-----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, WTOtRykPbcSaHoRQZnuR2oIBgvOB1QVpppMgGftmbt0LWpgo9Wpmzqn4rycB2Kmq MhmVkXIgkjcge4e2LJUHWw== 0000021175-97-000022.txt : 19971117 0000021175-97-000022.hdr.sgml : 19971117 ACCESSION NUMBER: 0000021175-97-000022 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971114 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: CNA FINANCIAL CORP CENTRAL INDEX KEY: 0000021175 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 366169860 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-05823 FILM NUMBER: 97722139 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-Q 1 3RD QUARTER 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------------------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997 COMMISSION FILE NUMBER 1-5823 -------------------------- CNA FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 36-6169860 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) CNA PLAZA Chicago, Illinois 60685 (Address of principal executive offices) (Zip Code) (312) 822-5000 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No... Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. CLASS OUTSTANDING AT NOVEMBER 1, 1997 - ---------------------------------- ------------------------------- Common Stock, Par value $2.50 61,798,262 - -------------------------------------------------------------------------------- Page (1) of (30) CNA FINANCIAL CORPORATION INDEX PART I. FINANCIAL INFORMATION PAGE NO. - ------- --------------------- -------- CONDENSED CONSOLIDATED FINANCIAL STATEMENTS: CONSOLIDATED BALANCE SHEET SEPTEMBER 30, 1997 (Unaudited) AND DECEMBER 31, 1996.............. 3 STATEMENT OF CONSOLIDATED OPERATIONS (Unaudited) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996........... 4 STATEMENT OF CONDENSED CONSOLIDATED STOCKHOLDERS' EQUITY (Unaudited) FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996....................................... 5 STATEMENT OF CONSOLIDATED CASH FLOWS (Unaudited) FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996............. 6 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) SEPTEMBER 30, 1997......................... 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS......................................... 15 PART II. OTHER INFORMATION - -------- ----------------- ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K........................... 26 SIGNATURES............................................................. 27 EXHIBIT 11 COMPUTATION OF NET INCOME PER COMMON SHARE............... 28 EXHIBIT 12.1 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES.............................. 29 EXHIBIT 12.2 COMPUTATION OF RATIO OF NET INCOME, AS ADJUSTED, TO FIXED CHARGES............................... 29 EXHIBIT 27 FINANCIAL DATA SCHEDULE.................................. 30 (2)
CNA FINANCIAL CORPORATION CONSOLIDATED BALANCE SHEET - ----------------------------------------------------------------------------------------------- SEPTEMBER 30 DECEMBER 31 1997 1996 (In millions of dollars) (Unaudited) - ----------------------------------------------------------------------------------------------- ASSETS Investments: Fixed maturities available for sale (cost: $27,784 and $27,540)...$ 28,169 $ 27,721 Equity securities available for sale (cost: $704 and $702)........ 863 859 Mortgage loans and real estate (less accumulated depreciation: $4 and $4)........................ 98 123 Policy loans...................................................... 177 174 Other invested assets............................................. 732 681 Short-term investments............................................ 6,844 5,854 ---------- ------------ Total investments............................................... 36,883 35,412 Cash................................................................ 371 257 Insurance receivables: Reinsurance receivables .......................................... 6,031 6,530 Other insurance receivables....................................... 6,501 5,943 Less allowance for doubtful accounts.............................. (294) (277) Deferred acquisition costs.......................................... 2,223 1,854 Accrued investment income........................................... 410 508 Receivables for securities sold..................................... 704 264 Federal income taxes recoverable (includes $(15) and $151 due (to) from Loews)......................................................... (31) 134 Deferred income taxes............................................... 1,091 1,347 Property and equipment at cost (less accumulated depreciation: $563 and $436)...................................................... 698 645 Prepaid reinsurance premiums........................................ 372 295 Intangibles......................................................... 573 418 Other assets........................................................ 945 849 Separate Account business........................................... 6,012 6,121 - ----------------------------------------------------------------------------------------------- TOTAL ASSETS $ 62,489 $ 60,300 ===============================================================================================
CNA FINANCIAL CORPORATION CONSOLIDATED BALANCE SHEET - CONTINUED - ----------------------------------------------------------------------------------------------- September 30 December 31 1997 1996 (In millions of dollars) (Unaudited) - ----------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Insurance reserves: Claim and claim expense.........................................$ 30,150 $ 30,395 Unearned premiums............................................... 5,221 4,659 Future policy benefits.......................................... 4,508 4,181 Policyholders' funds............................................ 752 746 Securities sold under repurchase agreements........................ 1,176 100 Payables for securities purchased.................................. 1,088 405 Participating policyholders' equity................................ 126 119 Short-term debt.................................................... 150 - Long-term debt..................................................... 2,721 2,765 Other liabilities.................................................. 2,668 3,749 Separate Account business.......................................... 6,012 6,121 ----------- ------------- TOTAL LIABILITIES.............................................. 54,572 53,240 ----------- ------------- Stockholders' equity: Common stock ($2.50 par value; Authorized - 200,000,000 shares; Issued - 61,841,969 shares)...................................... 155 155 Money market cumulative preferred stock............................ 150 150 Additional paid-in capital......................................... 435 435 Retained earnings.................................................. 6,706 6,024 Net unrealized investment gains.................................... 474 299 Treasury stock, at cost............................................ (3) (3) ------------ ------------- TOTAL STOCKHOLDERS' EQUITY..................................... 7,917 7,060 - ------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 62,489 $ 60,300 ================================================================================================= See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).
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CNA FINANCIAL CORPORATION STATEMENT OF CONSOLIDATED OPERATIONS (Unaudited) - ------------------------------------------------------------------------------------------------------- THIRD QUARTER NINE MONTHS - ------------------------------------------------------------------------------------------------------- PERIOD ENDED SEPTEMBER 30 1997 1996 1997 1996 (In millions of dollars, except per share data) - ------------------------------------------------------------------------------------------------------- Revenues: Premiums...................................... $ 3,336 $ 3,435 $10,031 $10,049 Net investment income......................... 530 540 1,641 1,676 Realized investment gains..................... 237 109 475 487 Other......................................... 206 172 537 454 --------- --------- -------- -------- 4,309 4,256 12,684 12,666 --------- --------- -------- -------- Benefits and expenses: Insurance claims and policyholders' benefits.. 2,854 2,839 8,607 8,401 Amortization of deferred acquisition costs.... 621 602 1,738 1,568 Other operating expenses...................... 384 464 1,223 1,470 Interest expense.............................. 57 51 153 155 --------- --------- -------- -------- 3,916 3,956 11,721 11,594 --------- --------- -------- -------- Income before income tax...................... 393 300 963 1,072 Income tax expense.............................. 119 61 276 302 --------- --------- -------- -------- $ 274 $ 239 $ 687 $ 770 ======================================================================================================= EARNINGS PER SHARE - ------------------ Net income ..................................... $ 4.41 $ 3.83 $ 11.04 $ 12.38 ========= ========= ======== ======== Weighted average outstanding shares of common stock (in millions of shares)............ 61.8 61.8 61.8 61.8 ======================================================================================================= See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).
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CNA FINANCIAL CORPORATION STATEMENT OF CONSOLIDATED STOCKHOLDERS' EQUITY (Unaudited) - ------------------------------------------------------------------------------------------------------------- Nine months Ended September 30, 1997 and 1996 Net Additional Unrealized Capital Paid in Retained Investment Gains Total Stock Capital Earnings (Losses) (In millions of dollars) - ------------------------------------------------------------------------------------------------------------- Balance, December 31, 1995 $ 302 $ 435 $ 5,066 $ 933 $ 6,736 Net income........................ - - 770 - 770 Change in net unrealized investment losses................. - - - (790) (790) Preferred dividends............... - - (5) - (5) - ------------------------------------------------------------------------------------------------------------- Balance, September 30, 1996 $ 302 $ 435 $ 5,831 $ 143 $ 6,711 ============================================================================================================= Balance, December 31, 1996 $ 302 $ 435 $ 6,024 $ 299 $ 7,060 Net income........................ - - 687 - 687 Change in net unrealized investment losses................. - - - 175 175 Preferred dividends............... - - (5) - (5) - ------------------------------------------------------------------------------------------------------------ Balance, September 30, 1997 $ 302 $ 435 $ 6,706 $ 474 $ 7,917 ============================================================================================================ See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).
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CNA FINANCIAL CORPORATION STATEMENT OF CONSOLIDATED CASH FLOWS (Unaudited) - ----------------------------------------------------------------------------------------------------------------- NINE MONTHS ENDED SEPTEMBER 30 1997 1996 (In millions of dollars) - ----------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income ................................................................... $ 687 $ 770 ------------ -------------- Adjustments to reconcile net income to net cash flows from operating activities: Net realized investment gains, pre-tax ...................................... (475) (487) Participating policyholders' interest........................................ 2 2 Amortization of intangibles.................................................. 20 19 Amortization of bond discount................................................ (81) (130) Depreciation................................................................. 132 118 Changes in: Insurance receivables, net.................................................. (42) (897) Deferred acquisition costs.................................................. (369) (285) Accrued investment income................................................... 98 52 Federal income taxes recoverable............................................ 165 99 Deferred income taxes....................................................... 156 139 Prepaid reinsurance premiums................................................ (77) 122 Insurance reserves.......................................................... 662 293 Reinsurance payables........................................................ (60) 235 Other liabilities........................................................... (991) 289 Other, net.................................................................. (186) (404) ------------ -------------- Total adjustments ...................................................... (1,046) (835) ------------ -------------- NET CASH FLOWS FROM OPERATING ACTIVITIES ............................... (359) (65) ------------ -------------- =================================================================================================================
CNA FINANCIAL CORPORATION STATEMENT OF CONSOLIDATED CASH FLOWS - CONTINUED (Unaudited) - ----------------------------------------------------------------------------------------------------------------- NINE MONTHS ENDED SEPTEMBER 30 1997 1996 (In millions of dollars) - ----------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of fixed maturities.................................................. (28,756) (24,783) Proceeds from fixed maturities: Sales......................................................................... 27,545 25,758 Maturities, calls and redemptions............................................. 1,668 1,658 Purchases of equity securities................................................. (854) (513) Proceeds from sale of equity securities........................................ 937 650 Change in short-term investments............................................... (993) (2,340) Purchases of property and equipment ........................................... (195) (149) Change in securities sold under repurchase agreements.......................... 1,075 (172) Change in other investments.................................................... 173 256 Investment in affiliates....................................................... (65) -- Other, net..................................................................... (151) 21 ------------ -------------- NET CASH FLOWS FROM INVESTING ACTIVITIES ............................... 384 386 ------------ -------------- Cash flows from financing activities: Dividends paid to preferred shareholders....................................... (5) (5) Receipts from investment contracts credited to policyholder account balances... 7 12 Return of policyholder account balances on investment contracts................ (18) (34) Change in short-term debt...................................................... -- (258) Principal payments on long-term debt........................................... (4) (3) Proceeds from issuance of long-term debt....................................... 109 10 ------------ -------------- NET CASH FLOWS FROM FINANCING ACTIVITIES............................... 89 (278) ------------ -------------- Net cash flows..................................................... 114 43 Cash at beginning of period..................................................... 257 222 ================================================================================================================== CASH AT END OF PERIOD $ 371 $ 265 ================================================================================================================== Supplemental disclosures of cash flow information: Cash (paid) received: Interest expense............................................................... $ (148) $ (166) Federal income taxes........................................................... 50 (43) =================================================================================================================== See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).
(6) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1997 (Unaudited) NOTE A. Basis of Presentation: The Condensed Consolidated Financial Statements (unaudited) include CNA Financial Corporation and its operating subsidiaries (CNA or the Company) which consist of property/casualty insurance companies (principally Continental Casualty Company and The Continental Insurance Company) and life insurance companies (principally Continental Assurance Company and Valley Forge Life Insurance Company). Loews Corporation (Loews) owns approximately 84% of the outstanding common stock of CNA. CNA is a multiple-line insurer underwriting property and casualty coverages; life, accident and health insurance; and pension and annuity business. CNA serves a wide spectrum of insureds, including individuals; small, medium and large businesses; associations; professionals and groups. The operating results for the interim periods are not necessarily indicative of the results to be expected for the full year. These statements should be read in conjunction with the financial statements and notes thereto included in CNA's Annual Report to Shareholders (incorporated by reference in Form 10-K) for the year ended December 31, 1996, filed with the Securities and Exchange Commission on March 31, 1997, and the information shown below. The accompanying condensed consolidated financial statements have been prepared in conformity with generally accepted accounting principles. Certain amounts applicable to the prior year have been reclassified to conform to classifications followed in 1997. All significant intercompany amounts have been eliminated. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In the opinion of CNA's management, these statements include all adjustments, consisting of normal recurring accruals, which are necessary for the fair presentation of the financial position, results of operations and cash flows in the accompanying condensed consolidated financial statements. CNA, its subsidiaries and Separate Accounts, invest from time to time in certain derivative financial instruments to increase investment returns and to reduce the impact of changes in interest rates on certain corporate borrowings. Financial instruments used for such purposes include interest rate swaps, put and call options, commitments to purchase securities, futures and forwards. Unrealized investment gains and losses on derivative securities, except for the interest rate swaps associated with corporate borrowings, are reflected as part of realized investment gains and losses. Unrealized gains or losses related to changes in the value of the interest rate swaps associated with corporate borrowings are not recognized. (7) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE B. Restricted Investments: On December 30, 1993, CNA deposited $987 million in an escrow account, pursuant to the Fibreboard Global Settlement Agreement, as discussed in Note C below. At September 30, 1997, the escrow account amounted to $1.1 billion. The funds are included in short-term investments and are invested substantially in U. S. Treasury securities. The escrow account is the prefunding mechanism to the trust fund for future claimants. NOTE C. Legal Proceedings and Contingent Liabilities: The following information updates legal proceedings and contingent liabilities reported in Note F of the Notes to the Consolidated Financial Statements in the 1996 Annual Report to Shareholders. FIBREBOARD LITIGATION CNA's primary property/casualty subsidiary, Continental Casualty Company ("Casualty"), has been party to litigation with Fibreboard Corporation ("Fibreboard") involving coverage for certain asbestos-related claims and defense costs (San Francisco Superior Court, Judicial Council Coordination Proceeding 1072). As described below, Casualty, Fibreboard, another insurer (Pacific Indemnity, a subsidiary of the Chubb Corporation), and a negotiating committee of asbestos claimant attorneys (collectively referred to as "Settling Parties") have reached a Global Settlement (the "Global Settlement") which is subject to court approval, to resolve all future asbestos-related bodily injury claims involving Fibreboard. Casualty, Fibreboard and Pacific Indemnity have also reached an agreement (the "Trilateral Agreement"), on a settlement to resolve the coverage litigation and provides funding for Fibreboard's asbestos claims in the event the Global Settlement does not obtain final court approval. On July 27, 1995, the United States District Court for the Eastern District of Texas entered judgment approving the Global Settlement Agreement and the Trilateral Agreement. As expected, appeals were filed as respects both of these decisions. On July 25, 1996, a panel of the United States Fifth Circuit Court of Appeals in New Orleans affirmed the judgment approving the Global Settlement Agreement by a 2 to 1 vote and affirmed the judgment approving the Trilateral Agreement by a 3 to 0 vote. Petitions for rehearing by the panel and Suggestions for Rehearing by the entire Fifth Circuit Court of Appeals as respects the decision on the Global Settlement Agreement were denied. Two petitions for certiorari were filed in the Supreme Court as respects the Global Settlement Agreement. On June 27, 1997, the Supreme Court granted these petitions, vacated the Fifth Circuit's judgment as respects the Global Settlement Agreement, and remanded to the Fifth Circuit for reconsideration in light of the Supreme Court's decision in Amchem Products Co. v. Windsor. The Fifth Circuit has --------------------------------- not yet rendered a decision on this remand. No further appeal was filed with respect to the Trilateral Agreement; therefore, court approval of the Trilateral Agreement has become final. GLOBAL SETTLEMENT AGREEMENT On April 9, 1993, Casualty and Fibreboard entered into an agreement pursuant to which, among other things, the parties agreed to use their best efforts to negotiate and finalize a global class action settlement with asbestos-related bodily injury and death claimants. (8) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED On August 27, 1993, the Settling Parties reached an agreement in principle for an omnibus settlement to resolve all future asbestos-related bodily injury claims involving Fibreboard. The Global Settlement Agreement was executed on December 23, 1993. The agreement calls for contribution by Casualty and Pacific Indemnity of an aggregate of $1.53 billion to a trust fund for a class of all future asbestos claimants, defined generally as those persons whose claims against Fibreboard were neither filed nor settled before August 27, 1993. An additional $10 million is to be contributed to the fund by Fibreboard. As indicated above, the Global Settlement approval is presently before the Fifth Circuit on remand by order of the Supreme Court vacating the Fifth Circuit's previous decision approving the Global Settlement. There is limited precedent with settlements which determine the rights of future personal injury claimants to seek relief. Through September 30, 1997, Casualty, Fibreboard and plaintiff attorneys had reached settlements with respect to approximately 135,620 claims, for an estimated settlement amount of approximately $1.62 billion plus any applicable interest. Final court approval of the Trilateral Agreement obligates Casualty to pay under these settlements. Approximately $1.59 billion including interest was paid through September 30, 1997, including approximately $590 million paid in the fourth quarter of 1996 and the first quarter of 1997 as a result of the Trilateral Agreement becoming final. As described above, such payments have been partially recovered from Pacific Indemnity. Casualty may negotiate other agreements for unsettled claims. Final court approval of the Trilateral Agreement and its implementation has eliminated any further material exposure with respect to the Fibreboard matter, and subsequent reserve adjustments, if any, will not materially affect the results of operations or equity of CNA. TOBACCO LITIGATION CNA's primary property/casualty subsidiaries have been named as defendants as part of a "direct action" lawsuit, Richard P. Ieyoub v. The ------------------------------- American Tobacco Company, etal., filed by the Attorney General for the State of - -------------------------------- Louisiana, in state court, Calcasieu Parish, Louisiana. In that suit, filed against certain tobacco manufacturers and distributors (the "Tobacco Defendants") and over 100 insurance companies, the State of Louisiana seeks to recover medical expenses allegedly incurred by the State as a result of tobacco-related illnesses. The original suit was filed on March 13, 1996, against the Tobacco Defendants only. The insurance companies were added to the suit in March 1997 under a "direct action" statute in Louisiana. Under the direct action statute, the Louisiana Attorney General is pursuing liability claims against the Tobacco Defendants and their insurers in the same suit, even though none of the Tobacco Defendants has made a claim for insurance coverage. Recently, the United States District Court for the Western District of Louisiana, Lake Charles Division, granted a petition to remove this litigation to the federal district court. The district court's decision is currently on appeal to the United States Fifth Circuit Court of Appeals. During the pending appeal, all proceedings in state court and in the federal district court are stayed. Because of the uncertainties inherent in assessing the risk of liability at this very early stage of the litigation, management is unable to make a meaningful estimate of the amount or range of any loss that could result from an unfavorable outcome of the pending litigation. However, management believes that the ultimate outcome of the pending litigation should not materially affect the results of operations or equity of CNA. (9) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED OTHER LITIGATION CNA and its subsidiaries are also parties to other litigation arising in the ordinary course of business. The outcome of this other litigation will not, in the opinion of management, materially affect the results of operations or equity of CNA. ENVIRONMENTAL POLLUTION AND ASBESTOS-RELATED CLAIMS The CNA property/casualty insurance companies have potential exposures related to environmental pollution and asbestos-related claims. Environmental pollution clean-up is the subject of both federal and state regulation. By some estimates, there are thousands of potential waste sites subject to clean-up. The insurance industry is involved in extensive litigation regarding coverage issues. Judicial interpretations in many cases have expanded the scope of coverage and liability beyond the original intent of the policies. The Comprehensive Environmental Response Compensation and Liability Act of 1980 ("Superfund") and comparable state statutes ("mini-Superfund") govern the clean-up and restoration of abandoned toxic waste sites and formalize the concept of legal liability for clean-up and restoration by "Potentially Responsible Parties" ("PRP's"). Superfund and the mini-Superfunds (Environmental Clean-up Laws or "ECLs") establish a mechanism to pay for clean-up of waste sites if PRP's fail to do so, and to assign liability to PRP's. The extent of liability to be allocated to a PRP is dependent on a variety of factors. Further, the number of waste sites subject to clean-up is unknown. To date, approximately 1,300 clean-up sites have been identified by the Environmental Protection Agency on its National Priorities List. On the other hand, the Congressional Budget Office is estimating that there will be 4,500 National Priority List sites, and other estimates project as many as 30,000 sites that will require clean-up under ECLs. Very few sites have been subject to clean-up to date. The extent of clean-up necessary and the assignment of liability has not been established. CNA and the insurance industry are disputing coverage for many such claims. Key coverage issues include whether Superfund response costs are considered damages under the policies, trigger of coverage, applicability of pollution exclusions, the potential for joint and several liability and definition of an occurrence. Similar coverage issues exist for clean-up of waste sites not covered under Superfund. To date, courts have been inconsistent in their rulings on these issues. A number of proposals to reform Superfund have been made by various parties. Despite Superfund taxing authority expiring at the end of 1995, no reforms have yet been enacted by Congress. While the current Congress may address this issue, no predictions can be made as to what legislation, if any, will result. If there is legislation, and in some circumstances even if there is no legislation, the federal role in environmental clean-up may be materially reduced in favor of state action. Substantial changes in the federal statute or the activity of the EPA may cause states to reconsider their environmental clean-up statutes and regulations. There can be no meaningful prediction of the pattern of regulation that would result. Due to the inherent uncertainties described above, including the inconsistency of court decisions, the number of waste sites subject to clean-up, and the standards for clean-up and liability, the ultimate exposure to CNA for environmental pollution claims cannot be meaningfully quantified. (10) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED Claim and claim expense reserves represent management's estimates of ultimate liabilities based on currently available facts and case law. However, in addition to the uncertainties previously discussed, additional issues related to, among other things, specific policy provisions, multiple insurers and allocation of liability among insurers, consequences of conduct by the insured, missing policies and proof of coverage make quantification of liabilities exceptionally difficult and subject to adjustment based on new data. As of September 30, 1997 and December 31, 1996, CNA carried approximately $824 million and $908 million, respectively, of claim and claim expense reserves, net of reinsurance recoverables, for reported and unreported environmental pollution claims. The reserves relate to claims for accident years 1988 and prior, which coincides with CNA's adoption of the Simplified Commercial General Liability coverage form which included an absolute pollution exclusion. There was no unfavorable reserve development for the nine months ended September 30, 1997 and 1996. CNA has exposure to asbestos-related claims, including those attributable to the Fibreboard Claim. A detailed discussion of CNA's litigation with Fibreboard Corporation regarding asbestos-related bodily injury claims is discussed at the beginning of this note. Estimation of asbestos-related claim reserves encounter many of the same limitations discussed above for environmental pollution claims such as inconsistency of court decisions, specific policy provisions, multiple insurers and allocation of liability among insurers, missing policies and proof of coverage. As of September 30, 1997 and December 31, 1996, CNA carried approximately $1,415 million and $1,506 million, respectively, of claim and claim expense reserves, net of reinsurance recoverable, for reported and unreported asbestos-related claims. Unfavorable reserve development for the nine months ended September 30, 1997 and 1996, totaled $40 million and $38 million, respectively. The following table provides additional data related to CNA's environmental pollution and asbestos-related claims reserves. |------------------------------------------------------------------------------| | | |Reserve Summary September 30, 1997 December 31, 1996 | | -----------------------------------------------------| | Environmental Asbestos Environmental Asbestos| | Pollution Pollution | |------------------------------------------------------------------------------| |In millions of dollars) | | | |Gross reserves: | | Reported claims $ 288 $1,431 $ 289 $1,551 | | Unreported claims 577 101 714 94 | | ------ ------ ------- ------- | | 865 1,532 1,003 1,645 | |Less reinsurance recoverable (41) (117) (95) (139) | |------------------------------------------------------------------------------| |Net reserves $ 824 $1,415 $ 908 $1,506 | |==============================================================================| The results of operations in future years may continue to be adversely affected by environmental pollution and asbestos claims and claim expenses. Management will continue to monitor potential liabilities and make further adjustments as warranted. (11) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE D. Reinsurance: CNA assumes and cedes insurance with other insurers and reinsurers and members of various reinsurance pools and associations. CNA utilizes reinsurance arrangements to limit its maximum loss to provide greater diversification of risk and to minimize exposures on larger risks. The reinsurance coverages are tailored to the specific risk characteristics of each product line with CNA's retained amount varying by type of coverage. Generally, reinsurance coverage for property risks is on an excess of loss, per risk basis. Liability coverages are generally reinsured on a quota share basis in excess of CNA's retained risk. The ceding of insurance does not discharge the primary liability of the original insurer. CNA places reinsurance with other carriers only after careful review of the nature of the contract and a thorough assessment of each reinsurer's credit quality and claim settlement performance. Further, for carriers that are not authorized reinsurers in its states of domicile, CNA receives collateral, primarily in the form of bank letters of credit. |-----------------------------------------------------------------------------| |NINE MONTHS ENDED EARNED PREMIUMS ASSUMED/ | |SEPTEMBER 30 | | -------------------------------------- | | NET | |(In millions of dollars) DIRECT ASSUMED CEDED NET % | |-----------------------------------------------------------------------------| | | |1997 | | Life $ 649 $ 92 $ 90 $ 651 14.1% | | Accident and health 2,806 73 115 2,764 2.6 | | Property and casualty 6,087 1,078 549 6,616 16.3 | |-----------------------------------------------------------------------------| | TOTAL PREMIUMS $ 9,542 $ 1,243 $ 754 $10,031 12.4% | |=============================================================================| |1996 | | Life $ 520 $ 87 $ 33 $ 574 15.2% | | Accident and health 2,580 183 113 2,650 6.9 | | Property and casualty 6,702 1,056 933 6,825 15.5 | |-----------------------------------------------------------------------------| | TOTAL PREMIUMS $ 9,802 $ 1,326 $ 1,079 $10,049 13.2% | |=============================================================================| In the table above, life premium revenue is from long duration contracts, property/casualty earned premium is from short duration contracts, and approximately three-quarters of accident and health earned premium is from short duration contracts. Insurance claims and policyholders' benefits are net of reinsurance recoveries of $618 and $1,010 million for the nine months ended September 30, 1997 and September 30, 1996, respectively. (12) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED NOTE E. Debt: Long-term and short-term borrowings consisted of the following: |------------------------------------------------------------------------------| |LONG-TERM AND SHORT-TERM DEBT SEPTEMBER 30 DECEMBER 31| |(In millions of dollars) 1997 1996 | - -------------------------------------------------------------------------------| |Long-term: | | Variable Rate Debt: | | Credit Facility $ 400 $ 400 | | Commercial Paper 675 675 | | Credit Facility - CNA Surety 105 --- | |Senior Notes: | | 8 7/8%, due March 1, 1998* --- 150 | | 8 1/4%, due April 15, 1999 101 102 | | 7 1/4%, due March 1, 2003 146 146 | | 6 1/4%, due November 15, 2003 249 248 | | 6 3/4%, due November 15, 2006 248 248 | | 8 3/8%, due August 15, 2012 98 98 | | 7 1/4% Debenture, due November 15, 2023 247 247 | | 11% Secured Mortgage Notes, due June 20, 2013 388 387 | | 6.90% - 16.29% Secured Capital Leases, | | due December 31, 2011 46 47 | | Other 18 17 | |------------------------------------------------------------------------------| | TOTAL LONG-TERM DEBT $ 2,721 $ 2,765 | | Short-term: | | 8 7/8%, due March 1, 1998 150 --- | |------------------------------------------------------------------------------| | TOTAL DEBT $ 2,871 $ 2,765 | |==============================================================================| *Included in short-term in 1997. To finance the acquisition of Continental (including the refinancing of $205 million of Continental debt) CNA entered into a five-year $1.325 billion revolving credit facility. In 1996, the Company renegotiated the facility, extending the maturity to May 2001. The interest rate for the facility is based on the London Interbank Offered Rate (LIBOR), plus 16 basis points. Additionally, there is a facility fee of 9 basis points annually. The average interest rate on the borrowings under the revolver at September 30, 1997 was 5.82%. Under the terms of the facility, CNA may prepay the debt without penalty. On November 15, 1996, CNA issued $250 million of 6 3/4% senior notes, due November 15, 2006. The net proceeds from this issuance of approximately $248 million were used to pay down a portion of the borrowings outstanding under the revolving credit facility. As a result of this debt issuance, borrowing capacity under the revolving credit facility was reduced by $250 million to $1.075 billion. Concurrent with the paydown of $250 million on the revolving credit facility, CNA terminated interest rate swaps with a total notional amount of $250 million. CNA maintains a commercial paper program to take advantage of favorable interest rate spreads. The commercial paper borrowings are classified as long-term as $675 million of the committed bank facility will support the commercial paper program. The weighted-average yield on commercial paper at September 30, 1997 was 5.82%. As of November 1, 1997, the outstanding loans under the revolving credit facility were $400 million. There was no unused borrowing capacity under the facility after the effects of the commercial paper program. (13) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - CONCLUDED To offset the variable rate characteristics of the facility, CNA entered into interest rate swap agreements with several banks having a total notional principal amount of $950 million. These agreements terminate from May to December 2000. These agreements provide that CNA pay interest at a fixed rate, averaging 6.20% at September 30, 1997, in exchange for the receipt of interest at the three month LIBOR rate. The effect of these interest rate swaps was to increase interest expense by $3 million for the nine months ended September 30, 1997. The weighted average interest rate (interest and facility fees) on the variable rate acquisition debt, which includes the revolving credit facility and commercial paper, was 6.28% at September 30, 1997. This rate reflects the effect of the interest rate swaps. In conjunction with the merger with Capsure Holdings Corp. (See Note F) CNA's affiliate, CNA Surety entered into a $130 million, 5 year revolving credit facility which closed and was funded on September 30, 1997. The interest rate for the facility is based on LIBOR plus 20 basis points. Additionally there is a facility fee of 10 basis points annually. At September 30, 1997 the interest rate was 5.86%. As of September 30, 1997, $250 million of securities remained available for issuance under a shelf registration. On October 22, 1997, an additional $750 million shelf registration for senior and subordinated debt and preferred stock became effective. A portion of the net proceeds is expected to be used to pay down borrowings outstanding under the Company's revolving credit facility and/or commercial paper program. The remaining proceeds will be added to the Company's general funds and used for general corporate purposes, which may include, but are not limited to, pre-payment of other debt, and/or capital contributions to the Company's subsidiaries to strengthen such subsidiaries' continuing operations. NOTE F. Merger CNA Surety Corporation/Capsure Holdings Corp. In the fourth quarter of 1996, CNA Surety Corporation, an affiliate of CNA, entered into a merger agreement with Capsure Holdings Corp. (Capsure) to form a new stock company, CNA Surety Corporation. The transaction closed on September 30, 1997. In conjunction with the closing of the surety transaction, CNA recognized a realized investment gain of $89 million. The new company, in which CNA owns approximately 62% of the outstanding shares on a fully diluted basis, is the largest U.S. surety company with the broadest product line and most extensive distribution system. The remaining shares are held by existing Capsure shareholders and option holders. The transaction was accounted for as a purchase and, accordingly, CNA Surety's results of operations will be included in CNA's consolidated results of operations subsequent to the date of merger. At September 30, 1997, total assets of CNA Surety Corporation were $686 million. Capsure's revenues for the year ended December 31, 1996 were approximately $111 million. Total assets were approximately $313 million at December 31, 1996. (14) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and notes thereto found on pages 3 to 14, which contain additional information helpful in evaluating operating results and financial condition. CNA is one of the largest commercial insurers in the United States, the third largest property-casualty company and the twenty-second largest life insurance company in the country, based on 1996 net written premium. Based on market share, CNA ranks first among United States insurers in commercial auto, commercial affiliation marketing, commercial multiple peril, personal packages, surety, and ocean marine; second in commercial lines, general liability, medical malpractice, federal employees health benefit plans, multiple peril crop, offshore energy, and accounts receivable credit; third in automobile warranty, directors & officers, farmowners multiple peril, recreational watercraft, and workers' compensation; and fifth in reinsurance in the United States. In addition, CNA ranks first, second or third for various errors & omissions coverages for architects and engineers, accountants, lawyers and other professionals. Results of Operations: The following chart summarizes key components of operating results for the nine months and quarters ended September 30, 1997 and 1996.
|----------------------------------------------------------------------------------------------------------| |PERIOD ENDED SEPTEMBER 30 THIRD QUARTER NINE MONTHS | |(In millions of dollars) 1997 1996 1997 1996 | |----------------------------------------------------------------------------------------------------------| |OPERATING SUMMARY (EXCLUDING REALIZED INVESTMENT | | GAINS/LOSSES): | |Revenues: | | Premiums: | | Property/Casualty $ 2,489 $ 2,593 $ 7,489 $ 7,579 | | Life 847 842 2,542 2,470 | | ------ ------ ------ ------ | | 3,336 3,435 10,031 10,049 | | Net investment income 530 540 1,641 1,676 | | Other 206 171 537 454 | | ------ ------ ------ ------ | | 4,072 4,146 12,209 12,179 | |Benefits and expenses 3,911 3,957 11,712 11,583 | | ------ ------ ------ ------ | | Operating income before income tax 161 189 497 596 | |Income tax expense (40) (28) (114) (138) | | ------ ------ ------ ------ | | Net operating income $ 121 $ 161 $ 383 $ 458 | | ====== ====== ====== ====== | | | |SUPPLEMENTAL FINANCIAL DATA: | |Net operating income (loss) by group: | | Property/Casualty $ 121 $ 165 $ 385 $ 463 | | Life 24 23 71 78 | | Other, primarily interest expense (24) (27) (73) (83) | | ------ ----- ----- ----- | | 121 161 383 458 | | ------ ----- ----- ----- | |Net realized investment gains (losses) by group: | | Property/Casualty 126 52 221 232 | | Life 29 22 73 79 | | Other (2) 4 10 1 | | ------ ---- ------ ---- | | 153 78 304 312 | | ------ ---- ------ ---- | |Net income (loss) by group: | | Property/Casualty 247 217 606 695 | | Life 53 45 144 157 | | Other, primarily interest expense (26) (23) (63) (82) | | ------ ----- ------ ----- | | $ 274 $ 239 $ 687 $ 770 | |==========================================================================================================|
(15) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED Consolidated Results - -------------------- Consolidated revenues for the first nine months of both 1997 and 1996 were approximately $12.7 billion. Consolidated revenues excluding net realized investment gains, for the first nine months of both 1997 and 1996 were approximately $12.2 billion. For the first nine months, revenues reflect a decrease of $18 million (0.2%) in earned premiums, a decrease of $35 million (2.1%) in investment income and an increase of $83 million (18.3%) in other income. Net operating income, which excludes net realized investment gains, for the first nine months of 1997 was $383 million, or $6.12 per share, compared to net operating income of $458 million, or $7.33 per share, for the first nine months of 1996. Net operating income for the third quarter was $121 million, or $1.93 per share, compared with $161 million, or $2.57 per share, for the same quarter in 1996. CNA's income in the first nine months of 1997 is net of pretax losses of $79 million related to catastrophe claims; pretax catastrophe losses in the first nine months of 1996 were $280 million. Realized investment gains, net of tax, for the first nine months of 1997 were $304 million, or $4.92 per share, compared to net realized investment gains for the first nine months of 1996 of $312 million, or $5.05 per share. The components of the net realized investment gains (losses) are as follows: |-----------------------------------------------------------------------------| |REALIZED INVESTMENT GAINS(LOSSES) | |NINE MONTHS ENDED SEPTEMBER 30 1997 1996 | |(In millions of dollars) | |-----------------------------------------------------------------------------| |Bonds: | | U.S. Government $ 103 $ 102 | | Tax-exempt 26 109 | | Asset-backed 18 23 | | Taxable 102 14 | | ------- ------- | | Total bonds 249 248 | |Stocks 57 148 | |Derivative securities 2 11 | |Separate accounts and other 167 * 80 | | ------ ------- | | Realized investment gains reported in revenues 475 487 | |Participating policyholders' interest (8) (11) | |Income tax expense (163) (164) | | ------- -------- | | Net realized investment gains $ 304 $ 312 | |=============================================================================| *Includes a realized investment gain of $89 million on the merger of CNA Surety Corporation and Capsure Holdings Corp. (See Note F). Net income was $687 million, or $11.04 per share, compared to $770 million, or $12.38 per share, for the first nine months of 1996. Net income for the third quarter was $274 million, or $4.41 per share, compared with a net income of $239 million, or $3.83 per share, for the third quarter of 1996. (16) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED Property/Casualty Operations - ---------------------------- |------------------------------------------------------------------------------| |PROPERTY/CASUALTY GROUP THIRD QUARTER NINE MONTHS | |PERIOD ENDED SEPTEMBER 30 1997 1996 1997 1996 | |(In millions of dollars) | |----------------------------------------------------------------------------- | |OPERATING SUMMARY (EXCLUDING NET | | REALIZED INVESTMENT GAINS/LOSSES): | |Revenues: | | Premiums $ 2,489 $ 2,593 $ 7,489 $ 7,579 | | Net investment income 432 445 1,343 1,384 | | Other 173 137 448 379 | | ------ ------ ------ ------ | | 3,094 3,175 9,280 9,342 | |Benefits and expenses 2,936 2,979 8,781 8,740 | | ----- ----- ----- ----- | | Income before income tax 158 196 499 602 | |Income tax expense (37) (31) (114) (139)| | ------- ------- ------ ------| |Net operating income (excluding net | | realized investment gains/losses) $ 121 $ 165 $ 385 $ 463 | | | |==============================================================================| Property/casualty revenues, excluding net realized investment gains/losses, decreased $62 million for the first nine months ended September 30, 1997, when compared to the same period a year ago. Property/casualty earned premium decreased $90 million from the prior years comparable period. The decrease in earned premium is due primarily to a reduction in premium in the involuntary risk business , primarily workers' compensation, of $285 million and $70 million for the nine and three months ended September 30, 1997, compared to the same periods a year ago. These reductions are as a result of improved loss experience in the involuntary risk business. Property/casualty pretax operating income before realized gains reflects a decrease of $103 million for the first nine months of 1997 compared to the same period in 1996. The decrease in operating income stems from an increase in underwriting losses as well as a decline in investment income. This decrease was offset in part by lower operating expenses and favorable catastrophe loss experience. Pre-tax catastrophe losses of approximately $79 million for the nine months ended September 30, 1997 compared to $280 million for the respective period in 1996. Underwriting losses for the first nine and three months ended September 30, 1997, were $844 million and $273 million, compared to $783 million and $249 million for the same periods in 1996. The GAAP combined ratio for the nine months ending September 30, 1997 was 108.9% as compared to 108.6% for the comparable period in 1996. GAAP expense ratios were 29.9% and 31.0% for the nine month periods ended September 30, 1997 and September 30, 1996, respectively. There was profitability improvement in the personal insurance lines, both in the private passenger and homeowner lines. However, continued competitive pressures on virtually all other segments of the insurance market, particularly in the commercial insurance market, resulted in continued deterioration of the loss ratio. CNA, consistent with sound insurance reserving practices, regularly adjusts its reserve estimates in subsequent reporting periods as new facts and circumstances emerge that indicate the previous estimates need to be modified. These adjustments, referred to as "reserve development" are inevitable given the complexities of the reserving process and are recorded in the statement of operations in the period the need for the adjustments becomes apparent. Loss & loss adjustment expense reserve development for the nine months ended September 30, 1997 and 1996 was favorable and aggregated $297 million and $142 million, respectively (including the effects of unfavorable reserve development for asbestos related claims - see Note D). Favorable loss reserve development was partially offset by unfavorable premium development, which aggregated $165 million and $21 million for the nine months ended September 30, 1997 and 1996, respectively. (17) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED Loss reserve development for the nine months ended September 30, 1997 reflects continued favorable claim frequency (rate of claim occurrence) and severity (average cost per claim) experience, principally in the workers' compensation line of business as well as favorable experience in the surety line of business. In addition, involuntary risk exposures have developed to be less than previously anticipated, which reduced both premium and losses associated with the residual market pool participation, principally for workers' compensation. These trends reflect the positive effects of changes in workers' compensation laws, moderate increases in medical costs and a generally strong economy in which individuals return to the workplace more quickly. Pretax operating income excluding net realized investment gains/losses, for the property/casualty insurance subsidiaries was $499 million and $158 million for the nine months and three months ended September 30, 1997, compared to $602 million and $196 million for the same periods a year ago. Investment income decreased 3.0% and 2.9% for the nine and three months ended September 30, 1997, to $1,343 million and $432 million, respectively, when compared with the comparable periods a year ago of $1,384 million and $445 million, respectively. The decrease reflects reduced operating cash flow and a movement to lower market yields. The fixed maturities segment of the investment portfolio yielded 6.3% in the nine months of 1997 as compared to 6.6% for the nine months of 1996. The net income of CNA's property/casualty insurance subsidiaries, excluding net realized investment gains/losses, was $385 and $121 million for the nine and three months ended September 30, 1997, compared to $463 million and $165 million for the same periods in 1996. Net realized investment gains for the nine and three months ended September 30, 1997 were $221 million and $126 million, compared to $232 million and $52 million in the comparable periods of 1996. Life Operations - --------------- |------------------------------------------------------------------------------| |LIFE GROUP THIRD QUARTER NINE MONTHS | |PERIOD ENDED SEPTEMBER 30 1997 1996 1997 1996 | |(In millions of dollars) | |------------------------------------------------------------------------------| |OPERATING SUMMARY (EXCLUDING NET | | REALIZED INVESTMENT GAINS/LOSSES): | |Revenues: | | Premiums $ 847 $ 849 $ 2,544 $ 2,488 | | Net investment income 102 99 306 295 | | Other 33 32 89 75 | | ----- ----- ----- ----- | | 982 980 2,939 2,858 | |Benefits and expenses 943 945 2,827 2,737 | | ----- ----- ----- ----- | | Income before income tax 39 35 112 121 | |Income tax expense (15) (12) (41) (43)| | ------ ------ ------ ------ | |Net operating income (excluding net | | realized investment gains/losses) $ 24 $ 23 $ 71 $ 78 | | | |==============================================================================| Life group revenues, excluding net realized investment gains, were approximately $2.9 billion, up 2.8% for the nine months ended September 30, 1997 compared to the same period a year ago. Life premium revenues increased approximately 2.3% for the nine months ended September 30, 1997 when compared to the first nine months of 1996. Individual life operations increased approximately $45 million due to the continued growth in sales and renewal premiums in the Viaterm life product. Group life operations increased approximately $80 million with increases in the Federal Employees Health Benefit Program, group medical and specialty risks. The increase in premiums for these products is primarily offset by a drop in group reinsurance premium. Investment income for the nine months ended September 30, 1997 was $306 million as compared to $295 million for the same period a year ago. This increase can be mainly attributed to a larger asset base generated from increased operating cash flows. (18) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED The fixed maturities segment of the life investment portfolio, which is the primary investment segment, yielded 6.3% in the nine months of 1997 compared with 6.7% for the same period a year ago. Life group premiums declined approximately $2 million for the third quarter of 1997 when compared to the third quarter of 1996. The primary reasons for this decline are a decrease in annuity business and group reinsurance business offset in part by increases in Viaterm and Disability and Accident premium. Pretax operating income for the life insurance subsidiaries, excluding net realized investment gains/losses, was $112 million and $39 million for the nine and three months ended September 30, 1997, compared to $121 million and $35 million for the same periods in 1996. CNA's life insurance subsidiaries' net operating income, excluding net realized investment gains/losses was $71 million and $24 million for the nine and three months ended September 30, 1997 compared to $78 million and $23 million for the same periods in 1996. Net realized investment gains for the nine and three months ended September 30, 1997 were $73 million and $29 million, compared to $79 million and $22 million for the same periods of 1996. INVESTMENTS:
|--------------------------------------------------------------------------|----------------------------------| |SUMMARY OF GENERAL ACCOUNT INVESTMENTS AT MARKET VALUE | NINE MONTHS ENDED | | | SEPTEMBER 30, 1997 | | |-----------------|----------------| | | CHANGE IN | | | SEPTEMBER 30 DECEMBER 31| NET UNREALIZED | REALIZED | |(In millions of dollars) 1997 1996 | GAINS(LOSSES) | GAINS(LOSSES) | |--------------------------------------------------------------------------|-----------------|----------------| | | | | |FIXED MATURITY SECURITIES: | | | |U. S. Treasury securities and | | | | obligations of government agencies $ 12,046 $ 9,835 | $ 59 | $ 103 | |Asset-backed securities 4,763 6,292 | 69 | 26 | |Tax exempt securities 4,831 4,951 | 52 | 18 | |Taxable securities 6,529 6,643 | 24 | 102 | | -------- -------- | ---- | ---- | | Total fixed maturity securities 28,169 27,721 | 204 | 249 | |Stocks 863 859 | 1 | 57 | |Short-term investments and other 7,848 6,830 | 40 | 120* | |Derivative security investments 3 2 | -- | 2 | | -------- -------- | ---- | ---- | | TOTAL INVESTMENTS $ 36,883 $ 35,412 | 245 | 428 | | ======== ======== | | | |Separate accounts and discontinued operations | 35 | 47 | |Participating policyholders' interest | -- | (8) | |Income tax expense | (105) | (163) | | | ----- | ----- | | NET INVESTMENT GAINS | $ 175 | $ 304 | | | | | |--------------------------------------------------------------------------|-----------------|----------------| |--------------------------------------------------------------------------| |SHORT-TERM INVESTMENTS: | |--------------------------------------------------------------------------| |Security repurchase collateral $ 1,185 $ 101 | |Escrow 1,099 1,062 | |Commercial paper 2,446 3,207 | |Money markets 1,528 746 | |Other 586 738 | |--------------------------------------------------------------------------| | TOTAL SHORT-TERM INVESTMENTS $ 6,844 $ 5,854 | |--------------------------------------------------------------------------| *Includes a realized investment gain of $89 million on the merger of CNA Surety Corporation and Capsure Holdings Corp. (See Note F).
CNA's general account investment portfolio is managed to maximize after-tax investment return, while minimizing credit risks, with investments concentrated in high quality securities to support its insurance operations. CNA has the capacity to hold its fixed maturity portfolio to maturity. However, securities may be sold as part of CNA's asset/liability strategies or (19) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED to take advantage of investment opportunities generated by changing interest rates, prepayments, tax and credit considerations, or other similar factors. Accordingly, the fixed maturity securities are classified as available for sale. CNA has a securities lending program where securities are loaned to third parties, primarily major brokerage firms. Borrowers of these securities must deposit 100% of the fair value of the securities if the collateral is cash, or 102% if the collateral is securities. Cash deposits from these transactions are invested in short-term investments (primarily commercial paper). CNA continues to receive the interest on loaned debt securities, as beneficial owner, and accordingly, loaned debt securities are included within fixed maturity securities. The liabilities for securities sold subject to repurchase agreements are recorded at their contractual repurchase amounts. On December 30, 1993, CNA deposited $987 million in an escrow account, pursuant to the Fibreboard Global Settlement Agreement, as discussed in Note C. The funds are included in short-term investments and are invested mainly in U.S. Treasury securities. The escrow account at September 30, 1997 amounted to $1,100 million as compared to $1,071 million at year end 1996. In addition to interest rate swaps used to convert CNA's debt to acquire Continental from a variable rate to a fixed rate, CNA holds derivative financial instruments for purposes of enhancing income and total return. The derivative securities are marked-to-market with valuation changes reported as realized investment gains and losses. CNA's investment in, and risk in relation to, derivative securities are not significant. The general account portfolio consists primarily of high quality (BBB or higher) marketable fixed maturity securities, approximately 94% of which are rated as investment grade at September 30, 1997. At September 30, 1997, tax-exempt securities and short-term investments, excluding collateral for securities sold under repurchase agreements, comprised approximately 13% and 15%, respectively, of the general account's total investment portfolio compared to 14% and 16%, respectively, at December 31, 1996. Historically, CNA has maintained short-term assets at a level that provided for liquidity to meet its short-term obligations, as well as reasonable contingencies and anticipated claim payout patterns. At September 30, 1997, the major components of the short-term investment portfolio consist primarily of high-grade commercial paper and U.S. Treasury bills. Collateral for securities sold under repurchase agreements increased $1,084 million from December 31, 1996 to $1,185 million at September 30, 1997. As of September 30, 1997, the market value of CNA's general account investments in fixed maturities was $28.2 billion and was greater than amortized cost by approximately $385 million. This compares to a market value of $27.7 billion and $181 million of net unrealized investment gains at December 31, 1996. The gross unrealized investment gains and losses for the fixed maturity securities portfolio at September 30, 1997, were $508 million and $123 million, respectively, compared to $444 million and $263 million, respectively, at December 31, 1996. The increase in unrealized investment gains is attributable, in large part, to decreases in interest rates which have a positive effect on bond values. Net unrealized investment gains on general account fixed maturities at September 30, 1997 include net unrealized losses on high yield securities of $25 million, compared to net unrealized gains of $41 million at December 31, 1996. High yield securities are bonds rated as below investment grade by bond rating agencies, plus private placements and other unrated securities which, in the opinion of management, are below investment grade. Fair values of high yield securities in the general account were $1.79 billion at September 30, 1997 as compared to $2.02 billion at December 31, 1996. (20) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED At September 30, 1997, total Separate Account cash and investments amounted to $5.9 billion with taxable fixed maturity securities representing approximately 83% of the separate accounts' portfolio. Approximately 75% of separate account investments are used to fund guaranteed investments for which Continental Assurance Company guarantees principal and a specified return to the contractholders. The duration of fixed maturity securities included in the guaranteed investment portfolio are matched approximately with the corresponding payout pattern of the guaranteed investment contracts. The fair value of all fixed maturity securities in the guaranteed investment portfolio was $4.0 billion at September 30, 1997 compared to $3.8 billion at December 31, 1996. At September 30, 1997, fair value was greater than the amortized cost by approximately $43 million. This compares to an unrealized loss of $1 million at December 31, 1996. The gross unrealized investment gains and losses for the guaranteed investment fixed maturity securities portfolio at September 30, 1997 were $66 million and $23 million, respectively. The gross unrealized investment gains and losses for the guaranteed investment fixed maturity securities portfolio at December 31, 1996 were $55 million and $56 million, respectively. Carrying values of high yield securities in the guaranteed investment portfolio were $543 million and approximated market value at September 30, 1997 as compared to a carrying value of $472 million at December 31, 1996. Net unrealized investment losses on such high yield securities were $6 million at December 31, 1996. High yield securities (below BBB) generally involve a greater degree of risk than that of investment grade securities. Expected returns should, however, compensate for the added risk. The risk is also considered in the interest rate assumptions in the underlying insurance products. As of September 30, 1997, CNA's investment in high yield bonds, including Separate Accounts, was approximately 4% of total assets. In addition, CNA's investment in mortgage loans and investment real estate are substantially below the industry average, representing less than one quarter of one percent of its total assets. Included in CNA's fixed maturity securities at September 30, 1997, (general and guaranteed investment portfolios) are $7.3 billion of asset-backed securities, consisting of approximately 54% in collateralized mortgage obligations ("CMOs"), 9% in corporate asset-backed obligations, and 37% in U.S. Government issued pass-through certificates. The majority of CMOs held are U.S. Government agency issues, which are actively traded in liquid markets and are priced monthly by broker-dealers. At September 30, 1997, the fair value of asset-backed securities was more than amortized cost by approximately $91 million compared to net unrealized investment losses of $5 million at December 31, 1996. CNA limits the risks associated with interest rate fluctuations and prepayment by concentrating its CMO investments in early planned amortization classes with relatively short principal repayment windows. Over the last few years, much concern has been raised regarding the quality of insurance company invested assets. At September 30, 1997, 47% of the general account's fixed maturity securities portfolio was invested in U.S. Government securities, 30% in other AAA rated securities and 12% in AA and A rated securities. CNA's guaranteed investment portfolio includes fixed maturity securities which are comprised of 2% U.S. Government securities, 61% in other AAA rated securities and 13% in AA and A rated securities. These ratings are primarily from Standard & Poor's. CNA, its subsidiaries and Separate Accounts, invest from time to time in certain derivative financial instruments to increase investment returns and to reduce the impact of changes in interest rates on certain corporate borrowings. Financial instruments used for such purposes include interest rate swaps, put and call options, commitments to purchase securities, futures and forwards. (21) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED The fair values associated with these instruments are generally affected by changes in interest rates and the stock market. The credit exposure associated with these instruments is generally limited to the unrealized fair value of the instruments and will vary based on changes in market prices. The risk of default depends on the creditworthiness of the counterparty to the instrument. The fair value of derivatives generally reflects the estimated amounts that CNA would receive or pay upon termination of the contracts at the reporting date. Dealer quotes are available for substantially all of CNA's derivatives. For securities not actively traded, fair values are estimated using values obtained from independent pricing services, costs to settle or quoted market prices of comparable instruments. Unrealized investment gains and losses on derivative securities, except for the interest rate swaps associated with corporate borrowings, are reflected as part of realized investment gains and losses. Unrealized gains or losses related to changes in the value of the interest rate swaps associated with corporate borrowings are not recognized. One Separate Account product is an indexed group annuity contract for institutional investors which guarantees the S&P 500 rate of return plus 25 basis points. Deposits are taken for a 3 year period with no payout until the end of the period. CNA hedges the contract liability by purchasing S&P 500 futures contracts in a notional amount equal to the original deposit and investing the remaining cash in a variety of short term strategies. The futures contracts are rolled quarterly, and the number of contracts is adjusted periodically to approximate the future liability to the customer. As of September 30, 1997, CNA held 1,303 S&P 500 futures contracts with a notional value of $622 million. This position hedged a liability to depositors in a nearly equal amount. FINANCIAL CONDITION: |------------------------------------------------------------------------------| |FINANCIAL POSITION SEPTEMBER 30 DECEMBER 31| |(In millions of dollars, except per share data) 1997 1996 | |------------------------------------------------------------------------------| |Assets $ 62,489 $ 60,300 | |Stockholders' equity 7,917 7,060 | |Unrealized net appreciation included in | | stockholders' equity 474 299 | |Book value per common share 125.69 111.81 | |------------------------------------------------------------------------------| CNA's assets increased approximately $2.2 billion from December 31, 1996 to $62.5 billion at September 30, 1997. This change was primarily the result of an increase in securities sold under repurchase agreements of approximately $1.1 billion and increases of approximately $450 million in both receivables for securities sold and fixed maturities investments. During the first nine months of 1997, CNA's stockholders' equity increased by $857 million, or 12.1%, to $7.9 billion. The major components of this change were net operating income of $383 million, net realized investment gains of $304 million and an increase of $175 million in net unrealized investment gains. When compared to December 31, 1996, the statutory surplus of the property/casualty subsidiaries increased $435 million to $6.8 billion. The statutory surplus of the life insurance subsidiaries remained at approximately $1.2 billion, when compared to year end 1996. (22) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED LIQUIDITY AND CAPITAL RESOURCES: The liquidity requirements of CNA have been met primarily by funds generated from operations. The principal operating cash flow sources of CNA's property/casualty and life insurance subsidiaries are premiums and investment income and sales and maturities of investments. The primary operating cash flow uses are payments for claims, policy benefits and operating expenses. CNA's operating activities generated net negative cash flows of approximately $359 million and $65 million for the nine months ended September 30, 1997, and 1996, respectively. Negative cash flows in 1997 are primarily the result of substantial claim payments resulting from the settlement of the Fibreboard litigation. CNA believes that future liquidity needs will be met primarily by cash generated from operations. Net cash flows from operations are invested in marketable securities. Investment strategies employed by CNA's insurance subsidiaries consider the cash flow requirements of the insurance products sold and the tax attributes of the various types of marketable investments. CNA and the insurance industry are exposed to liability for environmental pollution, primarily related to toxic waste site clean-up. Refer to Note C to the Condensed Consolidated Financial Statements for further discussion of environmental pollution exposures. The chart below lists the current insurance ratings for CNA's Continental Casualty Company Intercompany Pool, The Continental Insurance Company Intercompany Pool and Continental Assurance Company (CAC) Intercompany Pool. Also shown are the ratings on the senior debt of both CNA Financial Corporation (CNA) and The Continental Corporation (Continental) and CNA's commercial paper and preferred stock.
|------------------|-------------------------------------||--------------------------------------------------| | | INSURANCE RATINGS || DEBT AND STOCK RATINGS | | |-------------------------------------||-------------------------------------|------------| | | FINANCIAL STRENGTH || | | | |----------|-------------|------------|| | | | | | | || CNA | Continental| | | | | ||-------------------------------------|------------| | | | | ||Senior Debt Commercial Preferred | Senior Debt| | | CCC | CAC | CIC || Paper Stock | | | |----------|-------------|------------|| | | | | | | ||------------|-------------|----------|------------| | | | | || | | | | |A.M. Best | A | A | A- || - | - | - | - | | | | | || | | | | | | | | || | | | | |Moody's | A1 | A1* | A2 || A3 | P2 | a3 | Baa1 | | | | | || | | | | | |----------|-------------|------------|| | | | | | | CLAIMS PAYING ABILITY || | | | | | |----------|-------------|------------|| | | | | | | | | || | | | | |Standard & Poor's | A+ | AA- | A- || A- | A2 | A- | BBB- | | | | | || | | | | | | | | || | | | | |Duff & Phelps | AA- | AA | - || A- | - | A- | - | |------------------|----------|-------------|------------||------------|-------------|----------|------------| *Applies to Continental Assurance Company only.
(23) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED ACCOUNTING STANDARDS: In June 1996, the Financial Accounting Standards Board (FASB) issued Statements on Financial Accounting Standards (SFAS) 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." This Statement provides standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. This Statement has been amended and is now effective for transfers and servicing of financial assets and extinguishment of liabilities occurring after December 31, 1996 or 1997, depending on the type of transaction. This Statement will not have a significant impact on CNA. In January 1997, the Securities and Exchange Commission approved amendments to Regulation S-X, Regulation S-K, Regulation S-B, and various forms to clarify and expand existing disclosure requirements with respect to derivative financial instruments and derivative commodity instruments. The new rules require enhanced descriptions in the footnotes to the financial statements of accounting policies for derivative financial instruments and derivative commodity instruments. They also require disclosure outside the financial statements of qualitative and quantitative information about market risk related to derivative financial instruments, other financial instruments and derivative commodity instruments. These amendments are effective for the year end 1997 financial statements and will not have a significant impact on CNA. In February 1997, the FASB issued SFAS 128, "Earnings per Share." This Statement establishes standards for computing and presenting earnings per share (EPS), which simplifies the computations originally established in APB Opinion No. 15, "Earnings per Share" and makes them comparable to international EPS standards. It replaces the presentation of primary EPS with basic EPS, which excludes dilution. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures and requires a reconciliation between the two computations. This Statement is effective for financial statements issued for periods ending after December 15, 1997. This Statement will not have a significant impact on CNA. In February 1997, the FASB issued SFAS 129, "Disclosure of Information about Capital Structure," which establishes standards for disclosing information about an entity's capital structure. The Statement consolidates existing disclosure requirements for ease of retrieval and greater visibility to nonpublic entities. The new Statement contains no change in disclosure requirements for companies previously subject to the requirements of APB Opinion No. 10, "Omnibus Opinion--1966," APB Opinion No. 15, "Earnings per Share," and FASB Statement 47, "Disclosure of Long-Term Obligations." It applies to all entities and is effective for financial statements issued for periods ending after December 15, 1997. This Statement has no impact on CNA. In June 1997, the FASB issued SFAS 130, "Reporting Comprehensive Income," which establishes accounting standards for reporting and display of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. This Statement requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. This Statement is effective for fiscal years beginning after December 15, 1997. This Statement is not expected to result in a significant change in CNA's disclosures. (24) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONCLUDED In June 1997, the FASB issued SFAS 131, "Disclosures about Segments of an Enterprise and Related Information," which establishes standards for the way that public business enterprises report information about operating segments in interim and annual financial statements. It requires that those enterprises report a measure of segment profit or loss, certain specific revenue and expense items, and segment assets, and that the enterprises reconcile the total of those amounts to the general-purpose financial statements. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This Statement is effective for financial statements for periods beginning after December 15, 1997. This Statement will redefine CNA's business segment disclosure. (25) CNA FINANCIAL CORPORATION PART II OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS: Exhibit Page Description of Exhibit Number Number -------- ------ Computation of Net Income per Common Share 11 28 Computation of Ratio of Earnings to Fixed Charges 12.1 29 Computation of Ratio of Net Income As Adjusted, to Fixed Charges 12.2 29 Financial Data Schedule 27 30 (b) REPORTS ON FORM 8-K: On July 30, 1997, CNA Financial Corporation issued a press release announcing that W. James MacGinnitie has been named chief financial officer and senior vice president of CNA. On July 24, 1997, CNA Financial Corporation issued a press release announcing senior management changes in Commercial Operations. (26) CNA FINANCIAL CORPORATION PART II OTHER INFORMATION - CONCLUDED SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CNA FINANCIAL CORPORATION Date: November 14, 1997 By: S\W. JAMES MACGINNITIE ----------------- --------------------- W. James MacGinnitie Senior Vice President and Chief Financial Officer (27) EXHIBIT 11 CNA FINANCIAL CORPORATION COMPUTATION OF NET INCOME PER COMMON SHARE - -------------------------------------------------------------------------------- Period Ended September 30 Third Quarter Nine Months (In millions, except per share data) 1997 1996 1997 1996 - -------------------------------------------------------------------------------- Earnings per share: Net income ........................... $ 274 $ 239 687 $ 770 Less preferred stock dividends........ 2 2 5 5 ------ ----- ------ ------ Net income available to common stockholders................. $ 272 $ 237 $ 682 $ 765 ====== ====== ====== ====== Weighted average shares outstanding... 61.8 61.8 61.8 61.8 ====== ====== ====== ====== Net income per common share........... $ 4.41 $ 3.83 $11.04 $ 12.38 ====== ====== ====== ====== ================================================================================ (28) EXHIBIT 12.1 CNA FINANCIAL CORPORATION COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - -------------------------------------------------------------------------------- PERIOD ENDED SEPTEMBER 30 1997 1996 (In millions of dollars, except ratios) - -------------------------------------------------------------------------------- Income before income tax and cumulative effect of accounting changes.................... $ 963 $ 1,072 Adjustments: Interest expense........................................... 153 155 Interest element of operating lease rental................. 25 26 ----- -------- Income before income tax and cumulative effect of accounting changes, as adjusted..........................$ 1,141 $ 1,253 ====== ====== Fixed charges: Interest expense...........................................$ 153 $ 155 Interest element of operating lease rental................. 25 26 ------- ------- Fixed charges.................................................$ 178 $ 181 ====== ====== Ratio of earnings to fixed charges (1)........................ 6.4 6.9 - -------------------------------------------------------------------------------- (1) For purposes of computing this ratio, earnings consist of income before income taxes and cumulative effect of accounting changes plus fixed charges of consolidated companies. Fixed charges consist of interest and that portion of operating lease rental expense which is deemed to be an interest factor for such rentals. EXHIBIT 12.2 CNA FINANCIAL CORPORATION COMPUTATION OF RATIO OF NET INCOME, AS ADJUSTED, TO FIXED CHARGES - -------------------------------------------------------------------------------- PERIOD ENDED SEPTEMBER 30 1997 1996 (In millions of dollars, except ratios) - -------------------------------------------------------------------------------- Net income.................................................... $ 687 $ 770 Adjustments: Interest expense, after tax................................ 100 101 Interest element of operating lease rental, after tax...... 16 17 -------- ------ Net income, as adjusted....................................... $ 803 $ 888 ==== ===== Fixed charges: Interest expense, after tax................................$ 100 $ 101 Interest element of operating lease rental, after tax...... 16 17 ------- ------ Fixed charges.................................................$ 116 $ 118 ====== ==== Ratio of net income, as adjusted, to fixed charges (1)........ 6.9 7.5 - -------------------------------------------------------------------------------- (1) For purposes of computing this ratio, net income has been adjusted to include fixed charges of consolidated companies, after tax. Fixed charges consist of interest and that portion of operating lease rental expense which is deemed to be an interest factor for such rentals. (29) EX-27 2 ARTICLE 7 FDS FOR 10-Q
7 0000021175 CNA FINANCIAL CORPORATION 1,000,000 9-MOS DEC-31-1997 JAN-1-1997 SEP-30-1997 28,169 0 0 863 92 6 36,883 371 6,031 2,223 62,489 34,658 5,221 126 752 2,871 0 150 155 7,612 62,489 10,031 1,641 475 537 8,607 1,862 1,099 963 276 687 0 0 0 687 11.04 11.04 23,734 6,400 297 1,904 4,266 23,667 297
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