% and 6.6% in 1997 and 1996, respectively. Net realized investment gains, in the table below, were $434 million, $478 million and $387 million for the years ended December 31, 1998, 1997 and 1996, respectively. NET INVESTMENT INCOME - - ------------------------------------------------------------------------------ Year Ended December 31 1998 1997 1996 - - ------------------------------------------------------------------------------ (In millions of dollars) Fixed maturities: Bonds: Taxable $1,490 $1,522 $1,716 Tax-exempt 340 288 273 Redeemable preferred stocks 2 7 2 Equity securities 33 37 25 Mortgage loans and real estate 5 10 11 Policy loans 11 6 12 Short-term investments 241 321 231 Security repurchase transactions-net 10 9 4 Other 67 56 45 - - ------------------------------------------------------------------------------- 2,199 2,256 2,319 Investment expense (53) (47) (43) - - ------------------------------------------------------------------------------- NET INVESTMENT INCOME $2,146 $2,209 $2,276 =============================================================================== ANALYSIS OF INVESTMENT GAINS (LOSSES) - - ------------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - ------------------------------------------------------------------------------- (In millions of dollars) Realized investment gains and (losses): Fixed maturities $ 467 $ 452 $ 293 Equity securities 38 103 216 Derivative securities 12 (7) 18 Other, including guaranteed Separate Account business 178 205* 92 - - ------------------------------------------------------------------------------- 695 753 619 Allocated to participating policyholders (14) (15) (14) Income tax expense (247) (260) (218) - - ------------------------------------------------------------------------------- NET REALIZED INVESTMENT GAINS $ 434 $ 478 $ 387 =============================================================================== * INCLUDES $95 MILLION RELATED TO CNA SURETY TRANSACTION. CNA FINANCIAL CORPORATION ------------------------- 40 The following table summarizes CNA's general account investments at cost or amortized cost for each of the last five years.
DISTRIBUTION OF INVESTMENTS - GENERAL ACCOUNT - - ----------------------------------------------------------------------------------------------------- December 31 1998 % 1997 % 1996 % 1995 % 1994 % - - ----------------------------------------------------------------------------------------------------- (In millions of dollars) Fixed maturities: Bonds: Taxable $23,348 66% $24,419 69% $22,631 65% $25,832 75% $17,484 63% Tax-exempt 6,127 17 4,534 13 4,860 14 3,453 10 3,717 13 Redeemable preferred stocks 36 -- 67 -- 49 -- 100 -- 423 2 Equity securities: Common stocks 734 2 567 2 478 1 734 2 729 3 Non-redeemable preferred stocks 321 1 128 -- 224 1 3 -- 8 -- Mortgage loans and real estate 62 -- 85 -- 123 -- 122 -- 47 -- Policy loans 177 -- 177 -- 174 -- 177 1 176 1 Other invested assets 806 2 544 2 617 2 483 1 103 -- Short-term investments 4,037 12 4,884 14 5,854 17 3,725 11 5,036 18 - - ----------------------------------------------------------------------------------------------------- TOTAL INVESTMENTS $35,648 100% $35,405 100% $35,010 100% $34,629 100% $27,723 100% ===================================================================================================== INVESTMENTS AT CARRYING VALUE* $37,177 $36,203 $35,412 $35,886 $26,943 ===================================================================================================== *AS REPORTED IN THE CONSOLIDATED BALANCE SHEET
The Company's general account investment portfolio consists primarily of publicly traded government bonds, asset-backed securities, mortgage-backed securities, municipal bonds, and corporate bonds. The Company's investment policies for both the general and separate accounts emphasize high credit quality and diversification by industry, issuer and issue. Assets supporting interest rate sensitive liabilities are segmented within the general account to facilitate asset/liability duration management. CNA FINANCIAL CORPORATION ------------------------- 41 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ----------------------------------------------------------------------------- Investments (cont.) The following table summarizes CNA's Separate Account investments at cost or amortized cost for each of the last five years.
DISTRIBUTION OF INVESTMENTS - SEPARATE ACCOUNT - - --------------------------------------------------------------------------------------------------- December 31 1998 % 1997 % 1996 % 1995 % 1994 % - - --------------------------------------------------------------------------------------------------- (In millions of dollars) Fixed maturities: Taxable bonds $4,061 82% $4,667 84% $4,590 82% $5,385 95% $5,451 88% Redeemable preferred stocks -- -- -- -- 4 -- 10 -- 18 -- Equity securities: Common stocks 171 3 115 2 101 2 167 3 117 2 Non-redeemable preferred stocks 31 1 22 1 10 -- -- -- -- -- Other invested assets 189 4 94 2 -- -- 46 1 38 1 Short-term investments 473 10 629 11 916 16 85 1 533 9 - - ----------------------------------------------------------------------------------------------------- TOTAL INVESTMENTS $4,925 100% $5,527 100% 5,621 100% $5,693 100% $6,157 100% ===================================================================================================== INVESTMENTS AT CARRYING VALUE $5,143 $5,722 $5,698 $5,872 $5,960 =====================================================================================================
Total Separate Account investments at fair value amounted to approximately $5.1 billion and $5.7 billion at December 31, 1998 and 1997, respectively, with taxable fixed maturities representing approximately 80.8% and 83.3% of the total, at December 31, 1998 and 1997, respectively. Approximately 64.3% and 73.8% of Separate Account investments at December 31, 1998 and 1997, respectively, are used to fund guaranteed investment contracts for which Continental Assurance Company guarantees principal and a specified return to the contractholders. The duration of fixed maturity securities included in the guaranteed investment contract portfolio are matched approximately with the corresponding payout pattern of the liabilities of the guaranteed investment contracts. One Separate Account product is an indexed group annuity contract for institutional investors which guarantees the Standard and Poor's (S&P) 500 rate of return plus 25 basis points annually. Deposits are taken from the customer for a three year period with no payout until the end of the period. CNA mitigates the risk associated with the contract liability by a combination of purchasing S&P 500 futures contracts in a notional amount equal initially to the original customer deposit and investing the remaining cash primarily in high quality investments. The number of futures contracts is adjusted regularly to approximate the liability to the contractholder. CNA believes it has the capacity to hold its fixed maturity portfolio to maturity. However, fixed maturity securities may be sold as part of CNA's asset/liability strategies or to take advantage of investment opportunities generated by changing interest rates, tax and credit considerations, or other similar factors. Accordingly, the fixed maturity securities are classified as available-for-sale. CNA FINANCIAL CORPORATION ------------------------- 42 - - ---------------------------------------------------------------------------- Investments (cont.) The general account portfolio consists primarily of high quality (rated BBB or higher) marketable fixed maturities, 93.3% and 95.0% of which are rated as investment grade at December 31, 1998 and 1997, respectively. The following table summarizes the ratings of CNA's general account fixed maturity bond portfolio at carrying value (fair value):
- - ------------------------------------------------------------------------------------------ December 31 1998 % 1997 % 1996 % - - ------------------------------------------------------------------------------------------ (In millions of dollars) U.S. government and affiliated securities $ 9,443 31.5% $13,679 46.4% $11,623 42.0% Other AAA rated 11,595 38.7 8,801 29.9 9,277 33.5 AA and A rated 4,884 16.3 3,796 12.9 3,786 13.7 BBB rated 2,061 6.8 1,695 5.8 1,387 5.0 Below investment grade 1,996 6.7 1,480 5.0 1,582 5.8 - - ------------------------------------------------------------------------------------------ TOTAL $29,979 100% $29,451 100% $27,655 100% ==========================================================================================
The following table summarizes the ratings of CNA's guaranteed investment contract separate account fixed maturity bond portfolio at carrying value (fair value): - - ------------------------------------------------------------------------------------------ December 31 1998 % 1997 % 1996 % - - ------------------------------------------------------------------------------------------ (In millions of dollars) U.S. government and affiliated securities $ 167 5.2% $ 148 3.9% $ 192 5.0% Other AAA rated 1,977 61.2 2,401 62.6 2,279 59.0 AA and A rated 476 14.8 569 14.8 723 18.7 BBB rated 339 10.5 406 10.6 345 8.9 Below investment grade 269 8.3 310 8.1 324 8.4 - - ------------------------------------------------------------------------------------------ TOTAL $ 3,228 100% $ 3,834 100% $ 3,863 100% ==========================================================================================
At year end 1998, 1997 and 1996, respectively, 83.1%, 89.8% and 92.0% of the general account portfolio and 76.8%, 82.1% and 85.7% of the guaranteed investment contract portfolio, in the tables above, were rated by major independent rating agencies. High yield securities are bonds rated as below investment grade by bond rating agencies and other unrated securities which, in the opinion of management, are below investment grade (below BBB). High yield securities generally involve a greater degree of risk than investment grade securities. However, expected returns should compensate for the added risk. The risk is also considered in the interest rate assumptions in the underlying insurance products. CNA's concentration in high yield bonds including Separate Account business was approximately 4.0% and 3.2% of total assets as of December 31, 1998 and 1997, respectively. Included in CNA's fixed maturity securities at December 31, 1998 (general and guaranteed investment contract portfolios) are $10.3 billion of asset-backed securities, at fair value, consisting of approximately 15.9% in U.S. government agency issued pass-through certificates, 51.8% in collater- CNA FINANCIAL CORPORATION ------------------------- 43 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ----------------------------------------------------------------------------- Investments (cont.) alized mortgage obligations (CMOs), 15.0% in corporate asset-backed obligations and 17.3% in corporate mortgage-backed pass-through certificates. The majority of CMOs held are actively traded in liquid markets and are priced by broker-dealers. CMOs are subject to prepayment risks that tend to vary with changes in interest rates. During periods of declining interest rates, CMOs generally prepay faster as the underlying mortgages are prepaid and refinanced by the borrowers in order to take advantage of the lower rates. Conversely, during periods of rising interest rates, prepayments generally slow which may result in a decrease in yield or a loss as a result of the slower prepayments. CNA limits the risks associated with interest rate fluctuations and prepayments by concentrating its CMO investments in planned amortization classes with relatively short principal repayment windows. CNA avoids investments in complex mortgage derivatives without readily ascertainable market prices. At December 31, 1998, the fair value of asset-backed securities was greater than the amortized cost by approximately $163 million compared with net unrealized gains of approximately $114 million at December 31, 1997. At December 31, 1998 and 1997, short-term investments primarily consisted of U.S. Treasury bills and commercial paper. The components of the short-term investment portfolio were as follows: SHORT-TERM INVESTMENTS - - --------------------------------------------- December 31 1998 1997 - - --------------------------------------------- (In millions of dollars) Commercial paper $1,398 $1,850 U.S. treasuries in escrow* 1,011 1,065 U.S. treasuries 506 558 Money markets 401 624 Security repurchase collateral 132 154 Other 589 633 - - --------------------------------------------- TOTAL SHORT-TERM INVESTMENTS $4,037 $4,884 ============================================= *SEE NOTE A TO THE CONSOLIDATED FINANCIAL STATEMENTS. CNA invests in certain derivative financial instruments primarily to reduce its exposure to market risk (principally interest rate, equity price and foreign currency risk). CNA considers its derivatives as being held for purposes other than trading. Derivative securities, except for interest rate swaps associated with certain corporate borrowings, are recorded at fair value at the reporting date, with changes in market value reflected in realized gains and losses. The interest rate swaps on corporate borrowings are accounted for using accrual accounting with the related income or expense recorded as an adjustment to interest expense; the changes in fair value are not recorded. The Company also uses derivatives to mitigate the risk associated with its indexed group annuity contracts by purchasing S&P 500 futures contracts in a notional amount equal to the contract liability relating to S&P 500 exposure. CNA FINANCIAL CORPORATION ------------------------- 44 - - ------------------------------------------------------------------------------ Investments (cont.) CNA's general account investments in bonds and redeemable preferred stocks, carried at their fair value, were $30.1 billion at December 31, 1998, compared with $29.5 billion at December 31, 1997. At December 31, 1998 and 1997, net unrealized gains on fixed maturity securities amounted to approximately $562 million and $528 million, respectively. The gross unrealized gains and losses for the fixed maturity securities portfolio at December 31, 1998, were $818 million and $256 million, respectively, compared to $644 million and $116 million, respectively, at December 31, 1997. Net unrealized gains on general account bonds include net unrealized losses on high yield securities of $101 million and $2 million, at December 31, 1998 and 1997, respectively. Carrying values of high yield securities in the general account were approximately $2.0 billion and $1.5 billion at December 31, 1998 and 1997, respectively. The Company's largest equity holding in a single issuer is Global Crossing, Ltd. (Global Crossing) common stock. As of December 31, 1998, the Company owned 20,037,584 shares, or 9.8% of the outstanding common stock of Global Crossing which was valued at $904 million at December 31, 1998. Net unrealized gains associated with this security approximated $841 million at December 31, 1998. Without registration or an exemption from registration, sales to the public of the Company's holdings of Global Crossing are governed by Rule 144 of the Securities Act of 1933 (the Act) and may not commence until August 13, 1999. The Company has the right, after August 13, 1999 to require Global Crossing to register under the Act up to 25% of the Company's holdings prior to December 31, 1999. At December 31, 1998 and 1997, fixed maturity securities in the guaranteed investment Separate Account contract portfolio, carried at fair value, amounted to $3.2 billion and $3.8 billion. Net unrealized gains on fixed maturity securities in these Separate Accounts amounted to approximately $64 million and $71 million at December 31, 1998 and 1997, respectively. The gross unrealized gains and losses for the fixed maturity securities portfolio at December 31, 1998, were $84 million and $20 million, respectively, compared to $87 million and $16 million, respectively, at December 31, 1997. At December 31, 1998, high yield securities in the guaranteed investment Separate Account contract portfolio, were carried at fair value, amounted to $269 million, compared to $310 million at December 31, 1997. Net unrealized losses on high yield securities held in such Separate Accounts were $9 million and $1 million at December 31, 1998 and 1997, respectively. CNA FINANCIAL CORPORATION ------------------------- 45 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ---------------------------------------------------------------------------- Market Risk Market Risk: - - ------------ Market risk is a broad term related to economic losses due to adverse changes in the fair value of a financial instrument. Market risk is inherent to all financial instruments, and accordingly, the Company's risk management policies and procedures include all market risk sensitive financial instruments. According to the Securities and Exchange Commission (SEC) disclosure rules, discussions regarding market risk focus on only one element of market risk-price risk. Price risk relates to changes in the level of prices due to changes in interest rates, equity prices, foreign exchange rates or other factors that relate to market volatility of the rate, index or price underlying the financial instrument. The Company's primary market risk exposures are due to changes in interest rates, although the Company has certain exposures to changes in equity prices and foreign currency exchange rates. Active management of market risk is integral to the Company's operations. The Company may use the following tools to manage its exposure to market risk within defined tolerance ranges: 1) change the character of future investments purchased or sold, 2) use derivatives to offset the market behavior of existing assets and liabilities or assets expected to be purchased and liabilities to be incurred, or 3) rebalance its existing asset and liability portfolios. For purposes of this disclosure, market risk sensitive instruments are divided into two categories: instruments entered into for trading purposes and instruments entered into for purposes other than trading. The Company's market risk sensitive instruments presented in the tables on pages 49-50, are classified as held for purposes other than trading. The Company does not generally hold or issue derivatives for trading purposes. INTEREST RATE RISK The Company has exposure to economic losses due to interest rate risk arising from changes in the level or volatility of interest rates. The Company attempts to mitigate its exposure to interest rate risk through active portfolio management. The Company may also reduce this risk by utilizing instruments such as interest rate swaps, interest rate caps, commitments to purchase securities, options, futures and forwards. This exposure is also mitigated by the Company's asset/liability matching strategy. EQUITY PRICE RISK The Company is exposed to equity price risk as a result of its investment in equity securities and equity derivatives. Equity price risk results from changes in the level or volatility of equity prices which affect the value of equity securities or instruments which derive their value from such securities or indexes. CNA attempts to mitigate its exposure to such risks by limiting its investment in any one security or index. FOREIGN EXCHANGE RISK Foreign exchange rate risk arises from the possibility that changes in foreign currency exchange rates will impact the value of financial instruments. The Company has foreign exchange exposure when it buys or sells foreign currencies or financial instruments denominated in a foreign currency. The Company's foreign transactions are primarily denominated in Canadian Dollars, British Pounds, German Deutsche Marks, Chilean CNA FINANCIAL CORPORATION ------------------------- 46 - - ------------------------------------------------------------------------------ Market Risk (cont.) Pesos, Argentinean Pesos and Japanese Yen. This exposure is mitigated by the Company's asset/liability matching strategy and through the use of forwards for those instruments which are not matched. SENSITIVITY ANALYSIS CNA monitors its sensitivity to interest rate risk by evaluating the change in its financial assets and liabilities relative to fluctuations in interest rates. The evaluation is made using an instantaneous change in interest rates of varying magnitudes on a static balance sheet to determine the effect such a change in rates would have on the Company's market value at risk and the resulting effect on stockholders' equity. The analysis presents the sensitivity of the market value of the Company's financial instruments to selected changes in market rates and prices. The range of changes chosen reflects the Company's view of changes which are reasonably possible over a one-year period. The selection of the range of values chosen to represent changes in interest rates should not be construed as the Company's prediction of future market events, but rather an illustration of the impact of such events. The sensitivity analysis estimates the change in the market value of the Company's interest-sensitive assets and liabilities that were held on December 31, 1998 and 1997 due to instantaneous parallel changes in the year-end yield curve. Also the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Accordingly, the analysis may not be indicative of, is not intended to provide, and does not provide a precise forecast of the effect of changes of market interest rates on the Company's income or stockholders' equity. Further, the computations do not contemplate any actions CNA would undertake in response to changes in interest rates. The sensitivity analysis assumes an instantaneous shift in market interest rates, with scenarios of interest rates increasing and decreasing 100 and 150 basis points from their levels at December 31, 1998 and 1997 with all other variables held constant. A 100 and 150 basis point increase in market interest rates would result in a pre-tax decrease in the financial instrument position of $1.7 billion and $2.6 billion, respectively, at December 31, 1998, compared to $1.6 billion and $2.4 billion, respectively, at December 31, 1997. Similarly, a 100 and 150 basis point decrease in market interest rates would result in a pre-tax increase in the net financial instrument position of $1.6 billion and $2.4 billion, respectively, for both periods under comparison. The Company's debt, including certain related interest rate swap agreements, as of December 31, 1998 and 1997, is denominated in U.S. dollars. At December 31, 1998 and 1997, approximately 93% and 91%, respectively, of the Company's long-term debt has been issued at or effectively converted to fixed rates, and as such, interest expense would not be impacted by interest rate shifts. The impact of a 100 and 150 basis point increase in interest rates on the fixed rate debt would result in a decrease in the market value of the debt by $157 million and $229 million, respectively, at December 31, 1998, compared to $117 million and $176 million, respectively, at December 31, 1997. The impact of a 100 and 150 basis point decrease in the interest rates would result in an increase in the market value of fixed rate debt by $174 million and $268 million, respectively, at current year end, compared to $117 million and $176 million, respectively, at December 31, 1997. The impact of a 100 and 150 basis point increase in interest rates on the CNA FINANCIAL CORPORATION ------------------------- 47 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ----------------------------------------------------------------------------- Market Risk (cont.) variable rate debt at December 31, 1998 would result in an additional $2 million and $3 million, respectively, in interest expense per year, compared to $3 million and $4 million, respectively, in interest expense per year at December 31, 1997. Similarly, a 100 and 150 basis point decrease in interest rates would result in like decreases in interest expense per year. Equity price risk was measured assuming an instantaneous 10% and 25% change in the Standard & Poor's 500 Index (the Index) from its level of December 31, 1998 and 1997, with all other variables held constant. The Company's equity holdings were assumed to be positively correlated with the Index. At December 31, 1998, a 10% and 25% decrease in the Index would result in a $320 million and $795 million decrease, respectively, compared to $177 million and $441 million decrease, respectively, at December 31, 1997, in the market rate of the Company's equity investments. Of these amounts, $92 million and $229 million, respectively, in the current year, and $66 million and $166 million, respectively, in the prior year would be offset by decreases in liabilities to customers under variable annuity contracts. Similarly, increases in the Index would result in like increases in the market value of the Company's equity investments and increases in liabilities to customers under variable annuity contracts. The sensitivity analysis also assumes an instantaneous 10% and 20% change in the foreign currency exchange rates versus the U.S. dollar from their levels at December 31, 1998 and 1997, with all other variables held constant. At December 31, 1998, a 10% and 20% strengthening of the U.S. dollar versus other currencies would result in decreases of $220 million and $441 million, respectively, in the market value of certain financial instruments that are denominated in foreign currencies, compared to $47 million and $94 million, respectively, at December 31, 1997. Weakening of the U.S. dollar versus all other currencies would result in like increases in the market value of certain financial instruments that are denominated in foreign currencies. CNA FINANCIAL CORPORATION ------------------------- 48 - - ---------------------------------------------------------------------------- Market Risk (cont.) The following tables reflect the estimated effects on the market value of the Company's financial instruments at December 31, 1998 and 1997, due to an increase in interest rates of 100 basis points, a 10% decline in the S&P 500 index, and a decline of 10% in foreign currency exchange rates. HELD FOR OTHER THAN TRADING PURPOSES - - ----------------------------------------------------------------------------- December 31, 1998 Market Interest Currency Equity Value Rate Risk Risk Risk - - ----------------------------------------------------------------------------- (In millions of dollars) General Account: Fixed maturity securities $30,073 $(1,549) $(156) $ - Equity securities 1,970 - (21) (197) Short term investments 4,037 (21) (43) - Interest rate swaps (20) 9 - - Interest rate caps 1 1 - - Other derivative securities 5 9 21 2 - - ----------------------------------------------------------------------------- TOTAL GENERAL ACCOUNT 36,066 (1,551) (199) (195) - - ----------------------------------------------------------------------------- Separate Account Business: Fixed maturity securities 4,155 (176) (20) (3) Equity securities 297 - - (30) Short term investments 473 - (1) - Equity index futures 2 4 - (92) Other derivative securities 2 (1) - - - - ----------------------------------------------------------------------------- TOTAL SEPARATE ACCOUNT BUSINESS 4,929 (173) (21) (125) - - ----------------------------------------------------------------------------- TOTAL ALL SECURITIES $40,995 $(1,724) $(220) $(320) ============================================================================= DEBT $(3,160) $ 157 $ - $ - ============================================================================= HELD FOR OTHER THAN TRADING PURPOSES - - ----------------------------------------------------------------------------- December 31, 1997 Market Interest Currency Equity Value Rate Risk Risk Risk - - ----------------------------------------------------------------------------- (In millions of dollars) General Account: Fixed maturity securities $29,548 $(1,409) $ (20) $ (10) Equity securities 814 - (7) (82) Short term investments 4,884 (11) (21) - Interest rate swaps (12) 20 - - Interest rate caps 4 4 - - Other derivative securities 2 1 1 3 - - ----------------------------------------------------------------------------- TOTAL GENERAL ACCOUNT 35,240 (1,395) (47) (89) - - ----------------------------------------------------------------------------- Separate Account Business: Fixed maturity securities 4,769 (190) - (1) Equity securities 206 - - (21) Short term investments 629 (1) - - Equity index futures - 1 - (66) Other derivative securities - (3) - - - - ----------------------------------------------------------------------------- TOTAL SEPARATE ACCOUNT BUSINESS 5,604 (193) - (88) - - ----------------------------------------------------------------------------- TOTAL ALL SECURITIES $40,844 $(1,588) $ (47) $(177) ============================================================================= DEBT $(2,897) $ 117 $ - $ - ============================================================================= CNA FINANCIAL CORPORATION ------------------------- 49 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ------------------------------------------------------------------------------ Market Risk (cont.) The following tables reflect the estimated effects on the market value of the Company's financial instruments at December 31, 1998 and 1997, due to an increase in interest rates of 150 basis points, a 25% decline in the S&P 500 index, and a decline of 20% in foreign currency exchange rates. HELD FOR OTHER THAN TRADING PURPOSES - - ------------------------------------------------------------------------------ December 31, 1998 Market Interest Currency Equity Value Rate Risk Risk Risk - - ------------------------------------------------------------------------------ (In millions of dollars) General Account: Fixed maturity securities $30,073 $(2,347) $(313) $ - Equity securities 1,970 - (42) (493) Short term investments 4,037 (31) (85) - Interest rate swaps (20) 14 - - Interest rate caps 1 1 - - Other derivative securities 5 14 42 10 - - ------------------------------------------------------------------------------ TOTAL GENERAL ACCOUNT 36,066 (2,349) (398) (483) - - ------------------------------------------------------------------------------ Separate Account Business: Fixed maturity securities 4,155 (272) (41) (9) Equity securities 297 - - (74) Short term investments 473 (1) (2) - Equity index futures 2 6 - (229) Other derivative securities 2 (1) - - - - ------------------------------------------------------------------------------ TOTAL SEPARATE ACCOUNT BUSINESS 4,929 (268) (43) (312) - - ------------------------------------------------------------------------------ TOTAL ALL SECURITIES $40,995 $(2,617) $(441) $(795) ============================================================================== DEBT $(3,160) $ 229 $ - $ - ============================================================================== December 31, 1997 Market Interest Currency Equity Value Rate Risk Risk Risk - - ------------------------------------------------------------------------------ (In millions of dollars) General Account: Fixed maturity securities $29,548 $(2,113) $ (39) $ (24) Equity securities 814 - (14) (204) Short term investments 4,884 (17) (43) - Interest rate swaps (12) 30 - - Interest rate caps 4 7 - - Other derivative securities 2 1 2 7 - - ----------------------------------------------------------------------------- TOTAL GENERAL ACCOUNT 35,240 (2,092) (94) (221) - - ----------------------------------------------------------------------------- Separate Account Business: Fixed maturity securities 4,769 (285) - (3) Equity securities 206 - - (51) Short term investments 629 (1) - - Equity index futures - 2 - (166) Other derivative securities - (5) - - - - ----------------------------------------------------------------------------- TOTAL SEPARATE ACCOUNT BUSINESS 5,604 (289) - (220) - - ----------------------------------------------------------------------------- TOTAL ALL SECURITIES $40,844 $(2,381) $ (94) $(441) ============================================================================= DEBT $(2,897) $ 176 $ - $ - ============================================================================= CNA FINANCIAL CORPORATION ------------------------- 50 - - ------------------------------------------------------------------------------ Year 2000 Year 2000: - - ---------- IMPACT OF YEAR 2000 ON THE COMPANY The widespread use of computer programs, both in the United States and internationally, that rely on two digit date fields to perform computations and decision-making functions may cause computer systems to malfunction when processing information involving dates beginning in 1999. Such malfunctions could lead to business delays and disruptions. The Company renovated or replaced many of its legacy systems and upgraded its systems to accommodate business for the Year 2000 and beyond. In addition, the Company is checking embedded systems in computer hardware and other infrastructure such as elevators, heating and ventilating systems, and security systems. Based upon its current assessment, CNA estimates that the total cost to replace and upgrade its systems to accommodate Year 2000 processing is expected to be approximately $60 to $70 million. As of December 31, 1998, the Company has spent approximately $59 million on Year 2000 readiness matters. However, prior to 1997, the Company did not specifically separate technology charges for Year 2000 from other information technology charges. In addition, while some hardware charges are included in the budget figures, the Company's hardware costs typically are included as part of ongoing technology updates and not specifically as part of the Year 2000 project. All funds spent and to be spent have been or will be financed from current operating funds. The Company believes that it will be able to resolve the Year 2000 issue in a timely manner. As of December 31, 1998, CNA has internally certified all of its internal applications and systems as being ready for the year 2000. However, due to the interdependent nature of computer systems, there may be an adverse impact on the Company if banks, independent agents, vendors, insurance agents, third party administrators, various governmental agencies and other business partners fail to successfully address the Year 2000 issue. In addition, certain non-insurance affiliates are not yet Year 2000 ready, but they are expected to be ready on a timely basis. In the event that they are not, it is unclear at this time whether the impact on the Company would be material. To mitigate this impact, the Company is communicating with these various entities to coordinate Year 2000 conversion. The Company already has sent Year 2000 information packages to more than 12,000 independent agents to encourage them to become Year 2000 ready on a timely basis. The Company also has sent Year 2000 information to almost 300,000 business policyholders to increase their awareness of the Year 2000 issue. Similar information packages have been sent to healthcare providers, lawyers and others with whom the Company has business relationships. Because of the interdependent nature of the issue, the Company cannot be sure that there will not be a disruption in its business. The Company also has developed business resumption plans to ensure that the Company is able to continue critical processes through other means in the event that it becomes necessary to do so. Formal strategies have been developed within each business unit and support organization to include appropriate recovery processes and use of alternative vendors. More than 200 strategies have been developed to address all the recovery plans for approximately 400 processes. These plans are being updated quarterly. CNA FINANCIAL CORPORATION ------------------------- 51 MANAGEMENT'S DISCUSSION AND ANALYSIS - - ---------------------------------------------------------------------------- Year 2000 (cont.) In addition, property/casualty insurance companies may have an underwriting exposure related to the Year 2000 issue. There can be no assurance that policyholders will not suffer losses resulting from Year 2000 issues and seek indemnification under insurance policies underwritten by the Company. Coverage, if any, will depend on the facts and circumstances of the claim and the provisions of the policy. It is impossible to estimate with any degree of accuracy the extent to which various types of policies issued by the Company may afford coverage for losses or claims. At this time, the Company is unable to forecast the nature and range of the losses, the availability of coverage for the losses, or the likelihood of significant claims. As a result, the Company is unable to determine whether the adverse impact, if any, in connection with the foregoing circumstances would be material to the Company. CNA FINANCIAL CORPORATION ------------------------- 52 - - ----------------------------------------------------------------------------- Liquidity and Capital Resources Liquidity and Capital Resources: - - -------------------------------- The principal operating cash flow sources of CNA's property/casualty and life insurance subsidiaries are premiums and investment income. The primary operating cash flow uses are payments for claims, policy benefits and operating expenses. Net cash flows from operations are primarily invested in marketable securities. Investment strategies employed by CNA's insurance subsidiaries consider the cash flow requirements of the insurance products sold and the tax attributes of the various types of marketable investments. For the year ended December 31, 1998, net cash used in operating activities was $949 million, compared with net cash used of $193 million in 1997 and net cash provided of $620 million in 1996. The Company had substantially lower operating cash flows in 1998 and 1997, primarily due to increases in insurance receivables. On December 24, 1998, CNAF filed a Registration Statement on Form S-3 with the Securities and Exchange Commission relating to $600 million in senior and subordinated debt, junior debt, common stock, preferred stock and warrants. As of December 31, 1998, this registration was not effective. CNAF has a $795 million revolving credit facility that expires in May 2001. The amount available is reduced by CNAF's outstanding commercial paper. As of December 31, 1998, outstanding loans under the credit facility were $235 million and outstanding commercial paper was $500 million. There was $60 million of unused borrowing capacity under the facility at year end 1998. The interest rate on the bank loans is based on the London Interbank Offered Rate (LIBOR), plus 16 basis points. Additionally, there is a facility fee of 9 basis points annually. The average interest rate on the bank loans under the credit facility at December 31, 1998, 1997 and 1996, respectively was 5.49%, 6.16% and 5.72%. On December 23, 1998, CNAF sold $200 million of preferred stock to its majority shareholder, Loews Corporation. In 1998, CNAF issued $1 billion of senior notes under a $1 billion Registration Statement on Form S-3 filed with the Securities and Exchange Commission on August 18, 1997. This shelf registration incorporated $250 million of securities remaining available for issuance from a prior shelf registration. Since filing this shelf registration, CNAF has issued in four separate offerings senior notes with an aggregate principal amount of $1 billion. Proceeds from these debt issues were used to repay or refinance existing debt, provide funds for acquisitions, and increase the capital of Continental Casualty Company. On November 15, 1996, CNAF issued $250 million, 6.75% Senior Notes, due November 15, 2006. On March 1, 1996, CNAF paid, at the due date, $250 million of 8.625% senior notes. To offset the variable rate characteristics of the credit facility, CNAF entered into interest rate swap agreements with several banks. These agreements convert variable debt into fixed debt resulting in fixed rates on notional amounts of $650 million as of December 31, 1998. The effect of these interest rate swaps was to increase interest expense by approximately $2 million, $4 million and $7 million for the years ended December 31, 1998, 1997 and 1996, respectively. CNA FINANCIAL CORPORATION ------------------------- 53 MANAGEMENTS'S DISCUSSION AND ANALYSIS - - ---------------------------------------------------------------------------- Liquidity and Capital Resources (cont.) CNAF has a commercial paper program in place, in which it borrows from investors and replaces a like amount of bank financing. As of December 31, 1998, the commercial paper program totaled $500 million as compared with $675 million as of December 31, 1997. The weighted-average interest rate on commercial paper was 5.89%, 6.05% and 5.67% at December 31, 1998, 1997 and 1996 respectively. The commercial paper borrowings are classified as long-term, as borrowing capacity under the revolving credit facility will support the commercial paper program (at an undrawn cost of 9 basis points). The weighted-average interest rate (interest and facility fees) on the revolving credit facility, commercial paper and the effect of the interest rate swaps, was 6.36%, 6.35% and 6.28% at December 31, 1998, 1997 and 1996 respectively. The table below reflects ratings issued by A.M. Best, Standard and Poor's, Moody's and Duff & Phelps for CNA's Continental Casualty Company (CCC) Intercompany Pool, Continental Insurance Company (CIC) Intercompany Pool and Continental Assurance Company (CAC) Intercompany Pool. Also rated were CNAF's senior debt, commercial paper and preferred stock and The Continental Corporation's (Continental) senior debt. |-----------------|---------------------|------------------------------------| | | INSURANCE RATINGS | DEBT AND STOCK RATINGS | | |---------------------|------------------------------------| | | Financial Strength | | | |---------------------| | | | | | | CNA Continental| | | | | |-----------------|---------|--------| | | CCC | CAC | CIC |Senior|Commercial|Prefered | Senior | | | | | |Debt | Paper | Stock | Debt | | |-----|-----|---------|------|----------|---------|--------| |A.M. Best | A | A | A- | - | - | - | - | |Moody's | A1 | A1*| A2 | A3 | P2 | a3 | Baa1 | |Standard & Poor's| A+ | AA-| A- | A- | A2 | BBB | BBB- | | |-----|-----|---------| | | | | | |Claims Paying Ability| | | | | | |-----|---------------| | | | | |Duff & Phelps | AA-| AA | - | A- | - | BBB+ | - | |-----------------|-----|-----|---------|------|----------|---------|--------| *APPLIES TO CONTINENTAL ASSURANCE COMPANY ONLY. CNA FINANCIAL CORPORATION ------------------------- 54 - - ---------------------------------------------------------------------------- Accounting Standards Accounting Standards: - - --------------------- ACCOUNTING BY INSURANCE AND OTHER ENTERPRISES FOR INSURANCE-RELATED ASSESSMENTS In December 1997, the American Institute of Certified Public Accountants' Accounting Standards Executive Committee issued Statement of Position (SOP) 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." SOP 97-3 requires that entities recognize liabilities for insurance-related assessments when all of the following criteria have been met: an assessment has been imposed or it is probable that an assessment will be imposed; the event obligating an entity to pay an imposed or probable assessment has occurred on or before the date of the financial statements; and the amount of the assessment can be reasonably estimated. This SOP is effective for financial statements for fiscal years beginning after December 15, 1998. The effects of this SOP will result in CNA recording an after-tax charge in the first quarter of 1999 between $145 million and $175 million as a cumulative effect of a change in accounting principle. ACCOUNTING FOR THE COSTS OF COMPUTER SOFTWARE DEVELOPED OR OBTAINED FOR INTERNAL USE In March 1998, the American Institute of Certified Public Accountants' Accounting Standards Executive Committee issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use." For purposes of this SOP, internal-use software is software acquired, internally developed or modified solely to meet the entity's internal needs for which no substantive plan exists or is being developed to market the software externally during the software's development or modification. Accounting treatment for costs associated with software developed or obtained for internal use, as defined by this SOP, is based upon a number of factors, including the point in time during the project that costs are incurred as well as the types of costs incurred. This SOP is effective for financial statements for fiscal years beginning after December 15, 1998 and will be adopted in the first quarter of 1999. CNA is currently evaluating the effects of this SOP. ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard 133, "Accounting for Derivative Instruments and Hedging Activities." This statement requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. This Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. CNA is currently evaluating the effects of this Statement on its accounting and reporting for derivative securities and hedging activities. CNA FINANCIAL CORPORATION ------------------------- 55 MANAGEMENT'S DISCUSSION AND ANALYSIS - - -------------------------------------------------------------------------- Accounting Standards (cont.) REPORTING ON THE COSTS OF START-UP ACTIVITIES In April 1998, the American Institute of Certified Public Accountants' Accounting Standards Executive Committee issued SOP 98-5, "Reporting on the Costs of Start-Up Activities." This SOP requires costs of start-up activities and organization costs, as defined, to be expensed as incurred. SOP 98-5 is effective for financial statements in 1999. Initial application of this SOP should be reported as a change in accounting principle, and will, accordingly, involve a cumulative adjustment. CNA does not expect the adoption of the SOP to have a significant impact on the results of operations or equity of CNA. ACCOUNTING FOR INSURANCE AND REINSURANCE CONTRACTS THAT DO NOT TRANSFER INSURANCE RISK In October 1998, the American Institute of Certified Public Accountants' Accounting Standards Executive Committee issued SOP 98-7, "Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." This guidance excludes long-duration life and health insurance contracts from its scope. This SOP is effective for financial statements in the year 2000, with early adoption encouraged. CNA is currently evaluating the effects of this SOP. CNA FINANCIAL CORPORATION ------------------------- 56 - - ----------------------------------------------------------------------------- Forward-Looking Statements Forward-Looking Statements: - - --------------------------- The statements contained in this management's discussion and analysis that are not historical facts are forward-looking statements. When included in this management's discussion and analysis, the words "believe," "expects," "intends," "anticipates," "estimates," and analogous expressions are intended to identify forward-looking statements. Such statements inherently are subject to a variety of risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties include, among others, the impact of competitive products, policies and pricing; product and policy demand and market responses; development of claims and the effect on loss reserves; the performance of reinsurance companies under reinsurance contracts with the Company; general economic and business conditions; changes in financial markets (interest rate, credit, currency, commodities and stocks) or in the value of specific investments held by the Company; changes in foreign, political, social and economic conditions; regulatory initiatives and compliance with governmental regulations; judicial decisions and rulings; rating agency policies and practices; the results of financing efforts; the actual closing of contemplated transactions and agreements and various other matters and risks (many of which are beyond the Company's control) detailed in the CNAF's Securities and Exchange Commission filings. These forward-looking statements speak only as of the date of this report. The Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statement contained herein to reflect any change in the Company's expectations with regard thereto or any change in events, conditions or circumstances on which any statement is based. CNA FINANCIAL CORPORATION ------------------------- 57
CONSOLIDATED FINANCIAL STATEMENTS - - ----------------------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS ASSETS - - ----------------------------------------------------------------------------------------------- December 31 1998 1997 - - ----------------------------------------------------------------------------------------------- (In millions of dollars, Investments: Fixed maturities available for sale (cost: $29,511 and $29,020).............................................$30,073 $29,548 Equity securities available for sale (cost: $1,055 and $695)................................................. 1,970 814 Mortgage loans and real estate (less accumulated depreciation: $1 and $1)................................................ 62 85 Policy loans............................................................... 177 177 Other invested assets...................................................... 858 695 Short-term investments .................................................... 4,037 4,884 - - ----------------------------------------------------------------------------------------------- TOTAL INVESTMENTS 37,177 36,203 - - ----------------------------------------------------------------------------------------------- Cash......................................................................... 217 383 Receivables: Reinsurance................................................................ 6,365 6,057 Insurance ................................................................. 6,504 6,224 Other ..................................................................... 300 208 Less allowance for doubtful accounts....................................... (328) (303) Deferred acquisition costs................................................... 2,422 2,142 Prepaid reinsurance premiums................................................. 331 202 Accrued investment income.................................................... 392 389 Receivables for securities sold.............................................. 255 744 Federal income taxes recoverable (includes $234 and $26 due from Loews).................................................... 251 18 Deferred income taxes........................................................ 995 1,070 Property and equipment at cost (less accumulated depreciation: $695 and $553)............................. 824 747 Intangibles, net of accumulated amortization................................. 368 620 Other assets................................................................. 1,083 1,159 Separate Account business.................................................... 5,203 5,812 - - ----------------------------------------------------------------------------------------------- TOTAL ASSETS $62,359 $61,675 =============================================================================================== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
CNA FINANCIAL CORPORATION ------------------------- 58
- - ----------------------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS (CONT.) LIABILITIES AND STOCKHOLDERS' EQUITY - - ----------------------------------------------------------------------------------------------- December 31 1998 1997 - - ----------------------------------------------------------------------------------------------- (In millions of dollars) Liabilities: Insurance reserves: Claim and claim adjustment expense ....................................$29,192 $29,558 Unearned premiums...................................................... 5,039 4,700 Future policy benefits................................................. 5,418 4,829 Policyholders' funds................................................... 789 742 Collateral on loaned securities........................................... 130 153 Payables for securities purchased......................................... 316 648 Participating policyholders' equity....................................... 140 132 Debt...................................................................... 3,160 2,897 Other liabilities......................................................... 3,611 3,723 Separate Account business................................................. 5,203 5,812 - - ----------------------------------------------------------------------------------------------- TOTAL LIABILITIES 52,998 53,194 - - ----------------------------------------------------------------------------------------------- Commitments and contingent liabilities - Notes A, B, C, E, F, and G Minority Interest............................................................ 204 172 Stockholders' equity: Common stock, $2.50 par value; Authorized - 200,000,000 shares; Issued - 185,525,907 shares; Outstanding as of December 31, 1998 -183,889,569 shares Outstanding as of December 31, 1997 -185,394,786 shares................. 464 464 Preferred stock........................................................... 350 150 Additional paid-in capital................................................ 126 126 Retained earnings......................................................... 7,258 6,983 Accumulated other comprehensive income.................................... 1,064 589 Treasury stock, at cost................................................... (61) (3) - - ----------------------------------------------------------------------------------------------- 9,201 8,309 Notes receivable from officer stockholders............................... (44) - - - ----------------------------------------------------------------------------------------------- TOTAL STOCKHOLDERS' EQUITY 9,157 8,309 - - ----------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $62,359 $61,675 =============================================================================================== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
CNA FINANCIAL CORPORATION ------------------------- 59 CONSOLIDATED FINANCIAL STATEMENTS - - ----------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF OPERATIONS - - ----------------------------------------------------------------------------- YEAR ENDED DECEMBER 31 1998 1997 1996 - - ----------------------------------------------------------------------------- (In millions of dollars, except per share data) - - ----------------------------------------------------------------------------- Revenues: Premiums.....................................$13,375 $13,482 $13,525 Net investment income........................ 2,146 2,209 2,276 Realized investment gains.................... 695 753 619 Other........................................ 858 628 568 - - ----------------------------------------------------------------------------- 17,074 17,072 16,988 - - ----------------------------------------------------------------------------- Claims, benefits and expenses: Insurance claims and policyholders' benefits.................. 11,717 11,268 11,371 Amortization of deferred acquisition costs... 2,180 2,138 1,856 Restructuring and other related charges ..... 246 - - Other operating expenses..................... 2,363 2,100 2,207 Interest expense............................. 219 198 200 - - ----------------------------------------------------------------------------- 16,725 15,704 15,634 - - ----------------------------------------------------------------------------- Income before income tax................. 349 1,368 1,354 Income tax expense............................. 47 392 380 Minority interest.............................. 20 10 9 ============================================================================= NET INCOME $ 282 $ 966 $ 965 - - ----------------------------------------------------------------------------- EARNINGS PER SHARE $ 1.49 $ 5.17 $ 5.17 ============================================================================= WEIGHTED AVERAGE OUTSTANDING SHARES OF COMMON STOCK (IN MILLIONS OF SHARES) 184.9 185.4 185.4 ============================================================================= SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. CNA FINANCIAL CORPORATION ------------------------- 60 - - ------------------------------------------------------------------------------ CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Notes Accumulated Receivable Additional Other From Total Common Preferred Paid in Comprehensive Retained Comprehensive Treasury Officer Stockholders' Stock Stock Capital Income Earnings Income Stock Stockholders Equity - - -------------------------------------------------------------------------------------------------------------------- (In millions of dollars) Balance, January 1, 1996 $464 $150 $126 $5,066 $ 933 $ (3) $ - $6,736 Comprehensive income: Net income.............. - - - $ 965 965 - - - 965 Other comprehensive loss.................... - - - (634) - (634) - - (634) ------- Total comprehensive income............ $ 331 ======= Preferred dividends..... - - - (7) - - - (7) - - -------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1996 464 150 126 6,024 299 (3) - 7,060 Comprehensive income: Net income.............. - - - $ 966 966 - - - 966 Other comprehensive income.................. - - - 290 - 290 - - 290 -------- Total comprehensive income............ $1,256 ======== Preferred dividends..... - - - (7) - - - (7) - - -------------------------------------------------------------------------------------------------------------------- Balance, December 31, 1997 464 150 126 6,983 589 (3) - 8,309 Comprehensive income: Net income.............. - - - $ 282 282 - - - 282 Other comprehensive income.................. - - - 475 - 475 - - 475 -------- Total comprehensive income............ $ 757 ======== Issuance of preferred stock................... - 200 - - - - - 200 Purchase of treasury stock................... - - - - - (102) - (102) Sale of treasury stock and issuance of notes receivable from officer stockholders......... - - - - - 44 (44) - Preferred dividends..... - - - (7) - - - (7) - - -------------------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1998 $464 $350 $126 $7,258 $1,064 $(61) $(44) $9,157 ==================================================================================================================== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
CNA FINANCIAL CORPORATION ------------------------- 61 CONSOLIDATED FINANCIAL STATEMENTS - - --------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS - - --------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - --------------------------------------------------------------------------- (In millions of dollars) CASH FLOWS FROM OPERATING ACTIVITIES: - - ------------------------------------- Net income .............................. $ 282 $ 966 $ 965 -------------------------------- Adjustments to reconcile net income to net cash flows from operating activities: Minority Interest ..................... 20 10 9 Deferred income tax provision.......... 47 144 352 Participating policyholders' interest.. 14 8 (5) Net realized investment gains, pre-tax. (695) (753) (619) Amortization of intangibles............ 93 30 25 Amortization of bond discount.......... (208) (100) (178) Depreciation........................... 166 158 138 Changes in: Receivables, net..................... (655) 147 84 Deferred acquisition costs........... (280) (288) (361) Accrued investment income............ (3) 119 38 Federal income taxes recoverable..... (233) 116 (1) Prepaid reinsurance premiums......... (129) 93 200 Insurance reserves................... 624 (133) (358) Other liabilities.................... 1 (641) 790 Other, net........................... 7 (69) (459) - - --------------------------------------------------------------------------- Total adjustments .................. (1,231) (1,159) (345) - - --------------------------------------------------------------------------- NET CASH FLOWS FROM OPERATING ACTIVITIES ............. $ (949) $ (193) $ 620 - - --------------------------------------------------------------------------- SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. CNA FINANCIAL CORPORATION ------------------------- 62 - - --------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS (cont.) - - --------------------------------------------------------------------------- Year Ended December 31 1998 1997 1998 - - --------------------------------------------------------------------------- (In millions of dollars) CASH FLOWS FROM INVESTING ACTIVITIES: - - ------------------------------------- Purchases of fixed maturities............ $(39,039) $(42,492) $(34,312) Proceeds from fixed maturities: Sales................................. 35,480 38,429 34,864 Maturities, calls and redemptions..... 3,564 2,997 1,796 Purchases of equity securities........... (1,071) (1,323) (972) Proceeds from sale of equity securities.. 848 1,406 1,077 Change in short-term investments......... 823 1,112 (2,029) Purchases of property and equipment ..... (261) (280) (205) Change in securities sold under repurchase agreements.................... (23) 53 (674) Change in other investments.............. 62 421 146 Acquisitions, (net of cash of $1 and $4). (120) (104) - Other, net............................... 180 (7) 21 NET CASH FLOWS FROM INVESTING ACTIVITIES 443 212 (288) - - --------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: - - ------------------------------------- Dividends paid to preferred shareholders.. (7) (6) (6) Purchase of treasury stock................ (102) - - Receipts from investment contracts credited to policyholder account balances......... (20) 7 11 Return of policyholder account balances on investment contracts.......... 6 (26) (41) Change in short-term debt................... - - (257) Principal payments on long-term debt........ (730) (5) (254) Proceeds from issuance of long-term debt.... 993 137 250 Issuance of preferred stock ................ 200 - - - - --------------------------------------------------------------------------- NET CASH FLOWS FROM FINANCING ACTIVITIES 340 107 (297) - - --------------------------------------------------------------------------- NET CASH FLOWS........................... (166) 126 35 Cash at beginning of period................. 383 257 222 - - --------------------------------------------------------------------------- CASH AT END OF PERIOD $ 217 $ 383 $ 257 =========================================================================== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: - - -------------------------------------------------- Cash (paid) received: Interest expense......................... $ (210) $ (201) $(211) Federal income taxes..................... (143) (95) 16 Non-cash transactions: Notes receivable from officer stockholders for sale of treasury stock.............. (44) - - =========================================================================== SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. CNA FINANCIAL CORPORATION ------------------------- 63 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ------------------------------------------------------------------------------ Note A -- Significant Accounting Policies Note A - Significant Accounting Policies: - - ----------------------------------------- BASIS OF PRESENTATION - - --------------------- The Consolidated Financial Statements include CNA Financial Corporation (CNAF) and its subsidiaries which include property/casualty insurance companies (principally Continental Casualty Company and The Continental Insurance Company) and life insurance companies (principally Continental Assurance Company and Valley Forge Life Insurance Company), collectively CNA, or the Company. Loews Corporation (Loews) owns approximately 85% of the outstanding common stock of CNAF. The accompanying Consolidated Financial Statements have been prepared in conformity with generally accepted accounting principles. Certain amounts applicable to prior years have been reclassified to conform to classifications followed in 1998. All material intercompany amounts have been eliminated. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. BUSINESS - - ---------------------- CNA serves a wide spectrum of customers, including small, medium and large businesses; associations; professionals; groups and individuals with a broad range of insurance and risk management products and services. Insurance products include property and casualty coverages; life, accident and health insurance; and pension products and annuities. CNA services include risk management, information services, health care management and claims administration. CNA products and services are marketed through agents, brokers, general agents and direct sales. INSURANCE - - ----------------------- PREMIUM REVENUES Insurance premiums on property/casualty and accident and health insurance contracts are earned ratably over the terms of the policies after provision for estimated adjustments on retrospectively rated policies and deductions for ceded insurance. Revenues on universal life-type contracts are comprised of contract charges and fees which are recognized over the coverage period. Other life insurance premiums and annuities are recognized as revenue when due after deductions for ceded insurance premiums. CLAIM AND CLAIM ADJUSTMENT EXPENSE RESERVES Claim and claim expense reserves, except reserves for structured settlements, workers' compensation lifetime claims and accident and health disability claims, are not discounted and are based on (a) case basis estimates for losses reported on direct business, adjusted in the aggregate for ultimate loss expectations, (b) estimates of unreported CNA FINANCIAL CORPORATION -------------------------- 64 - - ------------------------------------------------------------------------------- Note A - Significant Accounting Policies (cont.) losses, (c) estimates of losses on assumed insurance, and (d) estimates of future expenses to be incurred in settlement of claims. In establishing these estimates, consideration is given to current conditions and trends as well as past Company and industry experience. The effects of inflation, which can be significant, are implicitly considered in the reserving process and are part of the recorded reserve balance. Claim and claim adjustment expense reserves represent management's estimates of ultimate liabilities based on currently available facts and case law and the ultimate liability may vary significantly from such estimates. CNA regularly reviews its reserves and any adjustments to the previously established reserves are reflected in operating income in the period the need for such adjustments becomes apparent. Structured settlements have been negotiated for claims on certain property/casualty insurance policies. Structured settlements are agreements to provide periodic payments to claimants, which are fixed and determinable as to the amount and time of payment. Certain structured settlements are funded by annuities purchased from Continental Assurance Company for which the related annuity obligations are reflected as part of future policy benefits reserves. Obligations for structured settlements not funded by annuities are included in claim and expense reserves and carried at the present values determined using interest rates ranging from 6.0% to 7.5%. At December 31, 1998 and 1997 the discounted reserves for unfunded structured settlements were $893 million and $913 million, respectively (reflecting a discount of $1,511 million and $1,527 million, respectively). Workers' compensation lifetime claim reserves and accident and health disability claim reserves are discounted at interest rates allowed by insurance regulators that range from 3.5% to 6.0% with mortality and morbidity assumptions reflecting the Company's and current industry experience. At December 31, 1998 and 1997, such discounted reserves totaled $2,277 million and $2,196 million, respectively (reflecting a discount of $869 million and $882 million, respectively). FUTURE POLICY BENEFITS RESERVES Reserves for traditional life insurance products (whole and term life products) are computed based upon the net level premium method using actuarial assumptions as to interest rates, mortality, morbidity, withdrawals and expenses. Actuarial assumptions include a margin for adverse deviation and generally vary by plan, age at issue and policy duration. Interest rates range from 3% to 9% and mortality, morbidity and withdrawal assumptions reflect CNA and industry experience prevailing at the time of issue. Expense assumptions include the estimated effects of inflation and expenses beyond the premium paying period. Reserves for universal life-type contracts are equal to the account balances that accrue to the benefit of the policyholders. Interest crediting rates ranged from 4.30% to 7.25% for the three years ended December 31, 1998. INVOLUNTARY RISKS CNA's share of involuntary risks is mandatory and generally a function of its share of the voluntary market by line of insurance in each state. CNA records the estimated effects of its mandatory participation on an accrual basis, using either claim payments or premiums written in the current year depending on the assessment basis. CNA currently records assessments for insolvencies as they are paid. In 1999, CNA will account for these assessments in compliance with Statement of Position (SOP) 97-3. SOP-97-3 CNA FINANCIAL CORPORATION ------------------------- 65 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ------------------------------------------------------------------------------- Note A - Significant Accounting Policies (cont.) requires that insurance companies recognize liabilities for insurance-related assessments when an assessment is probable and will be imposed, when it can be reasonably estimated, and when the event obligating the entity to pay an imposed or probable assessment has occurred on or before the date of the financials. In the first quarter of 1999, CNA will record an after-tax charge between $145 million and $175 million as a cumulative effect of a change in accounting principle. REINSURANCE CNA assumes and cedes insurance with other insurers and reinsurers and members of various reinsurance pools and associations. CNA utilizes reinsurance arrangements to limit its maximum loss, provide greater diversification of risk and minimize exposures on larger risks. The reinsurance coverages are tailored to the specific risk characteristics of each product line with CNA's retained amount varying by type of coverage. Generally, reinsurance coverage for property risks is on an excess of loss, per risk basis. Liability coverages are generally reinsured on a quota share basis in excess of CNA's retained risk. CNA's life reinsurance includes coinsurance, yearly renewable term and facultative programs. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim or policy reserve liability and shown as a recoverable in the balance sheet. DEFERRED ACQUISITION COSTS Costs of acquiring property/casualty insurance business which vary with and are primarily related to the production of such business are deferred and amortized ratably over the period the related premiums are recognized. Such costs include commissions, premium taxes and certain underwriting and policy issuance costs. Anticipated investment income is considered in the determination of the recoverability of deferred acquisition costs. Life acquisition costs are capitalized and amortized based on assumptions consistent with those used for computing policy benefit reserves. Acquisition costs on traditional life business are amortized over the assumed premium paying periods. Universal life and annuity acquisition costs are amortized in proportion to the present value of estimated gross profits over the products' assumed durations. To the extent that unrealized gains or losses on available-for sale securities would result in an adjustment of deferred policy acquisition costs had those gains or losses actually been realized, the related unamortized deferred policy acquisition costs are recorded as an adjustment of the unrealized gains or losses included in stockholders' equity. PARTICIPATING BUSINESS Participating business represented 0.5%, 0.7% and 0.5% of gross life insurance in force and 0.7%, 0.7% and 0.7% of life insurance premium income for 1998, 1997, and 1996, respectively. Participating policyholders' equity is determined by allocating 90% of the net income or loss and unrealized investment gains or losses related to such business as allowed by applicable laws, less dividends determined by the Board of Directors. Revenues and benefits and expenses include amounts related to participating policies; the net income or loss allocated to participating policyholders' equity is a component of insurance claims and policyholders' benefits. CNA FINANCIAL CORPORATION -------------------------- 66 - - ------------------------------------------------------------------------------- Note A - Significant Accounting Policies (cont.) INVESTMENTS - - ------------------------------------- VALUATION OF INVESTMENTS CNA classifies its fixed maturities (bonds and redeemable preferred stocks) and its equity securities as available-for-sale, and as such, they are carried at fair value. The amortized cost of fixed maturities is adjusted for amortization of premiums and accretion of discounts to maturity. The amortization and accretion are included in investment income. CNA accounts for its derivative securities under the fair value method and includes them in other invested assets, except for interest rate swaps associated with certain corporate borrowings. Under this method, the derivative securities are recorded in the balance sheet at fair value at the reporting date with changes in fair value reflected in realized investment gains and losses. For interest rate swaps associated with certain corporate borrowings, amounts due or payable under these swaps are recorded as an adjustment to interest expense and changes in the fair value of the swaps are not reflected in the Company's financial statements. Mortgage loans are carried at unpaid principal balances, including unamortized premium or discount. Real estate is carried at depreciated cost. Policy loans are carried at unpaid balances. Short-term investments are carried at amortized cost, which approximates fair value. Other invested assets include joint ventures, limited partnerships, certain derivative securities and other investments. The joint ventures and limited partnerships are carried at cost plus CNA's equity interest in changes in the investee's net assets. CNA's equity interest in such changes is reflected in investment income, realized investment gains/losses and unrealized investment gains/losses, as appropriate. The Company may from time to time invest in securities which have a limited market or the sale of which may be restricted in whole or in part. The Company carries these securities at fair value, with unrealized investment gains and losses reflected as a separate component of accumulated other comprehensive income. INVESTMENT GAINS AND LOSSES All securities transactions are recorded on the trade date. Realized investment gains and losses are determined on the basis of the amortized cost of the specific securities sold. Investments are written down to estimated fair values, and losses are charged to income when a decline in value is considered to be other than temporary. Unrealized investment gains and losses on fixed maturity securities and equity securities are reflected as part of stockholders' equity (accumulated other comprehensive income), net of minority interest, applicable deferred income taxes and participating policyholders' interest. EQUITY IN AFFILIATES CNA uses the equity method of accounting for investments in companies in which its ownership interest is at least twenty percent but not greater than fifty percent. Equity in operating income of these affiliates is reflected in other income. Equity in investment gains/losses is included in realized investment gains/losses or unrealized investment gains/losses as appropriate. CNA FINANCIAL CORPORATION ------------------------- 67 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ------------------------------------------------------------------------------- Note A - Significant Accounting Policies (cont.) SECURITIES LENDING ACTIVITIES CNA has a securities lending program where securities are loaned to third parties, primarily major brokerage firms. Borrowers of these securities must deposit 100% of the fair value of the securities if the collateral is cash, or 102%, if the collateral is securities. Cash deposits from these transactions are invested in short-term investments (primarily commercial paper). CNA continues to receive the interest on loaned debt securities as beneficial owner, and accordingly, loaned debt securities are included within fixed maturity securities. RESTRICTED INVESTMENTS On December 30, 1993, CNA deposited $987 million in an escrow account, pursuant to the Fibreboard Global Settlement Agreement, as discussed in Note F. The majority of the funds are included in short-term investments and are invested primarily in U.S. Treasury securities. The escrow account amounted to $1,130 million and $1,098 million at December 31, 1998 and 1997, respectively. SEPARATE ACCOUNT BUSINESS - - -------------------------------- Continental Assurance Company and Valley Forge Life Insurance Company write certain investment and annuity contracts. The supporting assets and liabilities of these contracts are legally segregated and reflected as assets and liabilities of Separate Account business. Continental Assurance Company guarantees principal and a specified return to the contractholders on approximately 64% and 74% of the Separate Account business at December 31, 1998 and 1997, respectively. Substantially all assets of the Separate Account business are carried at fair value. Separate Account liabilities are carried at contract values. INCOME TAXES ---------------------------------- The provision for income taxes includes deferred taxes, resulting from temporary differences between the financial statement and tax return bases of assets and liabilities under the liability method. Temporary differences primarily relate to insurance reserves (principally claim reserve discounting and unearned premium reserves), net unrealized investment gains/losses and deferred acquisition costs. PROPERTY AND EQUIPMENT - - ------------------------------------- Property and equipment are carried at cost less accumulated depreciation. Depreciation is based on the estimated useful lives of the various classes of property and equipment and determined principally on accelerated methods. The cost of maintenance and repairs is charged to income as incurred; major improvements are capitalized. MANAGEMENT SERVICES - - -------------------------------------- CNA reimburses Loews or pays directly for management services, travel and similar expenses, and expenses of investment facilities and services provided to CNA. Such reimbursements amounted to approximately $13 million, $11 million and $15 million in 1998, 1997 and 1996, respectively. CNA FINANCIAL CORPORATION ------------------------- 68 - - ------------------------------------------------------------------------------- Note A - Significant Accounting Policies (cont.) EARNINGS PER SHARE - - ---------------------------------------- Earnings per share applicable to common stock are based on weighted average outstanding shares, retroactively adjusted to reflect all stock splits. CNAF has no stock options or warrants; therefore, basic and fully diluted earnings per share are the same. The computation of earnings per share for December 31, 1998, 1997 and 1996 was as follows: - - ---------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - ---------------------------------------------------------------- (In millions, except per share amounts) Net income $ 282 $ 966 $ 965 Less: Preferred dividend (7) (7) (7) - - ---------------------------------------------------------------- Net income applicable to common stock $ 275 $ 959 $ 958 Weighted average outstanding common shares 184.9 185.4 185.4 - - ---------------------------------------------------------------- EARNINGS PER SHARE $1.49 $5.17 $5.17 ================================================================ CNA FINANCIAL CORPORATION ------------------------- 69 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ----------------------------------------------------------------------------- Note B -- Investments Note B - Investments: - - --------------------- NET INVESTMENT INCOME - - ----------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - ----------------------------------------------------------------------------- (In millions of dollars) Fixed maturities: Bonds: Taxable $1,490 $1,522 $1,716 Tax-exempt 340 288 273 Redeemable preferred stocks 2 7 2 Equity securities 33 37 25 Mortgage loans and real estate 5 10 11 Policy loans 11 6 12 Short-term investments 241 321 231 Security repurchase transactions-net 10 9 4 Other 67 56 45 - - ----------------------------------------------------------------------------- 2,199 2,256 2,319 Investment expense (53) (47) (43) - - ----------------------------------------------------------------------------- NET INVESTMENT INCOME $2,146 $2,209 $2,276 ============================================================================= CNA FINANCIAL CORPORATION ------------------------- 70 - - ---------------------------------------------------------------------------- Note B -- Investments (cont.) ANALYSIS OF INVESTMENT GAINS (LOSSES) - - ---------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - ---------------------------------------------------------------------------- (In millions of dollars) Realized investment gains and (losses): Fixed maturities $467 $452 $293 Equity securities 38 103 216 Derivative securities 12 (7) 18 Other, including guaranteed Separate Account business 178 205* 92 -------------------- 695 753 619 Allocated to participating policyholders (14) (15) (14) Income tax expense (247) (260) (218) - - ---------------------------------------------------------------------------- Net realized investment gains 434 478 387 - - ---------------------------------------------------------------------------- Change in net unrealized investment gains and (losses): Fixed maturities 34 347 (878) Equity securities 796 (38) (24) Other, including guaranteed Separate Account business (107) 72 (122) -------------------- 723 381 (1,024) Minority interest (6) (5) 5 Allocated to participating policyholders - (4) 18 Income tax (expense) benefit (249) (101) 357 - - ---------------------------------------------------------------------------- Change in net unrealized investment gains (losses) 468 271 (644) - - ---------------------------------------------------------------------------- NET REALIZED AND UNREALIZED INVESTMENT GAINS (LOSSES) $902 $749 $(257) ============================================================================ *INCLUDES $95 MILLION RELATED TO THE CNA SURETY TRANSACTION. SUMMARY OF PROCEEDS FROM SALES AND GROSS REALIZED INVESTMENT GAINS (LOSSES) FOR FIXED MATURITIES AND EQUITY SECURITIES - - ----------------------------------------------------------------------------
1998 1997 1996 --------------------- ----------------------- ----------------------- Fixed Equity Fixed Equity Fixed Equity Year Ended December 31 Maturities Securities Maturities Securities Maturities Securities - - ----------------------------------------------------------------------------------------------- (In millions of dollars) Proceeds from sales $35,480 $848 $38,429 $1,406 $34,864 $1,077 =============================================================================================== Gross realized gains $ 621 $119 $ 651 $ 137 $ 412 $ 241 Gross realized losses (154) (81) (199) (34) (119) (25) - - ----------------------------------------------------------------------------------------------- NET REALIZED GAINS ON SALES $ 467 $ 38 $ 452 $ 103 $ 293 $ 216 ===============================================================================================
CNA FINANCIAL CORPORATION ------------------------- 71 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ---------------------------------------------------------------------------- Note B - Investments (cont.)
ANALYSIS OF NET UNREALIZED INVESTMENT GAINS (LOSSES) INCLUDED IN STOCKHOLDERS' EQUITY - - ----------------------------------------------------------------------------------------- 1998 1997 ------------------------------- --------------------------- December 31 Gains Losses Net Gains Losses Net - - ----------------------------------------------------------------------------------------- (In millions of dollars) Fixed maturities $ 818 $ (256) $ 562 $ 644 $ (116) $ 528 Equity securities 1,051 (136) 915 190 (71) 119 Other, including guaranteed Separate Account business 217 (166) 51 268 (110) 158 -------------------------------------------------------------- $2,086 $ (558) 1,528 $1,102 $ (297) 805 ==================== ================ Minority Interest (6) - Allocated to participating policyholders (4) (4) Deferred income taxes (527) (278) - - -------------------------------------------------------------------------------------------- NET UNREALIZED INVESTMENT GAINS $ 991 $ 523 ============================================================================================
SUMMARY OF INVESTMENTS IN FIXED MATURITIES AND EQUITY SECURITIES AVAILABLE FOR SALE - - ------------------------------------------------------------------------------ Gross Gross Amortized Unrealized Unrealized Market December 31, 1998 Cost Gains Losses Value - - ------------------------------------------------------------------------------ (In millions of dollars) United States Treasury securities and obligations of government agencies $ 7,568 $ 183 $ 17 $ 7,734 Asset-backed securities 8,096 130 12 8,214 States, municipalities and political subdivisions - tax-exempt $ 6,127 206 12 6,321 Corporate securities 5,074 135 143 5,066 Other debt securities 2,610 104 70 2,644 Redeemable preferred stocks 36 60 2 94 - - ----------------------------------------------------------------------------- Total fixed maturities 29,511 818 256 30,073 Equity securities 1,055 1,051 136 1,970 - - ------------------------------------------------------------------------------ TOTAL $30,566 $1,869 $392 $32,043 ============================================================================== CNA FINANCIAL CORPORATION ------------------------- 72 - - ----------------------------------------------------------------------------- Note B - Investments (cont.) SUMMARY OF INVESTMENTS IN FIXED MATURITIES AND EQUITY SECURITIES AVAILABLE FOR SALE - - ------------------------------------------------------------------------------ Gross Gross Amortized Unrealized Unrealized Market December 31, 1997 Cost Gains Losses Value - - ------------------------------------------------------------------------------ (In millions of dollars) United States Treasury securities and obligations of government agencies $12,883 $119 $ 22 $12,980 Asset-backed securities 4,716 98 10 4,804 States, municipalities and political subdivisions - tax-exempt 4,534 194 4 4,724 Corporate securities 5,253 142 49 5,346 Other debt securities 1,567 61 31 1,597 Redeemable preferred stocks 67 30 - 97 - - ------------------------------------------------------------------------------ Total fixed maturities 29,020 644 116 29,548 Equity securities 695 190 71 814 - - ------------------------------------------------------------------------------ TOTAL $29,715 $834 $187 $30,362 ============================================================================== SUMMARY OF INVESTMENTS IN FIXED MATURITIES BY CONTRACTUAL MATURITY - - ----------------------------------------------------------------------------- 1998 1997 ------------------- ------------------ Amortized Market Amortized Market December 31 Cost Value Cost Value - - ----------------------------------------------------------------------------- (In millions of dollars) Due in one year or less $ 3,167 $ 3,273 $ 2,058 $ 2,077 Due after one year through five years 5,419 5,437 11,520 11,525 Due after five years through ten years 5,380 5,353 3,323 3,373 Due after ten years 7,449 7,796 7,403 7,769 Asset-backed securities not due at a single maturity date 8,096 8,214 4,716 4,804 - - ----------------------------------------------------------------------------- TOTAL $29,511 $30,073 $29,020 $29,548 ============================================================================= Actual maturities may differ from contractual maturities because securities may be called or prepaid with or without call or prepayment penalties. The carrying value of investments (other than equity securities) that have not produced income for the last twelve months is $23 million at December 31, 1998. At December 31, 1998, there were no investments in a single issuer, other than the U.S. government, that, when aggregated exceeded 10% of stockholders' equity. The Company's largest equity holding in a single issuer is Global Crossing, Ltd. (Global Crossing) common stock. On December 31, 1998, the CNA FINANCIAL CORPORATION ------------------------- 73 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ------------------------------------------------------------------------------ Note B - Investments (cont.) Company owned 20,037,584 shares, or 9.8% of the outstanding common stock of Global Crossing which was valued at $904 million. Net unrealized gains associated with this security approximated $841 million at December 31, 1998. Without registration or an exemption from registration, sales to the public of the Company's holdings of Global Crossing are governed by Rule 144 of the Securities Act of 1933 (the Act) and may not commence until August 13, 1999. The Company has the right after August 13, 1999 to require Global Crossing to register under the Act up to 25% of the Company's holdings prior to December 31, 1999. STATUTORY DEPOSITS - - ----------------------------------- Cash and securities with carrying values of $1.7 billion and $2.1 billion were deposited by CNAF's subsidiaries under requirements of regulatory authorities as of December 31, 1998 and 1997, respectively. CNA FINANCIAL CORPORATION ------------------------- 74 - - ----------------------------------------------------------------------------- Note C - Financial Instruments NOTE C - Financial Instruments: - - ------------------------------ In the normal course of business, CNA invests in various financial assets, incurs various financial liabilities, and enters into agreements involving derivative securities, including off-balance sheet financial instruments. Fair values are required to be disclosed for all financial instruments, whether or not recognized in the consolidated balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values may be based on estimates using present value or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rates and estimates of future cash flows. Potential taxes and other transaction costs have not been considered in estimating fair value. The estimates presented herein are subjective in nature and are not necessarily indicative of the amounts that CNA could realize in a current market exchange. Non-financial instruments such as real estate, deferred acquisition costs, property and equipment, deferred income taxes, intangibles and insurance reserves are excluded from fair value disclosure. Thus, the total fair value amounts cannot be aggregated to determine the underlying economic value of CNA. The carrying amounts reported in the consolidated balance sheet approximates fair value for cash, short-term investments, accrued investment income, receivables for securities sold, federal income taxes recoverable, securities sold under repurchase agreements, payables for securities purchased and certain other assets and other liabilities because of their short-term nature. Accordingly, these assets and liabilities are not listed in the following tables. The carrying amounts and estimated fair values of CNA's other financial instrument assets and liabilities are listed in the following tables. Derivative instruments are shown in a separate table. CNA FINANICIAL CORPORATION -------------------------- 75 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ------------------------------------------------------------------------------- Note C -- Financial Instruments (cont.)
FINANCIAL ASSETS - - ------------------------------------------------------------------------------------- 1998 1997 --------------------- -------------------- Carrying Estimated Carrying Estimated December 31 Amount Fair Value Amount Fair Value - - ------------------------------------------------------------------------------------- (In millions of dollars) Investments: Fixed maturities $ 30,073 $ 30,073 $ 29,548 $ 29,548 Equity securities 1,970 1,970 814 814 Mortgage loans 57 61 80 83 Policy loans 177 173 177 168 Other invested assets 858 858 695 695 Separate Account business: Fixed maturities 4,155 4,155 4,769 4,769 Equity securities 297 297 206 206 Other 216 216 117 117 Notes receivable from officer shareholders 44 39 - - - - -------------------------------------------------------------------------------------
The following methods and assumptions were used by CNA in estimating the fair value for the above financial assets. Fixed maturity securities and equity securities were based on quoted market prices, where available. For securities not actively traded, fair values were estimated using values obtained from independent pricing services, costs to settle or quoted market prices of comparable instruments. The fair values for mortgage loans and policy loans were estimated using discounted cash flow analyses at interest rates currently offered for similar loans to borrowers with comparable credit ratings. Loans with similar characteristics were aggregated for purposes of the calculations. Valuation techniques to determine fair value of other invested assets and other Separate Account business assets consisted of discounted cash flows and quoted market prices of the investments, comparable instruments or underlying assets of the investments. CNA FINANCIAL CORPORATION ------------------------- 76 - - ------------------------------------------------------------------------------- Note C - Financial Instruments (cont.) FINANCIAL LIABILITIES - - ------------------------------------------------------------------------------- 1998 1997 -------------------- ------------------- Carrying Estimated Carrying Estimated December 31 Amount Fair Value Amount Fair Value - - ------------------------------------------------------------------------------- (In millions of dollars) Premium deposits and annuity contracts $ 1,259 $ 1,205 $ 1,194 $ 1,145 Debt 3,160 3,179 2,897 2,928 Financial guarantee contracts 240 231 382 373 Separate Account business: Guaranteed investment contracts 2,423 2,478 3,414 3,448 Variable separate accounts 1,268 1,268 997 997 Deferred annuities 85 102 73 90 Other 600 600 614 614 - - ------------------------------------------------------------------------------ Premium deposits and annuity contracts were valued based on cash surrender values and the outstanding fund balances. CNA's Senior Notes and debentures were valued based on quoted market prices. The fair value for other long-term debt was estimated using discounted cash flow analyses, based on current incremental borrowing rates for similar types of borrowing arrangements. The fair value of the liability for financial guarantee contracts was based on discounted cash flows utilizing interest rates currently being offered for similar contracts. The fair values of guaranteed investment contracts and deferred annuities of the Separate Account business were estimated using discounted cash flow calculations, based on interest rates currently being offered for similar contracts with similar maturities. The fair values of the liabilities for variable Separate Account business are based on the quoted market values of the underlying assets of each variable Separate Account. The fair value of other Separate Account business liabilities approximated their carrying value. CNA FINANCIAL CORPORATION ------------------------- 77 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ------------------------------------------------------------------------------ Note C - Financial Instruments (cont.) DERIVATIVE FINANCIAL INSTRUMENTS - - -------------------------------------------- CNA invests in derivative financial instruments in the normal course of business primarily to reduce its exposure to market risk (principally interest rate, equity stock price and foreign currency risk). Financial instruments used for such purposes include interest rate swaps, interest rate caps, put and call options, commitments to purchase securities, futures and forwards. The Company generally does not hold or issue these instruments for trading purposes. CNA also uses derivatives to mitigate the risk associated with its indexed group annuity contracts by purchasing S&P 500 futures contracts in a notional amount equal to the portion of the customer liability related to S&P 500 exposure. The gross notional principal or contractual amounts of derivative financial instruments in the general account at December 31, 1998 and 1997 totaled $1,667 million and $1,609 million, respectively. The gross notional principal or contractual amounts of derivative financial instruments in the Separate Accounts totaled $1,193 million and $956 million at December 31, 1998 and 1997, respectively. The contractual or notional amounts are used to calculate the exchange of contractual payments under the agreements and are not representative of the potential for gain or loss on these agreements. The fair values associated with derivative financial instruments are generally affected by interest rates, equity prices and foreign currency exchange rates. The credit exposure associated with these instruments is generally limited to the unrealized fair value of the instruments and will vary based on the creditworthiness of the counterparties. Although the Company is exposed to the aforementioned credit risk, it does not expect any counterparty to fail to perform as contracted based on the creditworthiness of the counterparties. Due to the nature of the derivative securities, the Company does not require collateral. The fair value of derivatives generally reflects the estimated amounts that CNA would receive or pay upon termination of the contracts at the reporting date. Dealer quotes are available for substantially all of CNA's derivatives. For securities not actively traded, fair values are estimated using values obtained from independent pricing services, costs to settle or quoted market prices of comparable instruments. CNA FINANCIAL CORPORATION ------------------------- 78 - - ------------------------------------------------------------------------------- Note C - Financial Instruments (cont.) A summary of the aggregate contractual or notional amounts, estimated fair values and gains or losses related to derivative financial instruments as of and for the year ended December 31, 1998 and 1997 are presented below.
- - --------------------------------------------------------------------------------------------- CONTRACTUAL/ ASSET/(LIABILITY) RECOGNIZED DECEMBER 31, 1998 NOTIONAL AMOUNT FAIR VALUE GAIN (LOSS) - - --------------------------------------------------------------------------------------------- (In millions of dollars) General Account Interest rate swaps - corporate borrowings $ 650 $(10) $ -- Interest rate swaps - other 78 (10) (30) Interest rate caps 500 1 (2) Futures - short 158 -- (3) Forwards 211 (1) (6) Options purchased 70 3 51 Options written -- -- 2 - - --------------------------------------------------------------------------------------------- TOTAL $1,667 $(17) $ 12 ============================================================================================= Separate Accounts Futures - long $ 928 $ 2 $ 156* Futures - short 51 -- (1) Forwards 2 -- -- Commitments to purchase government and municipal securities 69 1 4 Options purchased 77 1 (1) Options written 66 -- 2 - - --------------------------------------------------------------------------------------------- TOTAL $1,193 $ 4 $ 160 ============================================================================================= *AMOUNT IS OFFSET BY AN INCREASE IN THE LIABILITY TO PARTICIPANTS.
CNA FINANCIAL CORPORATION ------------------------- 79 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ----------------------------------------------------------------------------- Note C - Financial Instruments (cont.)
- - ----------------------------------------------------------------------------------------------- CONTRACTUAL/ ASSET/(LIABILITY) RECOGNIZED DECEMBER 31, 1997 NOTIONAL AMOUNT FAIR VALUE GAIN (LOSS) - - ----------------------------------------------------------------------------------------------- (In millions of dollars) General Account Interest rate swaps - corporate borrowings $ 950 $ (4) $ -- Interest rate swaps - other 59 (8) (8) Interest rate caps 500 4 (1) Futures - short 21 -- (1) Forwards 11 -- 7 Commitments to purchase government and municipal securities -- -- 1 Options purchased 67 2 (5) Options written 1 -- -- - - ------------------------------------------------------------------------------------------------- TOTAL $1,609 $ (6) $ (7) ================================================================================================= Separate Accounts Futures - long $ 663 $ -- $ 112* Futures - short 48 -- -- Forwards 1 -- -- Commitments to purchase government and municipal securities 80 -- 1 Options purchased 91 -- (1) Options written 73 -- 2 - - -------------------------------------------------------------------------------------------------- TOTAL $ 956 $ -- $ 114 ================================================================================================== *AMOUNT IS OFFSET BY AN INCREASE IN THE LIABILITY TO PARTICIPANTS.
An interest rate swap is an agreement in which two parties agree to exchange, at specified intervals, interest payment streams calculated on an agreed-upon notional principal amount with at least one stream based upon a specified floating rate index. CNAF has entered into interest rate swap agreements to convert the variable rate of the borrowing under the revolving credit facility and the commercial paper program to a fixed rate. At December 31, 1998 and 1997, CNAF had outstanding interest rate swap agreements with several banks having a total notional principal amount of $650 million and $950 million, respectively. Those agreements, which terminate from May 2000 to December 2000, effectively fixed CNAF's interest rate exposure on $650 million and $950 million of variable rate debt, respectively. CNA FINANCIAL CORPORATION ------------------------- 80 - - ----------------------------------------------------------------------------- Note C - Financial Instruments (cont.) CNA also has outstanding trading interest rate swaps which primarily represent an exchange of the 90-day treasury bill rate for the change in the Goldman Sachs Commodities Index. Futures are contracts to buy or sell a standard quantity and quality of a commodity, financial instrument or index at a specified future date and price. Forwards are contracts between two parties to purchase and sell a specific quantity of a commodity, government security, foreign currency, or other financial instrument at a price specified at contract inception, with delivery and settlement at a specified future date. Commitments to purchase government and municipal securities are agreements to purchase securities in the future at a predetermined price. Options are contracts that grant the purchaser, for a premium payment, the right, but not the obligation, to either purchase or sell a financial instrument at a specified price within a specified period of time. An interest rate cap consists of a guarantee given by the issuer to the purchaser in exchange for the payment of a premium. This guarantee states that if interest rates rise above a specified rate the issuer will pay to the purchaser the difference between the then current market rate and the specified rate on the notional principal amount. CNA FINANCIAL CORPORATION ------------------------- 81 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ----------------------------------------------------------------------------- Note D -- Income Taxes Note D - Income Taxes: - - ---------------------- CNAF and its eligible subsidiaries (CNA Tax Group) are included in the consolidated Federal income tax return of Loews and its eligible subsidiaries. Loews and CNAF have agreed that for each taxable year, CNA will (i) be paid by Loews the amount, if any, by which the Loews consolidated Federal income tax liability is reduced by virtue of the inclusion of the CNA Tax Group in the Loews consolidated Federal income tax return, or (ii) pay to Loews an amount, if any, equal to the Federal income tax which would have been payable by the CNA Tax Group filing a separate consolidated tax return. In the event that Loews should have a net operating loss in the future computed on the basis of filing a separate consolidated tax return without the CNA Tax Group, CNAF may be required to repay tax recoveries previously received from Loews. This agreement between Loews and CNAF may be canceled by either party upon thirty days written notice. For 1998, the inclusion of the CNA Tax Group in the consolidated Federal income tax return of Loews has resulted in a decreased Federal income tax liability for Loews. Accordingly, Loews has paid or will pay to CNAF approximately $83 million for 1998. In 1997 and 1996, the inclusion of the CNA Tax Group increased the Federal income tax liability for Loews. Accordingly, CNAF has paid Loews approximately $210 million for 1997 and $99 million for 1996. CNA FINANCIAL CORPORATION ------------------------- 82 - - ------------------------------------------------------------------------------- Note D -- Income Taxes (cont.) A reconciliation between the statutory Federal income tax rate and CNA's effective income tax rate as a percentage of income before income taxes, after giving effect to minority interest, is as follows: - - --------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - --------------------------------------------------------------------------- Income taxes at statutory rates 35.0% 35.0% 35.0% Tax exempt interest and dividends received deduction (31.3) (6.7) (6.4) State income taxes 8.3 1.5 0.7 Other 2.3 (0.9) (1.0) - - --------------------------------------------------------------------------- EFFECTIVE INCOME TAX RATE 14.3% 28.9% 28.3% =========================================================================== The composition of CNA's total income tax expense allocated between operating income and realized investment gains and losses is as follows: - - --------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - --------------------------------------------------------------------------- (In millions of dollars) Income tax (benefit) expense on operating income $(200) $132 $162 Income tax expense on realized investment gains 247 260 218 - - --------------------------------------------------------------------------- TOTAL INCOME TAX EXPENSE $ 47 $392 $380 =========================================================================== The current and deferred components of CNA's income tax expense are as follows: - - --------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - --------------------------------------------------------------------------- (In millions of dollars) Current tax expense $ - $248 $ 28 Deferred tax expense 47 144 352 - - --------------------------------------------------------------------------- TOTAL INCOME TAX EXPENSE $ 47 $392 $380 =========================================================================== CNA FINANCIAL CORPORATION ------------------------- 83 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ------------------------------------------------------------------------------ Note D - Income Taxes (cont.) CNA's deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of CNA's deferred tax assets and liabilities as of December 31, 1998 and 1997, respectively, are set forth in the table below. The 1998 amounts reflect an increase in certain components of net deferred tax assets as a result of the finalization of an Internal Revenue Service examination. Such increase resulted in a corresponding reduction of intangible assets. - - ----------------------------------------------------------------- Year Ended December 31 1998 1997 - - ----------------------------------------------------------------- (In millions of dollars) Insurance reserves: Property/casualty claim reserves $1,183 $ 1,101 Unearned premium reserves 372 283 Life reserves 195 157 Other insurance reserves 27 22 Deferred acquisition costs (748) (667) Postretirement benefits other than pensions 142 149 Net unrealized gains (527) (278) Restructuring costs 56 - Other, net 295 303 - - ----------------------------------------------------------------- NET DEFERRED TAX ASSETS $ 995 $ 1,070 ================================================================= At December 31, 1998, gross deferred tax assets and liabilities amounted to approximately $2.7 billion and $1.7 billion, respectively. At December 31, 1997, gross deferred tax assets and liabilities amounted to approximately $2.7 billion and $1.6 billion, respectively. CNA has a history of profitability and as such, CNA's management believes it is more likely than not that the net deferred tax assets will be realized. CNA FINANCIAL CORPORATION ------------------------- 84 - - ------------------------------------------------------------------------------ Note E --Liability for Unpaid Claims and Claim Adjustment Expenses Note E - Liability for Unpaid Claims and Claim Adjustment Expenses: - - ------------------------------------------------------------------- CNA's property/casualty insurance claims and claim adjustment expense reserves represent the estimated amounts necessary to settle all outstanding claims, including claims which are incurred but not reported, as of the reporting date. The Company's reserve projections are based primarily on detailed analysis of the facts in each case, CNA's experience with similar cases and various historical development patterns. Consideration is given to such historical patterns as field reserving trends, loss payments, pending levels of unpaid claims and product mix, as well as court decisions, economic conditions and public attitudes. All of these can affect the estimation of reserves. Establishing loss reserves is an estimation process. Many factors can ultimately affect the final settlement of a claim and, therefore, the reserve that is needed. Changes in the law, results of litigation, medical costs, the cost of repair materials and labor rates can all impact ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably estimable than long-tail claims, such as general liability and professional liability claims. CNA FINANCIAL CORPORATION ------------------------- 85 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ------------------------------------------------------------------------------ Note E -- Liability for Unpaid Claims and Claim Adjustment Expenses (cont.) The table below provides a reconciliation between beginning and ending claim and claim adjustment expense reserve balances for 1998, 1997 and 1996. CHANGES IN RESERVES FOR PROPERTY/CASUALTY CLAIMS AND CLAIM ADJUSTMENT EXPENSES - - ------------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - ------------------------------------------------------------------------------- (In millions of dollars) Reserves at beginning of year: Gross $28,571 $29,395 $31,044 Ceded 5,326 5,660 6,089 - - ------------------------------------------------------------------------------- Net reserves at beginning of year 23,245 23,735 24,955 Net reserves of acquired insurance companies at date of acquisition 122 57 -- - - ------------------------------------------------------------------------------- Total net reserves 23,367 23,792 24,955 - - ------------------------------------------------------------------------------- Net incurred claims and claim adjustment expenses: Provision for insured events of current year 7,903 7,942 7,922 Increase (decrease) in provision for insured events of prior years 263 (256) (91) Amortization of discount 143 143 149 - - ------------------------------------------------------------------------------- Total net incurred 8,309 7,829 7,980 - - ------------------------------------------------------------------------------- Net payments attributable to: Current year events 2,791 2,514 2,676 Prior year events 5,954 5,862 6,524 - - ------------------------------------------------------------------------------- Total net payments 8,745 8,376 9,200 - - ------------------------------------------------------------------------------- Net reserves at end of year 22,931 23,245 23,735 Ceded at end of year 5,424 5,326 5,660 - - ------------------------------------------------------------------------------- GROSS RESERVES AT END OF YEAR* $28,355 $28,571 $29,395 =============================================================================== * EXCLUDES LIFE CLAIM AND CLAIM EXPENSE RESERVES AND INTERCOMPANY ELIMINATIONS OF $837 MILLION, $987 MILLION AND $1 BILLION AS OF DECEMBER 31, 1998, 1997 AND 1996, RESPECTIVELY, INCLUDED IN THE CONSOLIDATED BALANCE SHEET. The increase (decrease) in provision for insured events of prior years (reserve development) is comprised of the following components: RESERVE DEVELOPMENT-adverse/(favorable) - - ------------------------------------------------------------------------------- Year Ended December 31 1998 1997 1996 - - ------------------------------------------------------------------------------- (In millions of dollars) Asbestos $ 243 $ 105 $ 51 Environmental pollution and other mass tort 227 -- 65 Other (207) (361) (207) - - ------------------------------------------------------------------------------- TOTAL $ 263 $ (256) $ (91) =============================================================================== CNA FINANCIAL CORPORATION -------------------------- 86 - - ------------------------------------------------------------------------------- Note E - Liability for Unpaid Claims and Claim Adjustment Expenses (cont.) ENVIRONMENTAL, OTHER MASS TORT AND ASBESTOS RESERVES - - ---------------------------------------------------- Environmental pollution clean-up is the subject of both federal and state regulation. By some estimates, there are thousands of potential waste sites subject to clean-up. The insurance industry is involved in extensive litigation regarding coverage issues. Judicial interpretations in many cases have expanded the scope of coverage and liability beyond the original intent of the policies. The Comprehensive Environmental Response Compensation and Liability Act of 1980 (Superfund) and comparable state statutes (mini-Superfund) govern the clean-up and restoration of abandoned toxic waste sites and formalize the concept of legal liability for clean-up and restoration by Potentially Responsible Parties (PRPs). Superfund and the mini-Superfunds establish mechanisms to pay for clean-up of waste sites if PRPs fail to do so, and to assign liability to PRPs. The extent of liability to be allocated to a PRP is dependent on a variety of factors. Further, the number of waste sites subject to clean-up is unknown. To date, approximately 1,300 clean-up sites have been identified by the Environmental Protection Agency on its National Priorities List (NPL). The addition of new clean-up sites to the NPL has slowed in recent years. Many clean-up sites have been designated by state authorities as well. Many policyholders have made claims against various CNAF insurance subsidiaries for defense costs and indemnification in connection with environmental pollution matters. These claims relate to accident years 1989 and prior, which coincides with CNA's adoption of the Simplified Commercial General Liability coverage form which included an absolute pollution exclusion. CNA and the insurance industry are disputing coverage for many such claims. Key coverage issues include whether clean-up costs are considered damages under the policies, trigger of coverage, allocation of liability among triggered policies, applicability of pollution exclusions and owned property exclusions, the potential for joint and several liability and definition of an occurrence. To date, courts have been inconsistent in their rulings on these issues. A number of proposals to reform Superfund have been made by various parties. However, no reforms were enacted by Congress in 1998 and it is unclear as to what positions the Congress or the Administration will take and what legislation, if any, will result. If there is legislation, and in some circumstances even if there is no legislation, the federal role in environmental clean-up may be materially reduced in favor of state action. Substantial changes in the federal statute or the activity of the EPA may cause states to reconsider their environmental clean-up statutes and regulations. There can be no meaningful prediction of the regulation that would result. Due to the inherent uncertainties described above, including the inconsistency of court decisions, the number of waste sites subject to clean-up, and the standards for clean-up and liability, the ultimate liability of CNA for environmental pollution claims may vary substantially from the amount currently recorded. As of December 31, 1998 and 1997, CNA carried approximately $787 million and $773 million, respectively, of claim and claim adjustment expense reserves, net of reinsurance recoverables, for reported and unreported environmental pollution and other mass tort claims. In 1998 CNA CNA FINANCIAL CORPORATION ------------------------- 87 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ------------------------------------------------------------------------------ Note E - Liability for Unpaid Claims and Claim Adjustment Expenses (cont.) recorded $227 million of adverse development compared to no development in 1997. The additional strengthening in 1998 was based upon the Company's continuous review of these types of exposures, as well as its internal study and annual analysis of environmental pollution and other mass tort claims. This analysis indicated deterioration in claim experience related to pollution claims, as well as some emerging mass tort exposures. CNAF's insurance subsidiaries have exposure to asbestos claims, including those attributable to CNA's litigation with Fibreboard Corporation. A detailed discussion of CNA's litigation with Fibreboard Corporation regarding asbestos-related bodily injury claims can be found in Note F. Estimation of asbestos claim reserves involves many of the same limitations discussed above for environmental pollution claims such as inconsistency of court decisions, specific policy provisions, allocation of liability among insurers, missing policies and proof of coverage. As of December 31, 1998 and 1997, CNA carried approximately $1,456 million and $1,400 million, respectively, of claim and claim adjustment expense reserves, net of reinsurance recoverables, for reported and unreported asbestos-related claims. In 1998, CNA recorded $243 million of adverse development compared to $105 million of adverse development in 1997. As with the Company's exposure to environmental pollution and other mass tort exposures, the additional reserve strengthening in 1998 for asbestos-related claims, was a result of management's continuous review of development with respect to these exposures, as well as a review of the results of the Company's annual analysis of these claims which was completed in conjunction with the study of environmental pollution and other mass tort claims. This analysis indicated deterioration in claims experience and claim counts for asbestos-related claims. The results of operations in future years may continue to be adversely affected by environmental pollution and asbestos claims and claim adjustment expenses. Management will continue to monitor these liabilities and make further adjustments as warranted. OTHER PROPERTY AND CASUALTY RESERVES - - ------------------------------------------------- Other lines favorable loss and loss adjustment expense reserve development for 1998 of $207 million was due to favorable loss development of approximately $100 million in commercial lines business and approximately $105 million of favorable loss development in personal lines business. The favorable development in the commercial lines business was primarily attributable to improved frequency and severity in the commercial auto lines, as well as some continued improvement in workers' compensation. The favorable development in the personal lines business was attributable to improved trends, particularly in personal auto liability. Other lines favorable loss and loss adjustment expense reserve development for 1997 of $361 million was due to favorable loss development of $540 million in workers' compensation involuntary risks and $200 million of favorable loss development in personal lines. This favorable development was offset in part by unfavorable development in other commercial lines of $379 million. The favorable loss development in involuntary risks is attributable to better than expected results in workers' compensation and private passenger automobile lines stemming from improved frequency and severity in these lines. This favorable loss development was offset in part by unfavorable premium development of $340 million as estimates of premiums for prior years were reduced. CNA FINANCIAL CORPORATION ------------------------- 88 - - ------------------------------------------------------------------------------ Note E - Liability for Unpaid Claims and Claim Adjustment Expenses (cont.) The favorable loss development in personal lines was attributable to improved trends particularly in personal auto lines. The unfavorable development in other commercial lines was attributable to approximately $240 million in general liability lines as well as adverse trends in construction defect coverages, approximately $130 million in commercial multiperil, and adverse loss adjustment expense development of approximately $215 million, offset in part by favorable development of $206 million, primarily in workers' compensation and reinsurance lines. This unfavorable loss development was offset in part by favorable premium development of $170 million. The other favorable development during 1996 of $207 million was principally due to favorable experience in the workers' compensation line of business. CNA FINANCIAL CORPORATION ------------------------- 89 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ------------------------------------------------------------------------------ Note E -- Liability for Unpaid Claims and Claim Adjustment Expenses (cont.) The following tables provide additional data related to CNA's environmental pollution, other mass tort and asbestos-related claims activity.
RESERVE SUMMARY - - -------------------------------------------------------------------------------------- December 31 1998 1997 -------------------------- --------------------------- Environmental Environmental Pollution and Pollution and Other Mass Tort Asbestos Other Mass Tort Asbestos - - -------------------------------------------------------------------------------------- (In millions of dollars) Reported claims: Gross reserves $291 $1,305 $279 $1,198 Less reinsurance recoverable (41) (91) (36) (117) ------------------------------------------------------- Net reported claims 250 1,214 243 1,081 Net unreported claims 537 242 530 319 - - -------------------------------------------------------------------------------------- NET RESERVES $787 $1,456 $773 $1,400 ======================================================================================
ENVIRONMENTAL POLLUTION AND OTHER MASS TORT CHANGES IN RESERVES - - ------------------------------------------------------------------ Year ended December 31 1998 1997 1996 - - ------------------------------------------------------------------ (In millions of dollars) Net reserves at beginning of year $ 773 $ 908 $1,063 Reserve strengthening 227 -- 65 Less: Gross payments 274 258 304 Reinsurance recoveries (61) (123) (84) ------------------------------ Net payments 213 135 220 - - ------------------------------------------------------------------ NET RESERVES AT END OF YEAR $ 787 $ 773 $ 908 ================================================================== ASBESTOS CHANGES IN RESERVES - - ------------------------------------------------------------------ Year ended December 31 1998 1997 1996 - - ------------------------------------------------------------------ (In millions of dollars) Net reserves at beginning of year $1,400 $1,506 $2,191 Reserve strengthening 243 105 51 Less: Gross payments 239 268 787 Reinsurance recoveries (52) (57) (51) ------------------------------- Net payments 187 211 736 - - -------------------------------------------------------------------- NET RESERVES AT END OF YEAR $1,456 $1,400 $1,506 ==================================================================== CNA FINANCIAL CORPORATION ------------------------- 90 - - ----------------------------------------------------------------------------- Note F -- Legal Proceedings and Contingent Liabilities Note F - Legal Proceedings and Contingent Liabilities: - - ------------------------------------------------------ FIBREBOARD LITIGATION - - ---------------------------------------- CNAF's primary property/casualty subsidiary, Continental Casualty Company (Casualty), has been party to litigation with Fibreboard Corporation (Fibreboard) involving coverage for certain asbestos-related claims and defense costs (San Francisco Superior Court, Judicial Council Coordination Proceeding 1072). As described below, Casualty, Fibreboard, another insurer (Pacific Indemnity, a subsidiary of the Chubb Corporation), and a negotiating committee of asbestos claimant attorneys (collectively referred to as "Settling Parties") have reached a Global Settlement Agreement to resolve all future asbestos-related bodily injury claims involving Fibreboard, which is subject to court approval. Casualty, Fibreboard and Pacific Indemnity have also reached an agreement (the "Trilateral Agreement") on a settlement to resolve the coverage litigation in the event the Global Settlement Agreement does not obtain final court approval. On July 27, 1995, the United States District Court for the Eastern District of Texas entered judgment approving the Global Settlement Agreement and the Trilateral Agreement. As expected, appeals were filed as respects both of these decisions. On July 25, 1996, a panel of the United States Fifth Circuit Court of Appeals in New Orleans affirmed the judgment approving the Global Settlement Agreement by a 2 to 1 vote and affirmed the judgment approving the Trilateral Agreement by a 3 to 0 vote. Petitions for rehearing by the panel and Suggestions for Rehearing by the entire Fifth Circuit Court of Appeals as respects the decision on the Global Settlement Agreement were denied. Two petitions for certiorari were filed in the Supreme Court as respects the Global Settlement Agreement. On June 27, 1997, the Supreme Court granted these petitions, vacated the Fifth Circuit's judgment as respects the Global Settlement Agreement, and remanded the matter to the Fifth Circuit for reconsideration in light of the Supreme Court's decision in Amchem Products Co. v. Windsor. ------------------------------- On January 27, 1998, a panel of the United States Fifth Circuit Court of Appeals again approved the Global Settlement Agreement by a 2 to 1 vote. Two sets of Objectors filed petitions for certiorari, which were docketed on April 16 and 17, 1998, by the United States Supreme Court. On June 22, 1998, the Supreme Court granted the petition for certiorari filed by one set of Objectors. The Supreme Court heard oral arguments on December 8, 1998. No opinion has yet been released. No further appeal was filed with respect to the Trilateral Agreement; therefore, court approval of the Trilateral Agreement has become final. SETTLEMENT AGREEMENTS On April 9, 1993, Casualty and Fibreboard entered into an agreement pursuant to which, among other things, the parties agreed to use their best efforts to negotiate and finalize a global class action settlement with asbestos-related bodily injury and death claimants. On August 27, 1993, the Settling Parties reached an agreement in principle for an omnibus settlement to resolve all future asbestos-related bodily CNA FINANCIAL CORPORATION ------------------------- 91 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ------------------------------------------------------------------------------ Note F - Legal Proceedings and Contingent Liabilities (cont.) injury claims involving Fibreboard. The Global Settlement Agreement was executed on December 23, 1993. The agreement calls for contribution by Casualty and Pacific Indemnity of an aggregate of $1.53 billion to a trust fund for a class of all future asbestos claimants, defined generally as those persons whose claims against Fibreboard were neither filed nor settled before August 27, 1993. (As used in this note, "present" claims generally refers to asbestos claims filed against Fibreboard on or before August 27, 1993). An additional $10 million is to be contributed to the fund by Fibreboard. As indicated above, the Global Settlement Agreement has been approved by the Fifth Circuit a second time, but the Supreme Court granted a petition for certiorari and is currently reviewing the Fifth Circuit decision. On October 12, 1993, Casualty, Pacific Indemnity and Fibreboard entered into the Trilateral Agreement to settle the coverage litigation to operate in the event that the Global Settlement Agreement is disapproved. The Trilateral Agreement calls for payment by Casualty and Pacific Indemnity of an aggregate $2.0 billion, of which Casualty's portion is approximately $1.46 billion, to Fibreboard to resolve all claims by Fibreboard and all future and certain present asbestos claimants arising under the policy issued to Fibreboard by Casualty. Under either the Global Settlement Agreement or the Trilateral Agreement, Casualty is also obligated to pay prior settlements of present asbestos claims. As a result of the final approval of the Trilateral Agreement, such obligation has become final. Through December 31, 1998, Casualty, Fibreboard and plaintiff attorneys had reached settlements with respect to approximately 134,000 claims, for an estimated settlement amount of approximately $1.63 billion plus any applicable interest. Final court approval of the Trilateral Agreement obligated Casualty to pay under these settlements. Approximately $1.69 billion (including interest of $185 million) was paid through December 31, 1998. Such payments have been partially recovered from Pacific Indemnity. Casualty may negotiate other agreements for unsettled claims. Final court approval of the Trilateral Agreement and its implementation has substantially resolved Casualty's exposure with respect to asbestos claims involving Fibreboard. While there does exist the possibility of further adverse developments with respect to Fibreboard claims, management does not anticipate subsequent reserve adjustments, if any, to materially affect the equity of CNAF. Management will continue to monitor the potential liabilities with respect to Fibreboard asbestos claims and will make adjustments to claim reserves if warranted. TOBACCO LITIGATION - - ------------------------------------- CNA's primary property/casualty subsidiaries have been named as defendants as part of a "direct action" lawsuit, Richard P. Ieyoub v. The American Tobacco ------------------------------------------ Company, et. al., filed by the Attorney General for the State of Louisiana, in - - ----------------- CNA FINANCIAL CORPORATION ------------------------- 92 - - ------------------------------------------------------------------------------ Note F - Legal Proceedings & Contingent Liabilities (cont.) state court, Calcasieu Parish, Louisiana. In that suit, filed against certain tobacco manufacturers and distributors (the "Tobacco Defendants") and over 100 insurance companies, the State of Louisiana seeks to recover medical expenses allegedly incurred by the State as a result of tobacco-related illnesses. The original suit was filed on March 13, 1996, against the Tobacco Defendants only. The insurance companies were added to the suit in March 1997 under a "direct action" statute in Louisiana. Under the direct action statute, the Louisiana Attorney General is pursuing liability claims against the Tobacco Defendants and their insurers in the same suit, even though none of the Tobacco Defendants has made a claim for insurance coverage. In June of 1997, the above case was removed to the United States District Court for the Western District of Louisiana. The district court's decision denying a motion to remand the case to the state court is currently on appeal to the United States Fifth Circuit Court of Appeals. During the pending appeal, all proceedings in state court and in the federal district court are stayed. On November 23, 1998, the cigarette manufacturers and the attorneys general for 46 states (including Louisiana), and six other governmental entities reached an agreement regarding the resolution of their Medicaid reimbursement claims. The cigarette manufacturers have agreed to make annual payments in perpetuity, including a total of $206 billion through 2025. In exchange, the states have agreed to release their claims against the cigarette manufacturers and have further agreed to release any claims that they may have against cigarette distributors, retailers, component part manufacturers and their insurers. None of these latter entities are parties to the settlement agreement. The Attorney General of Louisiana and the defendants in the Ieyoub litigation are implementing procedures to secure dismissal of the Ieyoub litigation and resolution of the Attorney General's claims. Thus, the litigation may be dismissed with prejudice in the near future. However, in other states, third parties have challenged the November 1998 settlement agreement, and the Medicaid reimbursement lawsuits in those states may not be resolved for some time. In addition, the November 1998 settlement does not preclude the cigarette manufacturers, or other entities named as defendants in the various Medicaid reimbursement lawsuits, from seeking coverage under the insurance policies issued to those defendants. Because of the uncertainties inherent in assessing the risk of liability at this juncture, management is unable to make a meaningful estimate of the amount or range of any loss that could result from an unfavorable outcome of the pending litigation. However, management believes that the ultimate outcome of the pending litigation should not materially affect the results of operations or equity of CNAF. OTHER LITIGATION - - ---------------------------- CNAF and its subsidiaries are also parties to other litigation arising in the ordinary course of business. The outcome of this other litigation will not, in the opinion of management, materially affect the results of operations or equity of CNAF. CNA FINANCIAL CORPORATION ------------------------- 93 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ----------------------------------------------------------------------------- Note G -- Reinsurance Note G -- Reinsurance - - --------------------- The ceding of insurance does not discharge the primary liability of the original insurer. CNA places reinsurance with other carriers only after careful review of the nature of the contract and a thorough assessment of the reinsurers' credit quality and claim settlement performance. Further, for carriers that are not authorized reinsurers in CNA's states of domicile, CNA receives collateral, primarily in the form of bank letters of credit. Such collateral totaled approximately $774 million and $857 million at December 31, 1998 and 1997, respectively. CNA's largest recoverable from a single reinsurer, including prepaid reinsurance premiums, is with Lloyds of London and approximated $416 million and $451 million at December 31, 1998 and 1997, respectively. Insurance claims and policyholders' benefits expense is net of reinsurance recoveries of $994 million, $1,309 million and $1,220 million for 1998, 1997 and 1996, respectively. In the tables below, life premiums are primarily from long duration contracts, property/casualty premiums are from short duration contracts, and accident and health premiums are primarily from short duration contracts. The effects of reinsurance on earned premiums are shown in the following tables: - - ----------------------------------------------------------------------- Earned Assumed/ Premiums Net ---------------------------------- % Year Ended December 31 Direct Assumed Ceded Net - - ----------------------------------------------------------------------- (In millions of dollars) 1998 Property/casualty $ 8,327 $ 1,549 $ 897 $ 8,979 17.3% Accident and health 3,584 181 261 3,504 5.2 Life 1,014 159 281 892 17.8 - - ---------------------------------------------------------------------- TOTAL PREMIUMS $12,925 $ 1,889 $ 1,439 $13,375 14.1% ====================================================================== 1997 Property/casualty $ 8,528 $ 1,101 $ 612 $ 9,017 12.2% Accident and health 3,603 111 154 3,560 3.1 Life 908 128 131 905 14.1 - - ---------------------------------------------------------------------- TOTAL PREMIUMS $13,039 $ 1,340 $ 897 $13,482 9.9% ====================================================================== 1996 Property/casualty $ 9,003 $ 1,123 $ 989 $ 9,137 12.3% Accident and health 3,575 187 176 3,586 5.2 Life 736 121 55 802 15.1 - - ---------------------------------------------------------------------- TOTAL PREMIUMS $13,314 $ 1,431 $ 1,220 $13,525 10.6% ====================================================================== CNA FINANCIAL CORPORATION ------------------------- 94 - - ------------------------------------------------------------------------------ Note G - Reinsurance (cont.) The effects of reinsurance on written premiums are shown in the following tables: - - ----------------------------------------------------------------------- Written Assumed/ Premiums Net --------------------------------- % Year Ended December 31 Direct Assumed Ceded Net - - ----------------------------------------------------------------------- (In millions of dollars) 1998 Property/casualty $ 8,765 $ 1,429 $ 969 $ 9,225 15.5% Accident and health 3,785 178 257 3,706 4.8 Life 1,014 159 281 892 17.8 - - ----------------------------------------------------------------------- TOTAL PREMIUMS $13,564 $ 1,766 $ 1,507 $13,823 12.8% ======================================================================= 1997 Property/casualty $ 8,576 $ 1,262 $ 693 $ 9,145 13.8% Accident and health 3,592 133 155 3,570 3.7 Life 908 128 131 905 14.1 - - ---------------------------------------------------------------------- TOTAL PREMIUMS $13,076 $ 1,523 $ 979 $13,620 11.2% ====================================================================== 1996 Property/casualty $ 9,078 $ 1,197 $ 852 $ 9,423 12.7% Accident and health 3,708 188 183 3,713 5.1 Life 736 121 55 802 15.1 - - ---------------------------------------------------------------------- TOTAL PREMIUMS $13,522 $ 1,506 $ 1,090 $13,938 10.8% ====================================================================== The impact of reinsurance on life insurance in-force is shown in the following schedule: - - -------------------------------------------------------------------------- Life Insurance In-Force ------------------------------------ Assumed/ (In millions of dollars) Direct Assumed Ceded Net Net % - - -------------------------------------------------------------------------- DECEMBER 31, 1998 $297,488 $96,906 $128,896 $265,498 36.5% December 31, 1997 235,468 76,130 74,262 237,336 32.1 December 31, 1996 171,715 65,294 32,561 204,448 31.9 ========================================================================== CNA FINANCIAL CORPORATION ------------------------- 95 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ------------------------------------------------------------------------------- Note H -- Debt Note H - Debt: - - --------------
DEBT - - ----------------------------------------------------------------------------------------- December 31 1998 1997 - - ----------------------------------------------------------------------------------------- (In millions of dollars) Variable Rate Debt: Commercial Paper $ 500 $ 675 Credit Facility - CNAF 235 400 Credit Facility - CNA Surety 113 118 Senior Notes: 8.875%, due March 1, 1998 -- 150 8.25%, due April 15, 1999 100 102 7.25%, due March 1, 2003 147 146 6.25%, due November 15, 2003 249 249 6.50% , due April 15, 2005 497 -- 6.75%, due November 15, 2006 248 248 6.45%, due January 15, 2008 149 -- 6.60%, due December 15, 2008 199 -- 8.375%, due August 15, 2012 98 98 6.95%, due January 15, 2018 148 -- 7.25% Debenture, due November 15, 2023 247 247 11.0% Secured Mortgage Notes, due June 30, 2013 157 389 6.9% - 16.29% Secured Capital Leases, due through December 31, 2011 46 47 Other debt, due through 2019 (rates of 1.0% to 12.71%) 27 28 - - ----------------------------------------------------------------------------------------- TOTAL DEBT $3,160 $2,897 =========================================================================================
CNAF has a $795 million revolving credit facility that expires in May 2001. The amount available is reduced by CNAF's outstanding commercial paper borrowings. As of December 31, 1998, there was $60 million of unused borrowing capacity under the facility. The interest rate on the bank loans is based on the London Interbank Offered Rate (LIBOR), plus 16 basis points. Additionally, there is a facility fee of 9 basis points annually. The average interest rate on the bank loans under the credit facility at December 31, 1998, 1997 and 1996, was 5.49%, 6.16% and 5.72%, respectively. To offset the variable rate characteristics of the facility, CNAF entered into interest rate swap agreements with several banks having a total notional principal amount at December 31, 1998 and 1997 of $650 million and $950 million, respectively, which terminate from May 2000 to December 2000. These agreements provide that CNAF pay interest at a fixed rate, averaging 6.07% at December 31, 1998 and 6.20% for both December 31, 1997 and 1996, respectively, in exchange for the receipt of interest at the three month LIBOR rate. The effect of these interest rate swaps was to increase interest expense by approximately $2 million, $4 million and $7 million for the years ended December 31, 1998, 1997 and 1996, respectively. CNA FINANCIAL CORPORATION ------------------------- 96 - - ------------------------------------------------------------------------------- Note H - Debt (cont.) The commercial paper borrowings are classified as long-term as the program is fully supported by the committed credit facility. The weighted average interest rate on commercial paper at December 31, 1998 was 5.89% compared to 6.05% and 5.67% at December 31, 1997 and 1996, respectively. The weighted average interest rate (interest and facility fees) on the combined revolving credit facility, commercial paper borrowings and interest rate swaps was 6.36%, 6.35% and 6.28% at December 31, 1998, 1997 and 1996, respectively. In 1998, CNAF issued $1 billion of senior notes under a $1 billion Registration Statement on Form S-3 filed with the Securities and Exchange Commission on August 18, 1997. This shelf registration incorporated $250 million of securities remaining available for issuance from a prior shelf registration. Since filing the shelf registration, the Company has issued senior notes in four separate offerings senior notes with an aggregate principal amount of $1 billion. On September 30, 1997, CNA Surety, a 61% owned subsidiary of CNAF, entered into a $130 million, 5 year revolving credit facility. The interest rate on facility borrowings is based on LIBOR plus 20 basis points. Additionally, there is a facility fee of 10 basis points annually. At December 31, 1998 and 1997, the outstanding borrowings under this facility were $113 million and $118 million and the weighted average interest rate was 5.53% and 6.17%, respectively. The following table shows the future minimum principal payments on debt: FUTURE MINIMUM PRINCIPAL PAYMENTS - - --------------------------------------- (In millions of dollars) 1999 $ 103 2000 3 2001 739 2002 116 2003 403 Thereafter 1,814 Less: original issue discount (18) - - --------------------------------------- TOTAL $3,160 ======================================= CNA FINANCIAL CORPORATION ------------------------- 97 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - -------------------------------------------------------------------------- Note I -- Benefit Plans Note I - Benefit Plans: - - ----------------------- PENSION PLANS - - ------------------------- CNA has noncontributory pension plans covering all full-time employees age 21 or over who have completed at least one year of service. While the benefits for the plans vary, they are generally based on years of credited service and the employee's highest sixty consecutive months of compensation. CNA's funding policy is to make contributions in accordance with applicable governmental regulatory requirements. The assets of the plans are invested primarily in U.S. government securities with the balance in short-term investments, common stocks and other fixed income securities. Effective January 1, 1996, the retirement plans redefined compensation to include base pay, overtime and bonuses. This amendment generated an unrecognized prior service cost of $20 million. POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFITS - - ------------------------------------------------------ CNA provides certain health care benefits for eligible retirees, through age 64, and provides life insurance and reimbursement of Medicare Part B premiums for all eligible retired persons. Funding for these plans is generally to pay covered expenses as they are incurred. In 1998, CNA amended the Continental post-retirement plan to make the benefits available to Continental retirees equivalent to the benefits available to CNA retirees. As a result of this amendment, CNA's postretirement benefit obligation was reduced by $99 million. As a result of the Company's restructuring activities discussed in Note N, the Company recorded curtailment charges of approximately $19 million related to its pension and post-retirement plans. Additionally these curtailments resulted in a reduction of the pension and postretirement benefit obligations of $88 million and $34 million, respectfully. CNA FINANCIAL CORPORATION ------------------------- 98 - - ---------------------------------------------------------------------------- Note I - Benefit Plans (cont.) The following provides a reconciliation of benefit obligations: - - ------------------------------------------------------------------------------- POSTRETIREMENT PENSION BENEFITS BENEFITS - - ------------------------------------------------------------------------------- December 31 1998 1997 1998 1997 - - ------------------------------------------------------------------------------- (In millions of dollars) Change in benefit obligation: Benefit obligation at January 1 $1,780 $1,567 $ 377 $ 319 Service cost 58 54 11 10 Interest cost 126 119 28 25 Participants' contributions - - 5 2 Plan amendments - 1 (99) - Actuarial loss 118 122 67 41 Curtailment (88) - (34) - Benefits paid (94) (83) (34) (20) - - ------------------------------------------------------------------------------- Benefit obligation at December 31 1,900 1,780 321 377 - - ------------------------------------------------------------------------------- Change in plan assets: Fair value of plan assets at January 1 1,313 1,206 - - Actual return on plan assets 105 104 - - Company contributions 100 86 29 19 Participants' contributions - - 5 2 Benefits paid (94) (83) (34) (21) - - ------------------------------------------------------------------------------- Fair value of plan assets at December 31 1,424 1,313 - - - - ------------------------------------------------------------------------------- Funded status (476) (467) (321) (377) Unrecognized net actuarial loss 239 218 51 19 Unrecognized prior service cost (benefit) 60 88 (97) - Unrecognized net transition obligation - (2) - - - - ------------------------------------------------------------------------------- ACCRUED BENEFIT COST $ (177) $ (163) $(367) $(358) =============================================================================== NET PERIODIC BENEFIT COSTS - - ------------------------------------------------------------------------------ POSTRETIREMENT PENSION BENEFITS BENEFITS - - ------------------------------------------------------------------------------ December 31 1998 1997 1996 1998 1997 1996 - - ------------------------------------------------------------------------------ (In millions of dollars) Service cost - benefits attributed to employee service during the year $ 58 $ 54 $ 55 $11 $10 $12 Interest cost on projected benefit obligation 126 119 111 28 25 24 Expected return on plan assets (97) (98) (91) - - - Prior service cost amortization 10 11 10 (4) - - Actuarial loss 4 6 5 1 - - Transition amount amortization (2) (5) (6) - - - Curtailment loss 17 - - 2 - - - - ------------------------------------------------------------------------------ NET PERIODIC BENEFIT COST $116 $ 87 $ 84 $38 $35 $36 ============================================================================== CNA FINANCIAL CORPORATION ------------------------- 99 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ---------------------------------------------------------------------------- Note I -- Benefit Plans (cont.) Actuarial assumptions are set forth in the following table: - - --------------------------------------------------------------------------- POSTRETIREMENT PENSION BENEFITS BENEFITS - - --------------------------------------------------------------------------- December 31 1998 1997 1996 1998 1997 1996 - - --------------------------------------------------------------------------- Discount rate 6.75% 7.25% 7.50% 6.75% 7.25% 7.50% Expected return on plan assets 7.00 7.50 7.75-8.50 N/A N/A N/A Rate of compensation increases 5.70 5.70 5.70 N/A N/A N/A - - --------------------------------------------------------------------------- The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 8% in 1998, declining to an ultimate rate of 5% in 2002. The health care cost trend rate assumption has a significant effect on the amount of the benefit obligation and periodic cost reported. An increase in the assumed health care cost trend rate of 1% in each year would increase the accumulated postretirement benefit obligation as of December 31, 1998 by $16 million and the aggregate net periodic postretirement benefit cost for 1998 by $3 million. A decrease in the assumed health care cost trend rate of 1% in each year would decrease the accumulated postretirement benefit obligation as of December 31, 1998 by $14 million and the aggregate net periodic postretirement benefit cost for 1998 by $3 million. SAVINGS PLANS - - ------------------------------- CNA has savings plans, which are generally contributory plans, which allow employees to make regular contributions of up to 6% of their salary. CNA contributes an additional amount equal to 70% of the employee's regular contribution. Employees may also make additional contributions of up to 10% of their salaries for which there is no additional contribution by CNA. Contributions by the Company to the savings plans were $25 million, $23 million and $24 million in 1998, 1997 and 1996, respectively. CNA FINANCIAL CORPORATION ------------------------- 100 - - ----------------------------------------------------------------------------- Note J -- Leases Note J - Leases: - - ---------------- CNA occupies facilities under lease agreements that expire at various dates through 2011. CNA's home office is partially situated on grounds under leases expiring in 2058. In addition, data processing and office and transportation equipment are leased under agreements that expire at various dates through 2003. Most leases contain renewal options that provide for rent increases based on prevailing market conditions. Lease expense, net of sublease income, for the years ended December 31, 1998, 1997 and 1996 was $130 million, $100 million and $85 million, respectively. The table below shows the future minimum lease payments to be made under non-cancelable leases at December 31, 1998. - - ---------------------------------------------- Future Minimum Lease Payments - - ---------------------------------------------- (IN MILLIONS OF DOLLARS) 1999 $100 2000 87 2001 76 2002 63 2003 45 Thereafter 126 - - ---------------------------------------------- TOTAL $497 ============================================== CNA FINANCIAL CORPORATION ------------------------- 101 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - --------------------------------------------------------------------------- Note K -- Stockholders' Equity and Statutory Financial Information Note K - Stockholders' Equity and Statutory Financial Information: - - ------------------------------------------------------------------ SUMMARY OF CAPITAL STOCK - - ----------------------------------------------------------------------------- Number of Shares -------------------------- December 31 1998 1997 - - ----------------------------------------------------------------------------- Preferred stock, without par value, non-voting: Authorized 12,500,000 12,500,000 Money market cumulative preferred stock, without par value, non-voting; Issued and outstanding: Series E (stated value $100,000 per share) 750 750 Series F (stated value $100,000 per share) 750 750 Cumulative, exchangeable preferred stock, without par value, non-voting; Series G (stated value $100,000 per share) 2,000 -- Common stock with par value of $2.50; Authorized 200,000,000 200,000,000 Issued 185,525,907 185,525,907 Outstanding 183,889,569 185,394,786 Treasury stock 1,636,338 131,121 - - ----------------------------------------------------------------------------- On May 6, 1998, CNAF's Board of Directors approved a three-for-one split of CNAF's common stock and authorized a commensurate increase in the outstanding common shares from 61,798,262 to 185,394,786. The shares were distributed on June 1, 1998 at a rate of three shares for each one held by shareholders of record at the close of business on May 22, 1998. The table above reflects the effect of this stock split as if it had occurred on December 31, 1997. The dividend rate on money market preferred stock is determined approximately every 49 days by auction. The money market preferred stock is redeemable at CNAF's option, as a whole or in part, at $100,000 per share plus accrued and unpaid dividends. As of December 31, 1998, preferred dividends declared and payable were approximately $7 million. On August 5, 1998, CNAF's Board of Directors approved a plan (the Share Repurchase Program) to purchase, in the open market or through privately negotiated transactions, its outstanding common stock from time to time, as the Company's management deems appropriate. During 1998, pursuant to the announced Share Repurchase Program, CNAF purchased 2,734,800 shares of its common stock for approximately $102 million. Total shares purchased by CNAF and classified on the December 31, 1998 balance sheet as treasury stock are 1,636,338 for a decrease in stockholders' equity of approximately $61 million. CNA FINANCIAL CORPORATION ------------------------- 102 - - ------------------------------------------------------------------------------ Note K - Stockholders' Equity and Statutory Financial Information (cont.) On October 9, 1998, CNAF filed a Registration Statement on Form S-8 with the Securities and Exchange Commission registering $60 million of $2.50 par value common stock, to be offered pursuant to the CNAF Officer Stock Ownership Plan. On October 9, 1998, prior to the opening of the trading session on the New York Stock Exchange, CNAF sold 1,229,583 shares of common stock that were held in treasury to certain senior officers of CNAF at the average of the highest and lowest sale price on the New York Stock Exchange, composite transactions, which was a price of $34.91 per share. The purchases were financed by full recourse, collateralized loans from CNAF which, at December 31, 1998, totaled approximately $44 million, including accrued interest. The loans are ten year notes, which bear interest at the Applicable Federal Rate for October 1998 (5.39%), compounding semi-annually. On December 23, 1998, CNAF issued 2,000 shares of Series G cumulative, exchangeable preferred stock to Loews for $200 million. The dividend rate on the exchangeable preferred stock is reset quarterly at a rate equal to the 3 month London Interbank Offering Rate (LIBOR) on the reset date plus four basis points. On the fifth anniversary of the stocks' issuance, the interest rate increases to the 3 month LIBOR on the reset date plus one hundred and four basis points. The preferred stock is redeemable at the end of each calendar quarter without a premium at CNAF's option. After the fifth year, the stock is also exchangeable, at CNAF's option, into notes maturing on the tenth anniversary of the issuance of the Series G preferred stock and bearing a market rate of interest. CNA FINANCIAL CORPORATION -------------------------- 103 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ----------------------------------------------------------------------------- Note K - Stockholders' Equity and Statutory Financial Information (cont.) STATUTORY ACCOUNTING PRACTICES - - ------------------------------------------ CNAF's insurance subsidiaries are domiciled in various jurisdictions. These subsidiaries prepare statutory financial statements in accordance with accounting practices prescribed or otherwise permitted by the respective jurisdiction's insurance regulator. Prescribed statutory accounting practices are set forth in a variety of publications of the National Association of Insurance Commissioners as well as state laws, regulations, and general administrative rules. The Company's insurance subsidiaries have no material permitted accounting practices. CNAF's ability to pay dividends to its stockholders is affected, in part, by receipt of dividends from its subsidiaries. The payment of dividends to CNAF by its insurance subsidiaries without prior approval of the insurance department of each subsidiaries' domiciliary jurisdiction is limited to formula amounts. As of December 31, 1998, approximately $663 million of dividend payments are not subject to insurance department's pre-approval. Statutory capital and surplus and net income, determined in accordance with accounting practices prescribed by the regulation and statute of various insurance regulators, for property/casualty and life insurance subsidiaries are as follows: - - ------------------------------------------------------------------------------- Statutory Capital and Surplus Statutory Net Income(Loss) - - ------------------------------------------------------------------------------- December 31 Year Ended December 31 - - ------------------------------------------------------------------------------- (Unaudited) 1998 1997 1998 1997 1996 - - ------------------------------------------------------------------------------- (In millions of dollars) Property/casualty companies* $7,593 $7,123 $161 $1,043 $1,208 Life insurance companies 1,109 1,224 (57) 43 58 - - ------------------------------------------------------------------------------- * SURPLUS INCLUDES EQUITY OF PROPERTY/CASUALTY COMPANIES' OWNERSHIP IN LIFE INSURANCE SUBSIDIARIES. CNA FINANCIAL CORPORATION ------------------------- 104 - - ---------------------------------------------------------------------------- Note L -- Accumulated Other Comprehensive Income Note L -- Accumulated Other Comprehensive Income: - - ------------------------------------------------ Comprehensive income is comprised of all changes to stockholders' equity, including net income, except those changes resulting from investments by and distributions to stockholders. The change in the components of accumulated other comprehensive income are shown below: - - ------------------------------------------------------------------------------ Pre-tax Tax (expense) Net Year ended December 31 amount benefit Amount - - ------------------------------------------------------------------------------ (In millions of dollars) 1998 Net unrealized gains (losses) on investments: Gains arising during the period $ 933 $(327) $ 606 Allocated to minority interest (9) 3 (6) Reclassification adjustment for (gains) included in net income (207) 75 (132) Foreign currency translation adjustment 7 -- 7 - - ------------------------------------------------------------------------------ TOTAL OTHER COMPREHENSIVE INCOME $ 724 $(249) $ 475 ============================================================================== - - ------------------------------------------------------------------------------ Pre-tax Tax (expense) Net Year ended December 31 amount benefit Amount - - ------------------------------------------------------------------------------ (In millions of dollars) 1997 Net unrealized gains (losses) on investments: Gains arising during the period $ 570 $(171) $ 399 Allocated to minority interest (8) 3 (5) Allocated to participating policyholders' (4) -- (4) Reclassification adjustment for (gains) included in net income (186) 67 (119) Foreign currency translation adjustment 19 -- 19 - - ------------------------------------------------------------------------------ TOTAL OTHER COMPREHENSIVE INCOME $ 391 $(101) $ 290 ============================================================================== - - ------------------------------------------------------------------------------ Pre-tax Tax (expense) Net Year ended December 31 amount benefit Amount - - ------------------------------------------------------------------------------ (In millions of dollars) 1996 Net unrealized gains (losses) on investments: Losses arising during the period $(368) $ 129 $(239) Allocated to minority interest 8 (3) 5 Allocated to participating policyholders' 18 -- 18 Reclassification adjustment for (gains) included in net income (659) 231 (428) Foreign currency translation adjustment 10 -- 10 - - ------------------------------------------------------------------------------ TOTAL OTHER COMPREHENSIVE LOSS $(991) $ 357 $(634) ============================================================================== CNA FINANCIAL CORPORATION ------------------------- 105 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ----------------------------------------------------------------------------- Note L - Accumulated Other Comprehensive Income (cont.) The following tables display the changes in and the components of accumulated other comprehensive income included in the consolidated balance sheet and statements of stockholders' equity for 1998 and 1997. - - ------------------------------------------------------------------------------- TOTAL FOREIGN NET ACCUMULATED CURRENCY UNREALIZED OTHER TRANSLATION GAINS/(LOSSES) COMPREHENSIVE ADJUSTMENT ON INVESTMENTS INCOME - - ------------------------------------------------------------------------------- (In millions of dollars) Beginning Balance January 1, 1997 $47 $252 $ 299 Current Period Change 19 271 290 - - ------------------------------------------------------- ----------------------- Ending balance December 31, 1997 66 523 589 Current Period Change 7 468 475 - - ------------------------------------------------------------------------------- ENDING BALANCE DECEMBER 31, 1998 $73 $991 $1,064 =============================================================================== CNA FINANCIAL CORPORATION ------------------------- 106 - - ----------------------------------------------------------------------------- Note M -- Business Segments Note M - Business Segments: - - ---------------------------- The Company's reportable segments are strategic businesses that offer different types of products and services. The Company has seven operating segments: Agency Market Operations, Specialty Operations, CNA Re, Global Operations, Risk Management, Group Operations and Life Operations. Agency Market Operations provides a wide range of property/casualty products to individuals and small to mid-size businesses. Specialty Operations provides a broad array of professional, financial and specialty property/casualty products and services. CNA Re offers primarily traditional property/casualty treaty reinsurance. Global Operations provides marine, casualty, surety, warranty and specialty products. Risk Management serves the property/casualty needs of large domestic commercial businesses offering customized, solution-based strategies to address risk management needs. Group Operations offers a broad array of group life and health insurance and reinsurance products to employers, affinity groups and other entities that purchase insurance as a group. Life Operations provides financial protection to individuals through a full product line of term life insurance, universal life insurance, long-term care insurance, annuities and provides retirement service products to institutional markets. Corporate results consist of interest expense on corporate borrowings, certain run-off insurance operations, asbestos claims related to Fibreboard Corporation, financial guarantee insurance contracts, and certain non-insurance operations, principally the operations of Agency Management Systems, Inc., an information technology and agency software development subsidiary. The accounting policies of the segments are the same as those described in the summary of significant accounting polices. The Company manages its assets on a legal entity basis while segment operations are conducted across legal entities, as such assets are not readily identifiable by individual segment. In addition, distinct investment portfolios are not maintained for each segment, and accordingly, allocation of assets to each segment is not performed. Therefore investment income and realized investment gains/losses are allocated based on each segment's carried insurance reserves, as adjusted. CNA FINANCIAL CORPORATION ------------------------- 107 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ---------------------------------------------------------------------------- Note M -- Business Segments (cont.) All intercompany income and expense as well as intercompany dividends have been eliminated. Income taxes have been allocated on the basis of taxable income of the respective segments. Approximately 96% of the Company's premiums are derived from the United States. Premiums from any individual foreign country are not significant. Through August 1, 1989, CNA's property/casualty operations wrote financial guarantee insurance contracts. These contracts primarily represent industrial development bond guarantees and equity guarantees typically extending from ten to thirteen years. For these guarantees, CNA received an advance premium, which is recognized over the exposure period and in proportion to the underlying exposure insured. At December 31, 1998 and 1997, gross exposure of financial guarantee insurance contracts amounted to $507 million and $553 million, respectively. The degree of risk attached to this exposure is substantially reduced through reinsurance, diversification of exposures and collateral requirements. In addition, security interests in the real estate are also obtained. Approximately 36% and 39% of the risks were ceded to reinsurers at December 31, 1998 and 1997, respectively. Total exposure, net of reinsurance, amounted to $323 million and $337 million at December 31, 1998 and 1997, respectively. At December 31, 1998 and 1997, collateral consisting of letters of credit and debt service reserves amounted to $38 million and $23 million, respectively. CNA FINANCIAL CORPORATION ------------------------- 108 - - ---------------------------------------------------------------------------- Note M -- Business Segments (cont.) Gross unearned premium reserves for financial guarantee contracts were $7 million and $5 million at December 31, 1998 and 1997, respectively. Gross claim and claim expense reserves totaled $232 million and $377 million at December 31, 1998 and 1997, respectively. Group segment revenues include $2.0 billion, $2.1 billion and $2.1 billion in 1998, 1997 and 1996, respectively, under contracts covering U.S. government employees and their dependents (FEHBP). CNA FINANCIAL CORPORATION ------------------------- 109 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ---------------------------------------------------------------------------- Note M - Business Segments (cont.)
- - -------------------------------------------------------------------------------------------------------------- Agency Market Specialty Global YEAR ENDED DECEMBER 31, 1998 Operations Operations CNA Re Operations - - -------------------------------------------------------------------------------------------------------------- (In millions of dollars) Revenues, excluding realized investment gains: Premiums $5,247 $1,092 $ 944 $ 941 Net investment income 744 245 163 110 Other 107 27 5 82 - - -------------------------------------------------------------------------------------------------------------- Total revenues, excluding realized investment gains 6,098 1,364 1,112 1,133 Benefits and expenses: Insurance claims and policyholder benefits 4,431 951 707 585 Amortization of deferred acquisition costs 1,239 175 252 224 Interest expense -- -- -- 11 Restructuring and other related charges 96 5 1 1 Other 491 169 57 251 - - -------------------------------------------------------------------------------------------------------------- Total benefits and expenses 6,257 1,300 1,017 1,072 - - -------------------------------------------------------------------------------------------------------------- Operating income before income tax (159) 64 95 61 Income tax (expense) benefit 105 (6) (27) (18) - - -------------------------------------------------------------------------------------------------------------- Net operating income (excluding realized investment gains/losses) (54) 58 68 43 Realized investment gains, net of tax 171 57 27 17 Minority interest -- -- -- (25) - - -------------------------------------------------------------------------------------------------------------- NET INCOME $ 117 $ 115 $ 95 $ 35 ==============================================================================================================
- - -------------------------------------------------------------------------------------------------------------- Agency Market Specialty Global Year Ended December 31, 1997 Operations Operations CNA Re Operations - - -------------------------------------------------------------------------------------------------------------- (In millions of dollars) Revenues, excluding realized investment gains: Premiums $5,092 $1,251 $ 898 $ 854 Net investment income 787 268 153 117 Other 50 14 5 29 - - -------------------------------------------------------------------------------------------------------------- Total revenues, excluding realized investment gains 5,929 1,533 1,058 1,000 Benefits and expenses: Insurance claims and policyholder benefits 3,871 1,011 670 490 Amortization of deferred acquisition costs 1,242 247 247 173 Interest expense -- -- -- -- Other 384 149 79 221 - - -------------------------------------------------------------------------------------------------------------- Total benefits and expenses 5,497 1,407 996 884 - - -------------------------------------------------------------------------------------------------------------- Operating income before income tax 432 126 62 116 Income tax (expense) benefit (106) (31) (11) (35) - - -------------------------------------------------------------------------------------------------------------- Net operating income (excluding realized investment gains/losses) 326 95 51 81 Realized investment gains, net of tax 187 63 34 20 Minority interest -- -- -- (29) - - -------------------------------------------------------------------------------------------------------------- Net income $ 513 $ 158 $ 85 $ 72 ==============================================================================================================
- - -------------------------------------------------------------------------------------------------------------- Agency Market Specialty Global Year Ended December 31, 1996 Operations Operations CNA Re Operations - - -------------------------------------------------------------------------------------------------------------- Revenues, excluding realized investment gains: Premiums $5,346 $1,217 $ 944 $ 945 Net investment income 828 273 161 134 Other 13 -- 7 34 - - -------------------------------------------------------------------------------------------------------------- Total revenues, excluding realized investment gains 6,187 1,490 1,112 1,113 Benefits and expenses: Insurance claims and policyholder benefits 4,277 1,092 694 594 Amortization of deferred acquisition cost 1,183 232 119 221 Interest expense -- -- -- -- Other 560 79 172 145 - - -------------------------------------------------------------------------------------------------------------- Total benefits and expenses 6,020 1,403 985 960 - - -------------------------------------------------------------------------------------------------------------- Operating income before income tax 167 87 127 153 Income tax (expense) benefit (13) (15) (38) (44) - - -------------------------------------------------------------------------------------------------------------- Net operating income (excluding realized investment gains/losses) 154 72 89 109 Realized investment gains, net of tax 133 44 21 21 Minority interest -- -- -- (9) - - -------------------------------------------------------------------------------------------------------------- Net income $ 287 $ 116 $ 110 $ 121 =============================================================================================================
CNA FINANCIAL CORPORATION -------------------------- 110 - - --------------------------------------------------------------------------- Note M - Business Segments (cont.) - - --------------------------------------------------------------------------- Risk Group Life Total Management Operations Operations Corporate Eliminations Segments - - --------------------------------------------------------------------------- $ 823 $3,712 $ 684 $ (27) $(41) $13,375 144 133 525 82 -- 2,146 230 24 115 298 (30) 858 - - --------------------------------------------------------------------------- 1,197 3,869 1,324 353 (71) 16,379 909 3,177 871 127 (41) 11,717 98 5 178 9 -- 2,180 4 -- 14 219 (29) 219 88 39 7 9 -- 246 234 -- 731 104 326 -- 2,363 - - --------------------------------------------------------------------------- 1,333 3,952 1,174 690 (70) 16,725 - - --------------------------------------------------------------------------- (136) (83) 150 (337) (1) (346) 48 35 (58) 121 -- 200 - - --------------------------------------------------------------------------- (88) (48) 92 (216) (1) (146) 31 29 96 20 -- 448 -- -- -- 5 -- (20) - - --------------------------------------------------------------------------- $ (57) $ (19) $ 188 $(191) $(1) $ 282 =========================================================================== - - --------------------------------------------------------------------------- Risk Group Life Total Management Operations Operations Corporate Eliminations Segments - - --------------------------------------------------------------------------- $ 776 $3,093 $ 688 $ 20 $-- $13,482 158 117 501 108 -- 2,209 194 17 105 236 (24) 628 - - --------------------------------------------------------------------------- 1,128 4,037 1,294 364 (24) 16,319 893 3,375 855 103 -- 11,268 101 -- 120 8 -- 2,138 -- -- -- 222 (24) 198 196 680 147 244 -- 2,100 - - --------------------------------------------------------------------------- 1,190 4,055 1,122 577 (24) 15,704 - - --------------------------------------------------------------------------- (62) (18) 172 (213) -- 615 25 10 (66) 82 -- (132) - - --------------------------------------------------------------------------- (37) (8) 106 (131) -- 483 37 28 139 (15) -- 493 -- -- -- 19 -- (10) - - --------------------------------------------------------------------------- $ -- $ 20 $ 245 $(127) $-- $ 966 =========================================================================== - - --------------------------------------------------------------------------- Risk Group Life Total Management Operations Operations Corporate Eliminations Segments - - --------------------------------------------------------------------------- $ 572 $3,816 $ 654 $ 53 $(22) $13,525 179 118 485 98 -- 2,276 222 8 106 190 (12) 568 - - --------------------------------------------------------------------------- 973 3,942 1,245 341 (34) 16,369 567 3,272 838 59 (22) 11,371 60 (24) 61 4 -- 1,856 -- -- -- 212 (12) 200 248 674 144 185 -- 2,207 - - --------------------------------------------------------------------------- 875 3,922 1,043 460 (34) 15,634 - - --------------------------------------------------------------------------- 98 20 202 (119) -- 735 (24) (3) (74) 48 -- (163) - - --------------------------------------------------------------------------- 74 17 128 (71) -- 572 29 21 117 16 -- 402 -- -- -- -- -- (9) - - --------------------------------------------------------------------------- $ 103 $ 38 $ 245 $ (55) $-- $ 965 =========================================================================== CNA FINANCIAL CORPORATION ------------------------- 111 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ------------------------------------------------------------------------------ Note N - Restructuring and Other Related Charges Note N -- Restructuring and Other Related Charges: - - -------------------------------------------------- The Company finalized and approved a restructuring plan (the "Plan") in August 1998. In connection with the Plan, the Company incurred various expenses that were recorded in the third and fourth quarters of 1998. These restructuring and other related charges primarily related to the following activities: planned reductions in the workforce; the consolidation of certain processing centers; the exiting of certain businesses and facilities; the termination of related lease obligations; and the writeoff of certain assets related to these activities. The Plan contemplates a gross reduction in workforce of 4,500 employees, resulting in a planned net reduction of approximately 2,400 employees. According to the Plan, the various activities and workforce reductions should be completed by the end of 1999. The restructuring and other related charges were comprised of the following costs and expenses: a) costs and benefits related to planned employee terminations of $98 million, of which $53 million related to severance and outplacement costs and $24 million related to other employee transition related costs and $21 million related to benefit plan curtailment losses; b) writedown of certain assets to their fair value of $74 million, of which $59 million related to a writedown of an intangible asset, and $15 million abandoned leasehold improvements and other related fixed assets associated with leases that were terminated as part of the restructuring plan; c) lease termination costs of $42 million; d) losses incurred on the exiting of certain businesses of $32 million. The Company recorded $220 million of these restructuring and other related charges in the third quarter of 1998. Other charges such as parallel processing costs, relocation costs, and retention bonuses, did not qualify for accrual at the end of the third quarter under generally accepted accounting principles and are being expensed as incurred. In the fourth quarter of 1998, $26 million of these charges were recorded. The 1998 restructuring and other related charges for Agency Market Operations totaled approximately $96 million. The charges included employee severance and outplacement costs of $34 million related to the planned net reduction in the workforce of approximately 1,200 employees. Approximately $29 million of lease termination costs were also incurred in connection with the consolidation of four regional offices into two zone offices and a reduction of the number of claim processing offices from 24 to 8. The Agency Market Operations charges also included benefit plan costs of $12 million, parallel processing charges of $7 million and $5 million of other fixed asset writedowns. Other charges, including travel, relocation and other transition-related activity, which were expensed as incurred, totaled approximately $9 million. Through December 31, 1998, approximately 364 Agency Market Operations employees, the majority of whom were loss adjusters and office support staff, had been released at a cost of $8 million. CNA FINANCIAL CORPORATION ------------------------- 112 - - ----------------------------------------------------------------------------- Note N - Restructuring and Other Related Charges (cont.) The 1998 restructuring and other related charges for Risk Management totaled approximately $88 million. The charges included lease termination costs associated with the consolidation of claim offices in 36 market territories that totaled approximately $8 million. In addition, employee severance and outplacement costs relating to the planned net reduction in workforce of approximately 200 employees were approximately $10 million and the writedown of fixed and intangible assets totaled approximately $64 million. Parallel processing and other charges totaled approximately $6 million. The charges related to fixed and intangible assets were primarily due to a writedown of an intangible asset (goodwill) related to a business that had been acquired several years earlier. As part of the Company's periodic reviews of asset recoverability and as a result of several adverse events, the Company concluded, based on its discounted cash flow analysis completed in the third quarter of 1998, that a $59 million writeoff was necessary. The adverse events contributing to this conclusion included operating losses from the business, the loss of several significant customers whose business volume with this operation constituted a large portion of the revenue base, and substantial changes in the overall market demand for the services offered by this operation which, in turn, had negative effects on the prospects for achieving the profitability levels necessary to recover the intangible asset. Through December 31, 1998, approximately 152 Risk Management employees had been released at a cost of $2 million. The majority of the employees were adjusters and office support staff. The 1998 restructuring and other related charges for Group Operations totaled approximately $39 million. The charges included approximately $29 million of costs related to the Company's decision to exit the Employer Health and Affinity lines of business. These costs represent the Company's estimate of losses in connection with fulfilling the remaining obligations under contracts related to these lines. Earned premiums for these lines of business approximated $400 million in 1998. The 1998 charges also included employee severance and outplacement costs of approximately $7 million related to the planned net reduction in workforce of approximately 400 employees. Charges for lease termination costs and fixed asset writedowns totaled $3 million. Through December 31, 1998, approximately 56 Group Operations employees had been released at a cost of $1 million. The majority of the employees were claims and sales support staff. For the other segments of the Company, restructuring and other related charges totaled approximately $23 million for 1998. Charges related primarily to the closing of leased facilities were $3 million and employee severance and outplacement costs related to planned net reductions of 600 employees in the current workforce and benefit costs associated with those reductions were $13 million. In addition, there were charges of $4 million related to the writedown of certain assets and $3 million related to the exiting of certain businesses. Through December 31, 1998, approximately 270 employees of these other segments, most of whom were underwriters and office support staff, had been released at a cost of $3 million. CNA FINANCIAL CORPORATION ------------------------- 113 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ------------------------------------------------------------------------------- Note N - Restructuring and Other Related Charges (cont.) The following table sets forth the major categories of restructuring and other related charges that were initially accrued and recorded upon the finalization and approval of the Plan and the activity in the accrual for such costs during 1998. - - ------------------------------------------------------------------------------- Employee Termination and Lease Business Related Benefit Writedown Termination Exit Costs of Assets Costs Costs Total ------------------------------------------------------ Initial charge recorded in third quarter of 1998 $ 72 $ 74 $ 42 $ 32 $ 220 Less payments charged against liability (14) -- -- -- (14) Less costs that do not use cash (21) (74) -- -- (95) - - ------------------------------------------------------------------------------- ACCRUED COSTS AT DECEMBER 31, 1998 $ 37 $ -- $ 42 $ 32 $ 111 =============================================================================== CNA FINANCIAL CORPORATION ------------------------- 114 - - ----------------------------------------------------------------------------- Note O -- Merger with Capsure Holdings Corp. Note O - Merger with Capsure Holdings Corp: - - ------------------------------------------- In the fourth quarter of 1996, CNA entered into a merger agreement with Capsure Holdings Corp. (Capsure) to merge CNA's surety business with the business of Capsure and form a new stock company, CNA Surety Corporation ("CNA Surety"), in which CNA has an approximate 61% interest. The transaction closed on September 30, 1997 and was accounted for as a sale of approximately 39% of CNA's previous surety business and a purchase of 61% of Capsure. In conjunction with the closing of the transaction, CNA realized an investment gain of $95 million. CNA Surety's results of operations have been included in CNA's consolidated results of operations, net of minority interest subsequent to September 30, 1997. At December 31, 1997, total assets of CNA Surety were $727 million. CNA Surety's revenues and net income for the three months ended December 31, 1997 were approximately $71 million and $11 million, respectively. CNA FINANCIAL CORPORATION ------------------------- 115 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - ---------------------------------------------------------------------------- Note P -- Unaudited Quarterly Financial Data Note P - Unaudited Quarterly Financial Data: - - -------------------------------------------- - - ------------------------------------------------------------------------------ First Second Third Fourth Year - - ------------------------------------------------------------------------------ (In millions of dollars, except per share data) 1998 QUARTERS Revenues $4,328 $4,429 $4,129 $4,188 $17,074 Net operating income (loss) Excluding realized gains/losses 117 64 (70) (263) (152) Net realized investment gains 116 146 56 116 434 -------------------------------------------- Net income (loss) 233 210 (14) (147) 282 -------------------------------------------- Earnings (loss) per share 1.25 1.12 (0.09) (0.81) 1.49 1997 QUARTERS Revenues $4,132 $4,243 $4,309 $4,388 $17,072 Net operating income Excluding realized gains/losses 136 126 121 105 488 Net realized investment gains 42 109 153 174 478 -------------------------------------------- Net income 178 235 274 279 966 -------------------------------------------- Earnings per share 0.95 1.26 1.47 1.49 5.17 1996 QUARTERS Revenues $4,315 $4,095 $4,256 $4,322 $16,988 Net operating income Excluding realized gains/losses 145 152 161 120 578 Net realized investment gains 184 50 78 75 387 -------------------------------------------- Net income 329 202 239 195 965 -------------------------------------------- Earnings per share 1.77 1.08 1.28 1.04 5.17 - - ------------------------------------------------------------------------------ CNA FINANCIAL CORPORATION ------------------------- 116 INDEPENDENT AUDITORS' REPORT - - ---------------------------------------------------------------------------- THE BOARD OF DIRECTORS AND STOCKHOLDERS CNA FINANCIAL CORPORATION We have audited the consolidated balance sheets of CNA Financial Corporation (an affiliate of Loews Corporation) and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of CNA Financial Corporation and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. S/DELOITTE & TOUCHE LLP Chicago, Illinois February 10, 1999 CNA FINANCIAL CORPORATION --------------------------- 117 COMMON STOCK INFORMATION - - --------------------------------------------------------------------------- CNA's common stock is listed on the New York Stock, Chicago Stock and Pacific Exchanges and is also traded on the Philadelphia Stock Exchange. The number of holders of record of CNA's common stock as of March 1, 1999, was 2,732. As of March 1, 1999, Loews Corporation owned approximately 85 percent of CNA's outstanding common stock. The table below sets forth the high and low closing sales prices for CNA's common stock based on the New York Stock Exchange Composite Transactions. No dividends have been paid on CNA's common stock in order to develop and maintain a strong surplus position for CNA's insurance subsidiaries, which is necessary to support business growth in an increasingly competitive environment. CNA's ability to pay dividends is influenced, in part, by dividend restrictions of its principal operating insurance subsidiaries as described in Note K to the Consolidated Financial Statements. COMMON STOCK INFORMATION - - -------------------------------------------------------------------- 1998 1997 ------------------------------------------ Quarter High Low High Low - - -------------------------------------------------------------------- Fourth 44 11/16 34 1/2 43 15/16 39 23/32 Third 47 35 1/8 43 3/8 35 31/32 Second 53 5/16 45 1/2 35 5/32 32 5/16 First 51 42 1/6 38 1/4 34 3/8 - - -------------------------------------------------------------------- Invitation to the Annual Meeting - - -------------------------------- Shareholders are cordially invited to attend the annual meeting at 10 a.m. Wednesday, May 5, 1999, in Room 207N, CNA Plaza, 333 South Wabash Avenue, Chicago. Shareholders unable to attend are requested to exercise their right to vote by proxy. Proxy material will be mailed to shareholders prior to the meeting. Form 10-K - - ------------------------------------- A copy of CNA Financial Corporation's annual report on Form 10-K, which is filed with the Securities and Exchange Commission, will be furnished to shareholders without charge upon written request to: Jonathan D. Kantor Senior Vice President, General Counsel and Secretary CNA Financial Corporation CNA Plaza, 43 South Chicago, Illinois 60685 CNA FINANCIAL CORPORATION ------------------------- 118 CORPORATE DIRECTORY - - ----------------------------------------------------------------------------- DIRECTORS - - ------------------------------------------ Antoinette Cook Bush Partner; Skadden, Arps, Slate, Meagher & Flom Dennis H. Chookaszian* Chairman of the Executive Committee, CNA Financial Corporation Philip L. Engel President, CNA Robert P. Gwinn Retired Chairman and Chief Executive Officer, Encyclopedia Britannica Bernard L. Hengesbaugh* Chairman and Chief Executive Officer, CNA Walter F. Mondale Partner; Dorsey & Whitney, LLP Edward J. Noha Chairman of the Board, CNA Financial Corporation Joseph Rosenberg Senior Investment Strategist, Loews Corporation Richard L. Thomas** Chairman, Audit Committee; Retired Chairman of the Board, First Chicago NBD Corporation and The First National Bank of Chicago James S. Tisch Chairman, Finance Committee; Chief Executive Officer and President, Loews Corporation Laurence A. Tisch Chief Executive Officer of CNA Financial Corporation, Co-Chairman of the Board Loews Corporation Preston R. Tisch Co-Chairman of the Board, Loews Corporation Marvin Zonis Professor of International Political Economy, Graduate School of Business University of Chicago - - ------------------------------------------------------------------------------ *Mr. Chookaszian resigned as Chairman of the Board and Chief Executive Officer of CNA effective February 9, 1999. He was replaced by Mr. Hengesbaugh. **Mr. Thomas will not stand for re-election in May 1999. ***Mr. Tisch retired as Chairperson effective February 10, 1999 and was replaced by Mr. Chookaszian. ****Ms. Bush resigned as Chairperson effective February 12, 1999. CNA FINANCIAL CORPORATION ------------------------- 119 CORPORATE DIRECTORY - - --------------------------------------------------------------------------- EXECUTIVE COMMITTEE - - ---------------------------------------- Preston R. Tisch *** Antoinette Cook Bush Dennis H. Chookaszian*** Philip L. Engel Robert P. Gwinn Bernard L. Hengesbaugh Walter F. Mondale Edward J. Noha Joseph Rosenberg Richard L. Thomas** James S. Tisch Laurence A. Tisch Marvin Zonis FINANCE COMMITTEE - - --------------------------------------------- James S. Tisch, Chairperson Antoinette Cook Bush Dennis H. Chookaszian Philip L. Engel Robert P. Gwinn Bernard L. Hengesbaugh Walter F. Mondale Edward J. Noha Joseph Rosenberg Richard L. Thomas** Laurence A. Tisch Preston R. Tisch Marvin Zonis AUDIT COMMITTEE - - -------------------------------------------------- Richard L. Thomas, Chairperson** Antoinette Cook Bush Robert P. Gwinn Walter F. Mondale Marvin Zonis INCENTIVE COMPENSATION COMMITTEE - - -------------------------------------------------- Antoinette Cook Bush, Chairperson **** Robert P. Gwinn Richard L. Thomas** Marvin Zonis OFFICERS - - ---------------------------------------------------- Laurence A. Tisch Chief Executive Officer, CNA Financial Corporation Dennis H. Chookaszian * Chairman and Chief Executive Officer, CNA Philip L. Engel President, CNA Bernard L. Hengesbaugh* Chairman and Chief Executive Officer, CNA Jonathan D. Kantor Senior Vice President, General Counsel and Secretary, CNA Financial Corporation W. James MacGinnitie Senior Vice President and Chief Financial Officer, CNA Financial Corporation CNA ADMINISTRATIVE OFFICES - - ------------------------------------------------------------------ CNA Plaza Chicago, Illinois 60685 312-822-5000 TRANSFER AGENT AND REGISTRAR - - ------------------------------------------------------------------ First Chicago Trust Company of New York P.O. Box 2500 Jersey City, New Jersey 07303-2500 INDEPENDENT AUDITORS - - ------------------------------------------------------------------ Deloitte & Touche LLP 180 North Stetson Avenue Chicago, Illinois 60601 - - ----------------------------------------------------------------------------- *Mr. Chookaszian resigned as Chairman of the Board and Chief Executive Officer of CNA effective February 9, 1999. He was replaced by Mr. Hengesbaugh. **Mr. Thomas will not stand for re-election in May 1999. ***Mr. Tisch retired as Chairperson effective February 10, 1999 and was replaced by Mr. Chookaszian. ****Ms. Bush resigned as Chairperson effective February 12, 1999. CNA FINANCIAL CORPORATION ------------------------- 120 CNA FINANCIAL CORPORATION APPENDIX OMITTED GRAPH MATERIAL AND OTHER Exhibit 13.1 - CNA Financial Corporation Annual Report: * Bar graphs of: - Revenues for the period 1988 through 1998. - Assets for the period 1988 through 1998. - Stockholders' equity for the period 1988 through 1998. - Book value per common share 1988 through 1998. (See page 3 of Exhibit 13.1 for a table showing the data points used in the above graphs. * The following are outquotes located in the margins from the "Letters to Our Shareholders", found on pages 4 through 7 of the annual report. Page Outquotes 4 We see an insurance environment being transformed by consolidation, convergence of financial services, gloabalization and intense competition 5 We are fully focused on improved earnings and continued growth of shareholder value. 6 We will continue to concentrate our full management attention on improving the Company's bottom line. 7 We will continue to challenge all our businesses on the basis of their ability to sustain profitable, long-term growth. EX-27 7 ARTICLE 7 FDS FOR 10-K
7 0000021175 CNA FINANCIAL CORPORATION 1,000,000 12-MOS DEC-31-1998 JAN-1-1998 DEC-31-1998 30,073 0 0 1,970 57 5 37,177 217 6,365 2,422 62,359 29,192 5,039 140 789 3,160 0 350 464 8,387 62,359 13,375 2,146 695 858 11,717 2,180 2,629 349 (47) 282 0 0 0 282 1.49 1.49 23,367 7,903 406 2,791 5,954 22,931 263
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