-----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, RFIumt3xk4Zx5pjX5VSNdnT6qhCHOuJj4pE7sOtYLfhHVsl68VLl/4IW3ud+sdbz tHPT7qFhrgl5CNuMjDH7+w== 0000021175-98-000006.txt : 19980401 0000021175-98-000006.hdr.sgml : 19980401 ACCESSION NUMBER: 0000021175-98-000006 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 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-K SEC ACT: SEC FILE NUMBER: 001-05823 FILM NUMBER: 98583959 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 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, 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) 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 Stock 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 3, 1998, 61,798,262 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 $1,394 million. DOCUMENTS INCORPORATED BY REFERENCE: Portions of the CNA Financial Corporation 1997 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 1998 annual meeting of shareholders, pursuant to Regulation 14A, are incorporated by reference into Part III of this Report. ================================================================================ CNA FINANCIAL CORPORATION FORM 10-K ANNUAL REPORT FOR THE YEAR ENDED DECEMBER 31, 1997 Item Page Number PART I Number ------ ---- 1. Business.......................................................... 3 2. Properties........................................................ 12 3. Legal Proceedings................................................. 13 4. Submission of Matters to a Vote of Security Holders............... 13 PART II 5. Market for the Registrant's Common Stock and Related Stockholder Matters..................................... 15 6. Selected Financial Data........................................... 15 7. Management's Discussion and Analysis of Financial Condition and Results of Operations........................................... 15 7A. Quantitative and Qualitative Disclosures about Market Risk........ 15 8. Financial Statements and Supplementary Data....................... 15 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.......................... 15 PART III 10. Directors and Executive Officers of the Registrant................ 16 11. Executive Compensation............................................ 16 12. Security Ownership of Certain Beneficial Owners and Management.... 16 13. Certain Relationships and Related Transactions.................... 16 PART IV 14. Financial Statements, Schedules, Exhibits and Reports on Form 8-K. 16 2 PART I ITEM 1. BUSINESS CNA Financial Corporation (CNAF) was incorporated in 1967 as 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. On May 10, 1995 (the acquisition date) CNAF acquired all the outstanding common stock of 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 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. As multiple-line insurers, CNA underwrites property, casualty, life and accident and health coverages, as well as pension products and annuities. Their 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 1996 statutory net written premium. There are approximately 1,700 companies selling life insurance in the United States. CAC is ranked as the twenty-second largest life insurance organization based on 1996 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 the states' insurance departments. This formula varies by state. The formula for the majority of the states is 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. Some states, however, have an additional stipulation that dividends can't exceed prior year's surplus. Based upon the various state formulas, approximately $677 million in dividends can be paid to CNAF by its insurance affiliates in 1998 without prior approval. All dividends must be reported to the domiciliary insurance department prior to declaration and payment. 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. 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 3 REGULATION--(CONTINUED) transfers of assets may be subject to prior notice or approval, 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 Nation's tort reform 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, state courts have modified or overturned a significant number of these reforms. Additionally, new causes of action and theories of damages are more frequently proposed in state courts or legislatures. Continued unpredictability in the law means that insurance underwriting and rating is difficult in commercial lines, professional liability and some specialty coverages. Environmental clean-up remains the subject of both federal and state regulation. Last year Congress and the Clinton Administration failed to reach an agreement on efforts to overhaul the federal Superfund hazardous waste program. The legislative stalemate was 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 we cannot predict 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. See Note E of the Consolidated Financial Statements of the 1997 Annual Report to Shareholders for further discussion, 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. 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, 1997, all of CNAF's property/casualty and life insurance affiliates have adjusted capital amounts in excess of Company Action Levels. REINSURANCE Information as to the CNA's reinsurance business is set forth in Note G of the Consolidated Financial Statements of the 1997 Annual Report to Shareholders, incorporated by reference in Item 8, herein. EMPLOYEE RELATIONS CNA has approximately 24,700 full-time equivalent employees and has experienced satisfactory labor relations. CNA has never had work stoppages due to labor disputes. 4 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 1997 Annual Report to Shareholders for further discussion, incorporated by reference in Item 8, herein. BUSINESS SEGMENTS Information as to the Company's business segments is set forth in Note M of the Consolidated Financial Statements of the 1997 Annual Report to Shareholders, incorporated by reference in Item 8, herein. PROPERTY/CASUALTY BUSINESS The property/casualty group is comprised of commercial business, personal lines of insurance, involuntary risks and other related businesses. Customers of the commercial business include large national corporations, small and medium-sized businesses, groups and associations, and professionals. Coverages are written primarily through traditional insurance contracts, under which risk is transferred to the insurer. Many large commercial account policies are written under retrospectively-rated contracts, which are experience-rated. Premiums for such contracts may be adjusted, subject to limitations set by contract, based on loss experience of the insureds. Other experience-rated policies include provisions for dividends based on loss experience. Experience-rated contracts reduce but do not eliminate risk to the insurer. Commercial lines also includes reinsurance assumed from other insurance companies and certain group accident and health insurance coverages. Commercial business includes such lines as workers' compensation, general liability and commercial automobile, professional and specialty, multiple peril and accident and health coverages as well as reinsurance. Professional and specialty coverages include liability coverage for architects and engineers, lawyers, accountants, medical and dental professionals; directors and officers liability; and other specialized coverages. The major components of CNA's property/casualty commercial business are professional and specialty coverages, general liability and commercial automobile, and workers' compensation which accounted for 17%, 17% and 16%, respectively, of 1997 premiums earned. The property/casualty group markets personal lines of insurance, primarily automobile and homeowners coverages sold to individuals under monoline and package policies. Involuntary risks include mandatory participation in residual markets, statutory assessments for insolvencies of other insurers, and other similar charges. 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. The property/casualty group also provides other related services including loss control, policy administration and claim administration services under service contracts for fees. Such services are provided primarily in the workers' compensation market. 5 PROPERTY/CASUALTY BUSINESS--(CONTINUED) The following table sets forth supplemental data on a GAAP basis, except where indicated, for the property/casualty business:
- --------------------------------------------------------------------------------------------------------------- Year Ended December 31 1997 1996 1995 1994 1993 (In millions of dollars, except ratio information) - --------------------------------------------------------------------------------------------------------------- Commercial Premiums Earned (a) Professional and specialty............... $ 1,688 $ 1,845 $ 1,558 $ 1,010 $ 799 General liability and commercial automobile 1,682 1,754 1,649 1,261 1,155 Workers' compensation.................... 1,845 1,543 1,476 1,426 1,501 Multiple peril........................... 1,058 1,047 870 389 369 Accident and health...................... 1,062 919 699 557 428 Reinsurance and other.................... 1,083 1,189 974 774 712 ------- ------- ------- ------- ------- $ 8,418 $ 8,297 $ 7,226 $ 5,417 $ 4,964 ======= ======= ======= ======= ======= Personal Premiums Earned (a) Personal lines packages.................. $ 1,085 $ 1,063 $ 782 $ 563 $ 511 Monoline automobile and property coverages 440 367 325 314 343 Accident and health...................... 126 106 108 89 86 ------- ------- ------- ------- ------- $ 1,651 $ 1,536 $ 1,215 $ 966 $ 940 ======= ======= ======= ======= ======= Involuntary Risks Premiums Earned (a)(b) Workers' compensation.................... $ (249) $ 198 $ 178 $ 350 $ 292 Private passenger automobile............. 66 58 80 47 23 Commercial automobile................... 25 36 20 54 50 Property and multiple peril.............. 16 2 6 5 6 ------- ------- ------- ------- ------- $ (142) $ 294 $ 284 $ 456 $ 371 ======= ======= ======= ======= ======= Net Investment Income and Other Income (a) Commercial............................... $ 2,172 $ 2,074 $ 1,713 $ 1,145 $ 980 Personal................................. 209 222 231 178 156 Involuntary risks........................ 43 94 104 88 76 ------- ------- ------- ------- ------- $ 2,424 $ 2,390 $ 2,048 $ 1,411 $ 1,212 ======= ======= ======= ======= ======= Underwriting (Loss) Income (a) Commercial............................... $(1,421) $ (853) $ (921) $ (946) $(1,536) Personal................................. 124 (184) (102) (185) (100) Involuntary risks........................ 135 (106) (99) (70) (156) ------- ------- ------- ------- ------- $(1,162) $(1,143) $(1,122) $(1,201) $(1,792) ======= ======= ======= ======= ======= - ---------------------------------------------------------------------------------------------------------------
PROPERTY/CASUALTY BUSINESS--(CONTINUED)
- --------------------------------------------------------------------------------------------------------------- Year Ended December 31 1997 1996 1995 1994 1993 (In millions of dollars, except ratio information) - --------------------------------------------------------------------------------------------------------------- TRADE RATIOS - GAAP BASIS (C) Loss ratio............................... 77.1% 76.4% 77.9% 81.9% 96.2% Expense ratio............................ 31.3 30.9 29.4 28.3 27.2 Combined ratio (before policyholder 108.4 107.3 107.3 110.2 123.4 dividends)............................. Policyholder dividend ratio.............. 0.5 1.6 3.0 4.8 3.9 TRADE RATIOS - STATUTORY BASIS (C) Loss ratio............................... 77.5% 76.8% 78.6% 82.2% 96.4% Expense ratio............................ 30.7 30.6 29.2 27.8 27.1 Combined ratio (before policyholder 108.2 107.4 107.8 110.0 123.5 dividends)............................. Policyholder dividend ratio.............. 0.8 1.4 2.1 3.8 3.1 OTHER DATA - STATUTORY BASIS (D) Capital and surplus...................... $ 7,123 $6,349 $ 5,696 $ 3,367 $ 3,598 Written to surplus ratio................. 1.4 1.6 1.7 2.0 1.7 - ----------------------------------------------------------------------------------------------------------------- (a) Premiums earned, net investment income and underwriting loss includes the results of The Continental Corporation since the acquisition date. (b) Property/casualty involuntary risks include mandatory participation in residual markets, statutory assessments for insolvencies of other insurers and other similar charges.
6 PROPERTY/CASUALTY BUSINESS--(CONTINUED) (c) GAAP trade ratios reflect the results of CCC and its property/casualty insurance subsidiaries for the entire year, along with the results of Continental since the acquisition date. Statutory trade ratios reflect the results of CCC and its property/casualty insurance subsidiaries and Continental since January 1, 1995. Prior year ratios have not been restated to include Continental. 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. (d) Other data is determined on the statutory basis of accounting and reflects a capital contribution from CNAF of $475 million in 1993. In addition, dividends of $175 million, $545 million, $325 million, $175 million and $150 million were paid to CNAF by CCC in 1997, 1996, 1995, 1994 and 1993, respectively. Property/casualty insurance subsidiaries have received, or will receive, reimbursement from CNAF for general management and administrative expenses, unallocated loss adjustment expenses and investment expenses of $199 million, $195 million, $197 million, $170 million and $168 million in 1997, 1996, 1995, 1994 and 1993, respectively. The following table displays the distribution of gross written premium: ------------------------------------------------------------------------- GROSS WRITTEN PREMIUM % OF TOTAL ------------------------------ YEAR ENDED DECEMBER 31 1997 1996 1995 ------------------------------------------------------------------------- New York................................... 9.9 9.3 10.3 California................................. 8.8 8.5 9.7 Texas...................................... 6.2 6.0 6.5 Pennsylvania............................... 5.1 4.9 5.4 Florida.................................... 4.8 4.2 4.1 Illinois................................... 4.4 5.3 5.2 New Jersey................................. 4.3 4.1 4.6 All other states, countries or political subdivisions (a)........................... 48.0 46.8 44.4 Reinsurance assumed: Voluntary................................ 9.7 9.1 7.8 Involuntary.............................. (1.2) 1.8 2.0 ------- ------- ------ 100.0 100.0 100.0 ========================================================================= (a) No other state, country or political subdivision accounts for more than 3.0% of gross written premium. PROPERTY/CASUALTY BUSINESS--(CONTINUED) PROPERTY/CASUALTY CLAIM AND CLAIM EXPENSES The following loss reserve development table illustrates the change over time of reserves established for property/casualty claims and claims expense at the end of various calendar years. 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 that 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 EXPENSES--(CONTINUED) The loss reserve development table 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 1987(a) 1988(a) 1989(a) 1990(a) 1991(a) 1992(a) 1993(a) 1994(b) 1995(c) 1996 1997(d) (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 $28,240 Ceded recoverable........ -- -- -- 3,440 3,297 2,867 2,491 2,705 6,089 5,660 4,995 ----- ----- ----- ------ ----- ----- ----- ----- ----- ----- ----- Net reserves for unpaid claim and claim expenses.... 8,045 9,552 11,267 13,090 14,415 17,167 18,321 18,934 24,955 23,735 23,245 ----- ----- ------ ------ ------ ------ ------ ------ ------ ------ ------ NET PAID (CUMULATIVE) AS OF: One year later........... 1,763 2,040 2,670 3,285 3,411 3,706 3,629 3,656 6,510 5,851 -- Two years later.......... 2,961 3,622 4,724 5,623 6,024 6,354 6,143 7,087 10,485 -- -- Three years later........ 4,031 4,977 6,294 7,490 7,946 8,121 8,764 9,195 -- -- -- Four years later......... 5,007 6,078 7,534 8,845 9,218 10,241 10,318 -- -- -- -- Five years later......... 5,801 6,960 8,485 9,726 10,950 11,461 -- -- -- -- -- Six years later.......... 6,476 7,682 9,108 11,207 11,951 -- -- -- -- -- -- Seven years later........ 7,061 8,142 10,393 12,023 -- -- -- -- -- -- -- Eight years later........ 7,426 9,303 11,086 -- -- -- -- -- -- -- -- Nine years later......... 8,522 9,924 -- -- -- -- -- -- -- -- -- Ten years later.......... 9,097 -- -- -- -- -- -- -- -- -- -- NET RESERVES RE-ESTIMATED AS OF: End of initial year...... 8,045 9,552 11,267 13,090 14,415 17,167 18,321 18,934 24,955 23,735 23,245 One year later........... 8,086 9,737 11,336 12,984 16,032 17,757 18,250 18,922 24,864 23,479 -- Two years later.......... 8,345 9,781 11,371 14,693 16,810 17,728 18,125 18,500 24,294 -- -- Three years later........ 8,424 9,796 13,098 15,737 16,944 17,823 17,868 18,008 -- -- -- Four years later......... 8,516 11,471 14,118 15,977 17,376 17,765 17,511 -- -- -- -- Five years later.........10,196 12,496 14,396 16,440 17,329 17,560 -- -- -- -- -- Six years later..........11,239 12,742 14,811 16,430 17,293 -- -- -- -- -- -- Seven years later........11,480 13,167 14,810 16,551 -- -- -- -- -- -- -- Eight years later........11,898 13,174 14,995 -- -- -- -- -- -- -- -- Nine years later.........11,925 13,396 -- -- -- -- -- -- -- -- -- Ten years later..........12,203 -- -- -- -- -- -- -- -- -- -- ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ----- Total net (deficiency) (4,158) (3,844) (3,728) (3,461) (2,878) (393) 810 926 661 256 -- redundancy - -----------------------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------------------------ Schedule of Property/Casualty Loss Reserve Development Calendar Year Ended 1987(a) 1988(a) 1989(a) 1990(a) 1991(a) 1992(a) 1993(a) 1994(b) 1995(c) 1996 1997(d) (In millions of dollars) - -------------------------------------------------------------------------------------------------------------------- Reconciliation to gross re-estimated reserves: Net reserves re-estimated 12,203 13,396 14,995 16,551 17,293 17,560 17,511 18,008 24,294 23,479 -- Re-estimated ceded recoverable -- -- -- 2,939 2,672 2,085 1,904 2,405 6,560 6,108 -- ------ ------ ------ ------ ------ ------ ------ ------ ------- ------- ------ Total gross re-estimated -- -- -- 19,490 19,965 19,645 19,415 20,413 30,854 29,587 -- reserves - --------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------- Net (deficiency) redundancy related to: Asbestos claims. (3,073) (3,017) (2,919) (2,785) (2,738) (1,049) (449) (414) (156) (105) -- Environmental claims.... (1,000) (997) (970) (960) (914) (869) (423) (243) (63) -- -- ------ ------- ------- ------- ------ ------ ------- ------- ------- ------ ----- Total asbestos and environmental (4,073) (4,014) (3,889) (3,745) (3,652) (1,918) (872) (657) (219) (105) -- Other claims............ (85) 170 161 284 774 1,525 1,682 1,583 880 361 -- ------- ------ ------ ------ ------ ------ ------ ------ ------ ------------- Total net (deficiency) redundancy.............. (4,158) (3,844) (3,728) (3,461) (2,878) (393) 810 926 661 256 -- ======= ======= ======= ======= ======== ====== ====== ====== ====== ====== ===== - --------------------------------------------------------------------------------------------------------------------- (a) Reflects reserves of CNA's property/casualty insurance subsidiaries, excluding Continental reserves which were acquired on 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 gross reserves of acquired companies of $64 million.
8 PROPERTY/CASUALTY CLAIM AND CLAIM 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 1997 Annual Report to Shareholders, incorporated by reference in Item 8, herein. Reserve Development - ------------------- Information as to CNA's reserve development is set forth in Note E of the Consolidated Financial Statements of the 1997 Annual Report to Shareholders, incorporated by reference in Item 8, herein. LIFE BUSINESS CNA's life insurance operations market individual and group insurance products through licensed agents, most of whom are independent contractors, who sell life and/or group insurance for CNA and other companies on a commission basis. Insurance products are also marketed through other distribution channels such as banks, direct marketing and the Internet. The individual insurance products consist primarily of term, universal life, and fixed and variable annuity products. Group insurance products include life, accident and health consisting primarily of major medical and hospitalization, and pension products, such as guaranteed investment contracts and annuities. CNA's life insurance products are designed and priced using assumptions management believes to be reasonably conservative for mortality, morbidity, persistency, expense levels and investment results. Underwriting practices that management believes are prudent are followed in selecting the risks that will be insured. Further, actual experience related to pricing assumptions is monitored closely so that prospective adjustments to these assumptions may be implemented as necessary. CNA mitigates the risk related to persistency by including contractual surrender charge provisions in its ordinary life and annuity policies in the first five to ten years, thus providing for the recovery of acquisition expenses. The investment portfolios supporting interest sensitive products, including universal life and individual annuities, are managed separately to minimize surrender and interest rate risk. Profitability in the health insurance business continues to be impacted by intense competition and rising medical costs. CNA has pursued expense reduction through increases in automation and other productivity improvements. Further, increasing costs of health care have resulted in a continued market shift away from traditional forms of health coverage toward managed care products and experience-rated plans. CNA's life insurance subsidiaries ability to compete in this market will be increasingly dependent on its ability to control costs through managed care techniques, innovation and quality customer-focused service in order to position CNA properly in the evolving health care environment. 9 LIFE BUSINESS--(CONTINUED) The following table sets forth supplemental data on a GAAP basis, except where indicated for the life insurance business:
- ---------------------------------------------------------------------------------------------------------------- Year Ended December 31 1997 1996 1995 1994 1993 (In millions of dollars, except ratio information) - ---------------------------------------------------------------------------------------------------------------- INDIVIDUAL PREMIUM Life and annuities................................ $ 642 $ 629 $ 497 $ 369 $ 312 Accident and health............................... 3 2 33 33 31 --------- --------- --------- --------- --------- $ 645 $ 631 $ 530 $ 402 $ 343 ========= ========= ========= ========= ========= GROUP PREMIUM Accident and health (a)........................... $ 2,527 $ 2,548 $ 2,190 $ 2,111 $ 1,983 Life and annuities................................ 263 195 313 165 116 --------- --------- --------- --------- --------- $ 2,790 $ 2,743 $ 2,503 $ 2,276 $ 2,099 ========= ========= ========= ========= ========= NET INVESTMENT INCOME AND OTHER INCOME Individual........................................ $ 297 $ 292 $ 247 $ 194 $ 154 Group............................................. 236 214 198 166 143 --------- --------- --------- --------- --------- $ 533 $ 506 $ 445 $ 360 $ 297 ========= ========= ========= ========= ========= OPERATING INCOME BEFORE INCOME TAX Individual........................................ $ 88 $ 101 $ 65 $ 47 $ 14 Group............................................. 65 70 95 87 52 --------- --------- --------- --------- --------- $ 153 $ 171 $ 160 $ 134 $ 66 ========= ========= ========= ========= ========= GROSS LIFE INSURANCE IN-FORCE Individual (b).................................... $ 239,843 $ 172,213 $ 113,901 $ 80,560 $ 76,835 Group............................................. 71,755 64,796 52,145 46,873 35,413 --------- --------- --------- --------- --------- $ 311,598 $ 237,009 $ 166,046 $ 127,433 $ 112,248 ========= ========= ========= ========= ========= OTHER DATA - STATUTORY BASIS(c) Capital and surplus............................... $ 1,223 $ 1,163 $ 1,128 $ 1,055 $ 1,022 Capital and surplus-percent of total liabilities.. 22.4% 25.5% 28.2% 29.4% 30.1% Participating policyholders-percent of gross life insurance in force................................ 0.7% 0.5% 0.6% 0.9% 1.1% - ---------------------------------------------------------------------------------------------------------------- (a) Group accident and health premium includes contracts involving U.S. government employees and their dependents, and amounted to approximately $2.1 billion, $2.1 billion, $1.9 billion, $1.8 billion and $1.7 billion in 1997, 1996, 1995, 1994 and 1993, respectively. (b) Lapse ratios for individual life insurance, as measured by surrenders and withdrawals as a percentage of average ordinary life insurance in force, were 6.4%, 7.2%, 9.4%, 9.7% and 9.7% in 1997, 1996, 1995, 1994 and 1993, respectively. (c) Other data is determined on the basis of statutory accounting practices. Life insurance subsidiaries have received reimbursement from CNAF for general management and administrative expenses and investment expenses of $18 million, $29 million, $21 million, $25 million and $26 million in 1997, 1996, 1995, 1994, and 1993, respectively. 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.
10 LIFE BUSINESS--(CONTINUED) Guaranteed Investment Contracts - ------------------------------- CAC writes the majority of its group pension products as guaranteed investment contracts in a fixed Separate Account, which is permitted by Illinois insurance statutes. CAC guarantees principal and a specified return to guaranteed investment contractholders. This guarantee affords the contractholders additional security, in the form of CAC's general account surplus. The Company manages the liquidity and interest rate risks on the guaranteed investment contract portfolio by managing the duration of fixed maturity securities included in the investment portfolio supporting the guaranteed investment contracts with the corresponding payout pattern of the contracts, and assessing market value surrender charges on the majority of the contracts. The table below shows a comparison of the duration of assets and contracts, weighted average investment yield, weighted average interest crediting rates, and withdrawal characteristics of the guaranteed investment contract portfolio. - ------------------------------------------------------------------------------- December 31 1997 1996 1995 - ------------------------------------------------------------------------------- Duration in years: Assets....................................... 3.74 3.12 3.12 Contracts.................................... 3.63 3.16 2.98 ---- ---- ---- Difference................................... 0.11 (0.04) 0.14 ==== ====== ==== Weighted average investment yield............... 6.81% 7.44% 7.58% Weighted average interest crediting rates....... 6.78% 7.32% 7.45% Withdrawal characteristics: With market value adjustment................. 97% 95% 92% Non-withdrawable............................. 3 5 8 - ------------------------------------------------------------------------------- Total 100% 100% 100% =============================================================================== As shown above, the weighted average investment yield at December 31, 1997, 1996 and 1995 was more than the weighted average interest crediting rate. During 1997, general market interest rates were lower which led to an increase in the market value of CNA's fixed maturitiy securities. As a result of this increase, CNA was able to realize significant capital gains on its investment portfolio. However, the interest rates on fixed maturity securities purchased in this market had a lower yield which led to a narrowing of the spread between investment yields and crediting rates. INVESTMENTS Information as to the Company's investments is set forth in Note B of the Consolidated Financial Statements of the 1997 Annual Report to Shareholders, incorporated by reference in Item 8, herein. 11 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 28% 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 LOCATION BY CNA OR ITS 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 251,691* 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 219,285** Property/Casualty Chicago, Illinois Insurance Offices 1111 E. Broad St. 183,019** Property/Casualty Columbus, Ohio Insurance Offices 333 Glen Street 157,825** Property/Casualty Glen Falls, New York Insurance Offices 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 111 Congressional Blvd. 118,215** Property/Casualty Indianapolis, Indiana Insurance Offices 1431 Opus Place 106,151** Property/Casualty Downers Grove, Illinois Insurance Offices 2401 Pleasant Valley 102,376** Property/Casualty York, Pennsylvania Insurance Offices * Represents property owned by CNAF or its subsidiaries. ** Represents property leased by CNAF or its subsidiaries. *** Property is owned by Continental and 46% of it is occupied by CNAF or its subsidiaries. 12 ITEM 3. LEGAL PROCEEDINGS Information as to CNA's legal proceedings is set forth in Note F of the Consolidated Financial Statements of 1997 Annual Report to Shareholders, incorporated by reference in Item 8, herein. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. 13 EXECUTIVE OFFICERS OF THE REGISTRANT
POSITION AND OFFICES HELD FIRST BECAME WITH OFFICER OF NAME REGISTRANT AGE CNA PRINCIPAL OCCUPATION DURING PAST FIVE YEARS Laurence A. Tisch Chief Executive 75 * Co-Chairman of the Board and Co-Chief Executive Officer, CNA Officer of Loews Corporation. President, Chief Financial Executive Officer and Director of CBS, Inc. until Corporation November 1995. Executive officer of the Registrant since 1974. Dennis H. Chookaszian Chairman of the 54 1975 Chairman of the Board and Chief Executive Officer of Board and Chief CNA since September 1992. Prior thereto, Executive Mr. Chookaszian was President and Chief Operating Officer, CNA Officer of CNA. Executive officer of the Registrant since 1975. Philip L. Engel President, CNA 57 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. Executive Vice 51 1980 Executive Vice President and Chief Operating Officer Hengesbaugh President and of CNA since February 4, 1998. Senior Vice President Chief Operating of CNA since November 1990. Executive officer of the Officer, CNA Registrant since 1992. W. James MacGinnitie Senior Vice 59 1997 Senior Vice President and Chief Financial Officer of President and CNA and of the Registrant since October 1997. From Chief Financial 1994 through 1997, Partner at Ernst & Young LLP. Officer 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.
14 PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS Incorporated herein by reference from page 91 of the 1997 Annual Report to Shareholders. ITEM 6. SELECTED FINANCIAL DATA Incorporated herein by reference from page 2 of the 1997 Annual Report to Shareholders. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Incorporated herein by reference from pages 14 through 38 of the 1997 Annual Report to Shareholders. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Incorporated herein by reference under the heading Market Risk in the Management Discussion and Analysis of Financial Condition and Results of Operations of the 1997 Annual Report to Shareholders on pages 30 through 33. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Consolidated Balance Sheet - December 31, 1997 and 1996 Statement of Consolidated Operations - Year Ended December 3l, 1997, 1996 and 1995 Statement of Consolidated Stockholders' Equity - December 31, 1997, 1996 and 1995 Statement of Consolidated Cash Flows - Year Ended December 31, 1997, 1996 and 1995 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 40 through 90 of the 1997 Annual Report to Shareholders. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 15 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 l4A 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 (a) 1. FINANCIAL STATEMENTS: Number A separate index to the Consolidated Financial Statements is presented in Part II, Item 8..................................................................... 15 (a) 2. FINANCIAL STATEMENT SCHEDULES: Schedule I Summary of Investments............................................. 20 Schedule II Condensed Financial Information (Parent Company)................... 21 Schedule III Supplementary Insurance Information................................ 25 Schedule V Valuation and Qualifying Accounts and Reserves..................... 26 Schedule VI Supplementary Information Concerning Property/Casualty Insurance Operations............................................... 26 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........................................................... 27
16 PART IV ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS AND REPORTS ON FORM 8-K (continued)
(a) 3. EXHIBITS: Exhibit Description of Exhibit Number ------------------------ ------- (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, 1987 (Exhibit 3.1 to 1987 Form 10-K incorporated herein by reference.).................. 3.1 By-Laws of CNA Financial Corporation, as amended February 12, 1997 (Exhibit 3.2 to 1996 Form 10-K incorporated herein by reference.)........................ 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 Employment Agreement between CNA Financial Corporation and Dennis H. Chookaszian, dated December 31, 1995 (Exhibit 10.2 to 1995 Form 10K incorporated herein by reference.)....................... 10.2 Employment Agreement between CNA Financial Corporation and Philip L. Engel, dated December 31, 1995 (Exhibit 10.3 to 1995 Form 10K 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
17 PART IV ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS AND REPORTS ON FORM 8-K (continued)
(a) 3. EXHIBITS: Exhibit Description of Exhibit Number ------------------------ ---------- (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
18 PART IV ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS AND REPORTS ON FORM 8-K (continued)
(a) 3. EXHIBITS: Exhibit Description of Exhibit Number ------------------------ -------- (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) 1997 Annual Report...................................................................... 13.1* (21) Subsidiaries of CNA..................................................................... 21.1* (23) Independent Auditors' Consent........................................................... 23.1* (27) Financial Data Schedule................................................................. 27* *Filed herewith (b) REPORTS ON FORM 8-K: None
19
SCHEDULE I CNA FINANCIAL CORPORATION SUMMARY OF INVESTMENTS - ----------------------------------------------------------------------------------------------------------------- December 31 1997 1996 ----------------------------- --------------------------------- 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.... $13,798 $13,920 $13,920 $15,047 $15,045 $15,045 States, municipalities and political subdivisions-tax exempt............. 4,534 4,724 4,724 4,860 4,951 4,951 Foreign governments and political subdivisions........................ 998 998 998 1,200 1,214 1,214 Public utilities..................... 340 355 355 195 205 205 Convertibles and bonds with warrants attached............................ 3 2 2 167 169 169 All other corporate.................. 9,280 9,452 9,452 6,022 6,071 6,071 Redeemable preferred stocks.............. 67 97 97 49 66 66 ------ ------ ------ ------ ------ ------ Total fixed maturities available-for-sale................. 29,020 29,548 29,548 27,540 27,721 27,721 ------ ====== ------ ------ ====== ------ Equity securities available-for-sale: Common stocks: Public utilities..................... -- -- -- 11 15 15 Banks, trusts and insurance companies 8 7 7 132 185 185 Industrial and other................. 559 672 672 335 431 431 Non redeemable preferred stocks.......... 128 135 135 224 228 228 ------ ------ ------ ------ ------ ------ Total equity securities available-for-sale................. 695 $ 814 814 702 $ 859 859 ------ ====== ------ ------ ====== ------ Mortgage loans.............................. 80 80 113 113 Real estate................................. 5 5 10 10 Policy loans................................ 177 177 174 174 Other invested assets....................... 544 695 617 681 Short-term investments...................... 4,884 4,884 5,854 5,854 - ----------------------------------------------------------------------------------------------------------------- Total investments $35,405 $36,203 $35,010 $35,412 =================================================================================================================
20
SCHEDULE II CNA FINANCIAL CORPORATION (PARENT COMPANY) CONDENSED FINANCIAL INFORMATION FINANCIAL POSITION - ----------------------------------------------------------------------------------------------------------- DECEMBER 31 1997 1996 (In millions of dollars) - ----------------------------------------------------------------------------------------------------------- ASSETS: Investments in subsidiaries....................................... $ 9,770 $ 8,099 Deferred income taxes............................................. 511 877 Notes receivable from affiliate................................... 205 205 Short-term investments............................................ 174 2 Other............................................................. 4 16 -------- ------- Total assets.............................................. $ 10,664 $ 9,199 ======== ======= LIABILITIES: Debt.............................................................. $ 1,972 $ 1,971 Federal income taxes payable...................................... 108 29 Amounts due to affiliates......................................... 106 102 Other............................................................. 169 37 -------- ------- Total liabilities......................................... 2,355 2,139 Total stockholders' equity................................ 8,309 7,060 - ----------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 10,664 $ 9,199 =========================================================================================================== RESULTS OF OPERATIONS - ---------------------------------------------------------------------------------------------------------- YEAR ENDED DECEMBER 31 1997 1996 1995 (In millions of dollars) - ---------------------------------------------------------------------------------------------------------- REVENUES: Equity in income of subsidiaries before income tax: Operating income ..............................................$ 956 $1,089 $ 923 Realized investment gains...................................... 742 610 453 Net investment income............................................. 12 13 9 Realized investment gains (losses)................................ (4) (5) 3 ------- ------ ------- 1,706 1,707 1,388 ------- ------ ------- EXPENSES: Administrative and general expenses............................... 217 223 220 Interest expense.................................................. 131 135 125 Other............................................................. - 4 1 ------- ------ ------- 348 362 346 ------- ------ ------ Income before income tax................................... 1,358 1,345 1,042 Income tax expense................................................ 392 380 285 - ---------------------------------------------------------------------------------------------------------- NET INCOME $ 966 $ 965 $ 757 ========================================================================================================== See accompanying Notes to Condensed Financial Information.
21
SCHEDULE II (continued) CNA FINANCIAL CORPORATION (PARENT COMPANY) CONDENSED FINANCIAL INFORMATION Statement of Cash Flows - ---------------------------------------------------------------------------------------------------------------- Year ended December 31 1997 1996 1995 (In millions of dollars) - ---------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income........................................................... $ 966 $ 965 $ 757 ---- ---- ---- Adjustments to reconcile net income to net cash flows from operating activities: Equity in income of unconsolidated affiliates.................... (1,441) (1,377) (1,201) Realized losses (gains).......................................... 4 5 (3) Changes in: Federal income taxes............................................ 79 165 (113) Deferred income taxes........................................... 366 93 173 Other, net...................................................... (127) (131) 87 ------ ----- ----- TOTAL ADJUSTMENTS.............................................. (1,119) (1,245) (1,057) ------- ------ ------ NET CASH FLOWS FROM OPERATING ACTIVITIES....................... (153) (280) (300) ------ ----- ----- Cash flows from investing activities: Purchase of The Continental Corporation.............................. - - (1,126) Other acquisitions................................................... - - (13) Purchases of fixed maturities........................................ - - (709) Proceeds from fixed maturities: Sales............................................................. - - 501 Maturities........................................................ - - 201 Net proceeds from the sale of equity securities...................... - - (1) Change in short-term investments..................................... (15) (2) 1 Other................................................................ (4) (5) 7 ----- ----- ----- NET CASH FLOWS FROM INVESTING ACTIVITIES....................... (19) (7) (1,139) ------ ------ ------ Cash flows from financing activities: Dividends paid to preferred shareholders............................. (6) (6) (7) Dividend from affiliates............................................. 175 548 326 Proceeds from issuance of long-term debt............................. - 248 1,325 Principal payments on long-term debt................................ - (500) - Loan to The Continental Corporation.................................. - - (205) ----- ----- ----- NET CASH FLOWS FROM FINANCING ACTIVITIES....................... 169 290 1,439 ----- ----- ----- NET CASH FLOWS (3) 3 - Cash at beginning of year............................................... 3 - - - ------------------------------------------------------------------------------------------------------------------- CASH AT END OF YEAR $ - $ 3 $ - ===================================================================================================================
SCHEDULE II (continued) CNA FINANCIAL CORPORATION (PARENT COMPANY) CONDENSED FINANCIAL INFORMATION Statement of Cash Flows - (continued) - ---------------------------------------------------------------------------------------------------------------- Year ended December 31 1997 1996 1995 (In millions of dollars) - ---------------------------------------------------------------------------------------------------------------- Supplemental disclosures of cash flow information: Cash (paid) received: Interest ........................................................ $ (134) $(141) $(170) Federal income taxes............................................. (95) 15 103 =================================================================================================================== Noncash investing activities that are not reflected in the Statement of Cash Flows are listed below. The Continental Other December 31, 1995 Corporation - -------------------------------------------------------------------------------------------------------------------- Fair value of assets acquired..................................... $15,259 $ 13 Liabilities assumed............................................... (14,133) - ------- ----- Cash paid..................................................... $ 1,126 $ 13 ==================================================================================================================== See accompanying Notes to Condensed Financial Information.
22 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. Investment 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 1997. b. Long-term debt ------------------------------------------------------------------------- December 31 1997 1996 (In millions of dollars) ------------------------------------------------------------------------- Variable rate debt: Credit Facility.................................. $ 400 $ 400 Commercial Paper................................. 675 675 Senior Notes: 8 7/8 %, due March 1, 1998....................... 150 150 6 1/4%, due November 15, 2003.................... 249 248 6 3/4%, due November 15, 2006.................... 248 248 7 1/4% Debenture, due November 15, 2023............. 247 247 1.0% Urban Development Action Grant, due May 7, 2019. 3 3 -------------------------------------------------------------------------- Total $1,972 $1,971 ========================================================================= CNA Financial Corporation (CNAF)has in place a revolving credit facility that was used to finance the acquisition of The Continental Corporation.The interest rate on 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 December 31, 1997 and 1996, respectively was 6.16% and 5.72%. To take advantage of favorable interest rates, CNAF established a commercial paper program to replace borrowings under the revolving credit facility. 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 interest rate on commercial paper at December 31, 1997 was 6.05% compared to 5.67% at December 31, 1996. At year end 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. SCHEDULE II (continued) 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 of $950 million, which terminate from May 2000 to December 2000. These agreements provide that CNAF pay interest at a fixed rate, averaging 6.20% at December 31, 1997 and 1996, in exchange for the receipt of interest at the three month LIBOR rate. The 23 SCHEDULE II (continued) CNA FINANCIAL CORPORATION (PARENT COMPANY) CONDENSED FINANCIAL INFORMATION NOTES TO CONDENSED FINANCIAL INFORMATION--(CONTINUED) effect of these interest rate swaps was to increase interest expense by $4 million and $7 million for the years ended December 31, 1997 and 1996, respectively. 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 6.35% and 6.28% at December 31, 1997 and 1996, respectively. This rate reflects the effect of the interest rate swaps. On August 18, 1997, CNAF filed a Registration Statement on Form S-3 with the Securities and Exchange Commission relating to $1 billion of senior and subordinated debt and preferred stock that became effective on October 22, 1997. This new shelf registration incorporated $250 million of securities remaining available for issuance from a prior shelf registration. On January 8, 1998, the Company issued $150 million principal amount of 6.45% senior notes due January 15, 2008 and $150 million principal amount of 6.95% senior notes due January 15, 2018. The net proceeds were used to pay down bank loans drawn under the Company's revolving credit facility. Concurrent with the reduction in bank debt, the Company terminated $300 million in notional amount of interest rate swaps. On March 2, 1998 CNAF paid at the due date $150 million of 8 7/8% senior notes with funds drawn against the revolving credit facility (unaudited). c. Management and admininstrative expenses CNAF has reimbursed, or will reimburse, its subsidiaries for general management and administrative expenses, unallocated loss adjustment expenses and investment expense of $217 million, $223 million and $218 million in 1997, 1996 and 1995, respectively. d. Capital contributions There were no contributions made by CNAF to the capital of its insurance and other subsidiaries in 1997, 1996 or 1995. - -------------------------------------------------------------------------------- 24
SCHEDULE III CNA FINANCIAL CORPORATION SUPPLEMENTARY INSURANCE INFORMATION - ------------------------------------------------------------------------------------------------ Gross Insurance Reserves ------------------------------------------------- Claim Deferred and Future Policy- Acquisition Claim Policy Unearned holders' (In millions of dollars) Costs Expense Benefits Premiums Funds - ------------------------------ ------------ ------------ ------------- ------------ ------------ December 31, 1997 Property/Casualty: Commercial............ $ 804 $ 25,624 $ 91 $ 3,717 $ 150 Personal.............. 358 1,386 445 963 2 Involuntary risks..... -- 1,230 -- 20 -- Life: Individual............ 934 114 3,593 -- 31 Group................. 46 555 700 -- 559 ------- ------- ------- ------- ----- Subtotal............ 2,142 28,909 4,829 4,700 742 Other and intercompany eliminations.......... - 318 - - - ------- ------- ------- ------- ----- $ 2,142 $ 29,227 $ 4,829 $ 4,700 $ 742 ======= ======= ======= ======= ===== December 31, 1996 Property/Casualty: Commercial............ $ 822 $ 25,887 $ 47 $ 3,591 $ 172 Personal.............. 262 1,557 326 1,044 - Involuntary risks..... - 1,951 - 24 - Life: Individual............ 736 148 3,138 - 30 Group................. 34 519 670 - 544 ------- ------- ------- ------- --- Subtotal............ 1,854 30,062 4,181 4,659 746 Other and intercompany eliminations.......... -- 333 -- -- -- ------- ------- ------- ------- ----- $ 1,854 $ 30,395 $ 4,181 $ 4,659 $ 746 ======= ======= ======= ======= ===== December 31, 1995 Property/Casualty: Commercial............ $ 702 $ 27,309 $ 38 $ 3,607 $ 163 Personal.............. 258 1,427 260 869 - Involuntary risks..... 9 2,308 - 73 - Life: Individual............ 505 162 2,679 - 31 Group................. 19 473 539 - 511 ------- ------- ------- ------- ----- Subtotal............ 1,493 31,679 3,516 4,549 705 Other and intercompany eliminations.......... -- 353 -- -- -- ------- ------- ------- ------- ----- $ 1,493 $ 32,032 $ 3,516 $ 4,549 $ 705 ======= ======= ======= ======= =====
*Premiums written relates to property/casualty companies only.
SCHEDULE III CNA FINANCIAL CORPORATION SUPPLEMENTARY INSURANCE INFORMATION - CONTINUED - -------------------------------------------------------------------------------------------------------- Amortization Insurance of Net Net Claims and Deferred Other Premium Investment Policyholders' Acquisition Operating Premiums (In millions of dollars) Revenue Income Benefits Costs Expenses Written* - --------------------------------------------------------------------------------------------------------- December 31, 1997 Property/Casualty: Commercial............ $ 8,418 $ 1,601 $ 7,369 $ 1,855 $ 1,148 $ 8,570 Personal.............. 1,651 146 991 407 191 1,803 Involuntary risks..... (142) 43 (383) -- 107 (187) Life: Individual............ 645 248 633 122 99 -- Group................. 2,790 171 2,643 (1) 318 -- ------ ------ ------ ------ ------ ------ Subtotal............ 13,362 2,209 11,253 2,383 1,863 10,186 Other and intercompany eliminations.......... - - - - 2 - ------ ------ ------ ------ ------ ------ $13,362 $ 2,209 $11,253 $ 2,383 $ 1,865 $10,186 ====== ====== ====== ====== ====== ======= December 31, 1996 Property/Casualty: Commercial............ $ 8,297 $ 1,623 $ 6,703 $ 1,715 $ 1,104 $ 8,593 Personal.............. 1,536 166 1,184 402 273 1,731 Involuntary risks..... 294 92 244 62 92 287 Life: Individual............ 631 227 667 26 129 - Group................. 2,743 173 2,579 (13) 322 - ------ ------ ------ ------ ------ ------ Subtotal............ 13,501 2,281 11,377 2,192 1,920 10,611 Other and intercompany eliminations.......... (22) (5) (20) -- (40) -- ------ ------ ------ ------ ------ ------ $13,479 $ 2,276 $11,357 $ 2,192 $ 1,880 $10,611 ======= ====== ====== ====== ===== ====== December 31, 1995 Property/Casualty: Commercial............ $ 7,226 $ 1,463 $ 5,995 $ 1,495 $ 915 $ 7,561 Personal.............. 1,215 132 892 271 229 1,254 Involuntary risks..... 284 104 234 17 146 311 Life: Individual............ 530 214 507 71 134 - Group................. 2,503 155 2,340 (10) 276 - ------ ------ ------ ------ ------ ------- Subtotal............ 11,758 2,068 9,968 1,844 1,700 9,126 Other and intercompany eliminations.......... (23) 9 (24) -- (20) -- ------ ------ ------ ------ ------ ------ $ 11,735 $ 2,077 $ 9,944 $ 1,844 $ 1,680 $ 9,126 ======= ====== ====== ====== ===== ======
25 SCHEDULE V CNA FINANCIAL CORPORATION VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
- ---------------------------------------------------------------------------------------------------------------- Balance at Charged to Charged to Balance at Beginning Costs and Other End of (In millions of dollars) of Period Expenses Amounts Deductions Period - ---------------------------------------------------------------------------------------------------------------- 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 ===== ===== ====== ===== ===== Year Ended December 31, 1995 Deducted from assets: Allowance for doubtful accounts: Receivables................................. $ 128 $ 39 $ 143* $ 21 $ 289 ===== ===== ====== ====== ===== - -------------------------------------------------------------------------------------------------------------- * Includes Continental allowance at the acquisition date.
SCHEDULE VI CNA FINANCIAL CORPORATION SUPPLEMENTARY INFORMATION CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS
- -------------------------------------------------------------------------------------------------------- Consolidated Property/ Casualty Entities ------------------------------------- Year Ended December 31 1997 1996 1995 (In millions of dollars) - -------------------------------------------------------------------------------------------------------- Deferred acquisition costs.................................... $1,162 $ 1,084 $ 969 Reserves for unpaid claims and claim expenses................. 28,240 29,830 31,044 Discount deducted from claim and claim expense reserves above (based on interest rates ranging from 3.5% to 7.5%)......... 2,409 2,459 2,449 Unearned premiums............................................. 4,700 4,659 4,549 Earned premiums............................................... 9,927 10,127 8,725 Net investment income......................................... 1,790 1,881 1,699 Claim and claim expenses related to current year.............. 7,942 7,922 6,787 Claim and claim expenses related to prior years............... (256) (91) 122 Amortization of deferred acquisition costs.................... 2,262 2,179 1,783 Paid claim and claim expenses................................. 8,376 9,200 7,057 Premiums written.............................................. 10,186 10,611 9,126 - --------------------------------------------------------------------------------------------------------
26 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, 1997 and 1996 and for each of the three years in the period ended December 31, 1997 and have issued our report thereon dated February 18, 1998. Such consolidated financial statements and report are included in the Company's 1997 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. /S/DELOITTE & TOUCHE LLP Deloitte & Touche LLP Chicago, Illinois February 18, 1998 27 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 30, 1998 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 30, 1998 | /S/ROBERT P. GWINN Director | - ---------------------------------- | Robert P. Gwinn | | | /S/WALTER F. MONDALE Director | - -------------------------------- | Walter F. Mondale | 28 SIGNATURES--(CONTINUED) SIGNATURE TITLE /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 30, 1998 | /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 | | 29 EXHIBIT 11.1 CNA FINANCIAL CORPORATION COMPUTATION OF NET INCOME PER COMMON SHARE
============================================================================================= Year Ended December 31 1997 1996 1995 1994 1993 (In millions, except per share data) - ----------------------------------------------------------------------------------------------- Weighted average shares outstanding................ 61.8 61.8 61.8 61.8 61.8 ====== ====== ====== ====== ====== Net income.........................................$ 966 $ 965 $ 757 $ 36 $ 268 Less preferred stock dividends..................... 7 7 7 5 4 ------ ------ ------- ---- ------ Net income available to common stockholders........$ 959 $ 958 $ 750 $ 31 $ 264 ====== ====== ====== ====== ====== Earnings per share: Net income available to common stockholders.....$15.52 $15.51 $12.14 $ 0.51 $ 4.26 ====== ====== ====== ====== ======
30 EXHIBIT 12.1 CNA FINANCIAL CORPORATION COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
- --------------------------------------------------------------------------------------------- Year Ended December 31 1997 1996 1995 1994 1993 (In millions of dollars, except ratios) - --------------------------------------------------------------------------------------------- Income before income tax ........................$ 1,358 $ 1,345 $ 1,042 $(134) $ 94 Adjustments: Interest expense.............................. 198 200 182 71 36 Interest element of operating lease rental.... 34 32 47 19 18 -------- ------- ------- ------ ----- Income before income tax, as adjusted............$ 1,590 $ 1,577 $ 1,271 $ (44) $ 148 ====== ======= ======= ====== ===== Fixed charges: Interest expense..............................$ 198 $ 200 $ 182 $ 71 $ 36 Interest element of operating lease rental.... 34 32 47 19 18 ------- ------- ------- ----- ----- Total fixed charges..............................$ 232 $ 232 $ 229 $ 90 $ 54 ====== ======= ======= ===== ===== Ratio of earnings to fixed charges (1)........... 6.8 6.8 5.6 (0.5) 2.7 - --------------------------------------------------------------------------------------------- (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 1997 1996 1995 1994 1993 (In millions of dollars, except ratios) - ------------------------------------------------------------------------------------------------------ Net income................................................$ 966 $ 965 $ 757 $ 37 $ 268 Adjustments: Interest expense, after tax............................ 129 130 119 46 24 Interest element of operating lease rental, after tax.. 22 21 30 12 12 ------ ------ ----- ----- ----- Net income, as adjusted...................................$ 1,117 $ 1,116 $ 906 $ 95 $ 304 ====== ====== ===== ===== ===== Fixed charges: Interest expense, after tax............................$ 129 $ 130 119 $ 46 $ 24 Interest element of operating lease rental, after tax.. 22 21 30 12 12 ------ ------- ----- ----- ----- Total fixed charges.......................................$ 151 $ 151 $ 149 $ 58 $ 36 ====== ====== ===== ===== ===== Ratio of net income, as adjusted, to fixed charges (1).... 7.4 7.4 6.1 1.6 8.6 - ------------------------------------------------------------------------------------------------------ (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.
31 EXHIBIT 21.1 PRIMARY SUBSIDIARIES OF CNA PLACE OF INCORPORATION COMPANY AMS Services, Inc. Delaware Alexsis, Inc. Maryland American Casualty Company of Reading, Pennsylvania (ACCO) Pennsylvania Boston Old Colony Insurance Company Massachusetts Claims Administration Corp. Maryland CNA Casualty of California California CNA Surety Corporation Delaware Columbia Casualty Company Illinois Commercial Insurance Company of Newark, N.J. New Jersey Continental Assurance Company (CAC) Illinois Continental Casualty Company (CCC) Illinois Continental Lloyd's Insurance Company Texas Continental Reinsurance Corporation California Firemen's Insurance Company of Newark, New Jersey New Jersey Kansas City Fire and Marine Insurance Company Missouri National Fire Insurance Company of Hartford (NFI) Connecticut National-Ben Franklin Insurance Company of Illinois Illinois Niagara Fire Insurance Company Delaware Pacific Insurance Company California 32 EXHIBIT 21.1 - (continued) PRIMARY SUBSIDIARIES OF CNA--(continued) PLACE OF INCORPORATION COMPANY The Buckeye Union Insurance Company Ohio The Continental Corporation, Inc. New York The Continental Insurance Company New Hampshire The Continental Insurance Company of New Jersey New Jersey Convida Holdings, Ltd. Bahamas The Fidelity and Casualty Company of New York New Hampshire The Glens Falls Insurance Company Delaware The Mayflower Insurance Company, Ltd. Indiana Transcontinental Insurance Company New York Transcontinental Technical Services, Inc. (ServCo) Illinois 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. 33 EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement No. 33-50753 of CNA Financial Corporation and subsidiaries on Form S-3 of our reports dated February 18, 1998, appearing in and incorporated by reference in the Annual Report on Form 10-K of CNA Financial Corporation and subsidiaries for the year ended December 31, 1997. /S/DELOITTE & TOUCHE LLP Deloitte & Touche LLP Chicago, Illinois March 30, 1998 34 EX-13.1 2 1997 ANNUAL REPORT CNA FINANCIAL CORPORATION 1997 ANNUAL REPORT CNA PROFILE - ------------------------------------------------------------------------------- CNA FINANCIAL CORPORATION is a holding company whose primary subsidiaries consist of property/casualty and life insurance companies, collectively 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 has 1997 assets of $61.3 billion and stockholders' equity of $8.3 billion. This holding company's primary subsidiaries include Continental Casualty Company, a commercial lines writer, Continental Assurance Company, its primary life insurance subsidiary and The Continental Insurance Company, primarily a personal lines and ocean marine writer. In 1997, CNA observed its centennial year, celebrating a century of financial strength, stability and commitment to customers and business partners. CNA Financial Corporation stock is traded primarily on the New York Stock Exchange and, as of December 31, 1997, was approximately 84 percent owned by Loews Corporation. CNA FINANCIAL CORPORATION ------------------------- CNA TABLE OF CONTENTS - -------------------------------------------------------------------------------- 1997 2 FINANCIAL HIGHLIGHTS 4 LETTER FROM CNA FINANCIAL CORPORATION CHAIRMAN EDWARD J. NOHA 6 LETTER FROM CNA CHAIRMAN AND CEO DENNIS H. CHOOKASZIAN 13 FINANCIAL SECTION CONTENTS 14 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 40 FINANCIAL STATEMENTS 90 INDEPENDENT AUDITORS' REPORT 91 COMMON STOCK INFORMATION 92 CORPORATE DIRECTORY CNA FINANCIAL CORPORATION -------------------------- FINANCIAL HIGHLIGHTS - ------------------------------------------------------------------------------- Results of Operations and Financial Condition - -------------------------------------------------------------------------------- Year Ended December 31 1997 1996 1995* 1994 1993 - -------------------------------------------------------------------------------- (In millions of dollars, except per share data) RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- Revenues $17,072 $16,988 $14,700 $11,000 $11,011 - -------------------------------------------------------------------------------- Income (loss) before income tax 1,358 1,345 1,042 (134) 93 - -------------------------------------------------------------------------------- Net income (loss) excluding net realized investment gains/losses Property/Casualty 501 576 457 148 (267) Life 100 110 104 87 44 Other (113) (108) (98) (48) (29) - -------------------------------------------------------------------------------- Net operating income (loss) 488 578 463 187 (252) Net realized investment gains (losses) 478 387 294 (151) 519 - -------------------------------------------------------------------------------- Net income $ 966 $ 965 $ 757 $ 36 $ 267 ================================================================================ EARNINGS PER SHARE - -------------------------------------------------------------------------------- Net operating income (loss) $ 7.78 $ 9.25 $ 7.37 $ 2.94 $ (4.14) Net realized investment gains (losses) 7.74 6.26 4.77 (2.43) 8.40 - -------------------------------------------------------------------------------- Net income $ 15.52 $ 15.51 $ 12.14 $ 0.51 $ 4.26 ================================================================================ FINANCIAL POSITION - -------------------------------------------------------------------------------- Assets $61,269 $60,455 $60,360 $44,320 $41,912 Debt 2,897 2,765 3,026 914 915 Stockholders' equity 8,309 7,060 6,736 4,546 5,381 Book value per common share 132.02 111.81 106.56 71.13 84.65 Return on average common stockholders' equity 12.6% 14.0% 13.4% 0.7% 5.3% ================================================================================ STATUTORY SURPLUS - -------------------------------------------------------------------------------- Property/Casualty $ 7,123 $ 6,349 $ 5,696 $ 3,367 $ 3,598 Life 1,224 1,163 1,128 1,056 1,022 ================================================================================ * Includes The Continental Corporation since May 10, 1995, except for Statutory Surplus which includes The Continental Corporation since January 1, 1995. 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 1987 through 1997. CNA FINANCIAL CORPORATION (1987-1997) ($ in billions except per share data) |----------------------|-----------|--------|--------------|---------------| |Measurement Period | | | Stockholders'| Book Value Per| | (Fiscal Year Covered)| Revenues | Assets | Equity | Common Share | |----------------------|-----------|--------|--------------|---------------| |FYE 12/31/87..........| 6.9 | 21.6 | 3.1 | 46.40 | |FYE 12/31/88..........| 8.3 | 25.9 | 3.6 | 54.87 | |FYE 12/31/89..........| 9.1 | 30.9 | 4.2 | 64.74 | |FYE 12/31/90..........| 9.9 | 34.7 | 4.5 | 70.23 | |FYE 12/31/91..........| 11.1 | 39.2 | 5.1 | 80.24 | |FYE 12/31/92..........| 10.8 | 39.7 | 4.8 | 75.07 | |FYE 12/31/93..........| 11.0 | 41.9 | 5.4 | 84.65 | |FYE 12/31/94..........| 11.0 | 44.3 | 4.5 | 71.13 | |FYE 12/31/95..........| 14.7 | 60.4 | 6.7 | 106.56 | |FYE 12/31/96..........| 17.0 | 60.5 | 7.1 | 111.81 | |FYE 12/31/97..........| 17.1 | 61.3 | 8.3 | 132.02 | |--------------------------------------------------------------------------| CNA FINANCIAL CORPORATION ------------------------- 3 A LETTER TO OUR SHAREHOLDERS ------------------------------------------------------------------------------ 1997 FROM CNA FINANCIAL CORPORATION CHAIRMAN EDWARD J. NOHA CNA Financial Corporation reported strong earnings in 1997. Net income was $966 million, or $15.52 per share, compared with net income of $965 million, or $15.51 per share, in 1996. Net realized investment gains for 1997 were $478 million, or $7.74 per share, compared with net realized gains of $387 million, or $6.26 per share, for 1996. Net income for 1997, exclusive of net realized gains and losses, was $488 million, or $7.78 per share, compared with $578 million, or $9.25 per share. While down from the prior year, our operating earnings reflect a solid performance in an intensely competitive insurance marketplace. Consolidated revenues for 1997 were approximately $17.1 billion, compared with approximately $17.0 billion in 1996. Along with these strong financial results, CNA marked an important milestone in 1997--its 100th anniversary. CNA was founded in 1897 operating out of a two-room office in Detroit. Today, CNA is one of the largest U.S. insurance organizations with leadership positions in many of its businesses. As CNA looks to its second century, we see an insurance environment of rapid change with major opportunities for forward-looking companies. Consolidation, specialization and globalization are transforming the property/casualty marketplace. We see these trends in the intense competition that continues to hold down prices in CNA's bread-and-butter commercial lines business. The life insurance industry is being transformed by the entry of banks, brokerage firms and other efficient, aggressive competitors. The good news is that the graying of America is increasing demand for products and services that address the need for death protection and wealth accumulation. We see this trend in rapid growth of term insurance, annuities and assets invested in retirement plans. In health insurance, managed care has changed the requirements for success from centralized, highly-efficient claims processing capabilities to the ability to manage provider networks and health care information. This is evident in the trend toward professional practice management organizations and the assumption of risk by provider organizations for the total cost of care. Meanwhile, all segments of insurance are being affected by legislative and regulatory changes that are blurring the lines between insurance, banking and CNA FINANCIAL CORPORATION ------------------------- 4 - ------------------------------------------------------------------------------- 1997 securities and opening the door to a more competitive financial services marketplace. Within this rapidly changing environment, CNA is on course to build on the opportunities of change and increase the value of the enterprise. CNA is one of the only major U.S. multiline insurance organizations with a significant presence in property/casualty, life and health insurance. As a multiline company, CNA's challenge is to be competitive in each of our businesses with competitors that focus on a single business. Along with the challenge, however, are tremendous opportunities for operating efficiencies, cross-marketing and long-term growth of enterprise value. In addition, the multiline strategy diversifies CNA's business risks. We saw this advantage clearly in 1997, when results from our personal insurance business partially offset the market impact on our commercial property/casualty businesses. CNA continues to build on a solid financial foundation. We strive to maintain conservative loss reserves. We take a similar approach with our investment portfolio, which is weighted heavily toward high-quality bonds. In addition, at year end 1997, the statutory surplus of our property/casualty companies was approximately $7.1 billion, one of the largest in the industry. The surplus of our life companies was approximately $1.2 billion, also substantial. CNA remains committed to managing its investment portfolio to maximize the total return, including capital gains. This approach provides CNA the flexibility to take advantage of favorable market conditions, as we saw in 1997. Finally, CNA continues to focus on building the long-term economic value of the Company. We believe this is the right approach, because insurance is a business of long-term commitments to customers. As a result, we manage CNA for long-term stability, growth and overall return. In summary, CNA marked its Centennial year with strong financial results and continued progress toward our goal of building long-term value. Looking to the future, we believe that CNA's history and traditions combined with the dedication of our employees and business partners will be the springboard to an even more successful second century. On behalf of the board of directors, I would like to thank you, our shareholders, for your commitment and 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 - -------------------------------------------------------------------------------- 1997 FROM CNA CHAIRMAN AND CHIEF EXECUTIVE OFFICER DENNIS H. CHOOKASZIAN CNA continued as a profitable market leader under some of the most competitive conditions ever seen in the commercial insurance market-place. We maintained market share, produced a solid profit, strengthened our financial base and launched several important initiatives that position CNA for profitable growth and continued success. Several factors contributed to CNA's 1997 results. Heavy competition in the commercial property/ casualty marketplace adversely affected results in this part of our business. Meanwhile, our life, personal insurance and reinsurance businesses benefited from strong demand and a lower level of catastrophe losses as compared to recent historical amounts. In addition, we realized substantial capital gains on our investment portfolio. In addition to strong financial results, 1997 was a year of several important corporate initiatives. CNA spun off its surety business through a merger with Capsure Holdings Corp. The result of the merger is the formation of CNA Surety Corporation, a new, publicly traded company in which CNA has an approximate 62% interest. CNA Surety Corporation is currently the largest U.S. surety operation with the broadest product line and largest distribution force. The stock market has responded very positively to the transaction. CNA's pre-merger interest in the business was valued at about $298 million. At year end 1997, based on the stock price of the new company, the value of CNA's interest was $418 million, an increase in value of $120 million. CNA expects to use a similar approach to unlock the value of more of its businesses over the next several years. Another significant development was the launch of CNA UniSource, a professional employer organization, or PEO. PEOs are in the business of handling the administrative functions of employment, payroll, employee benefits and risk management. PEOs are a growth industry because they relieve small employers of major administrative burdens. They also enable their customers to provide their employees with benefits comparable to those offered by large companies. As the first major insurance organization to launch a PEO, CNA is well positioned for the opportunities of this high-growth business. Also in 1997, CNA launched Hedge Financial Products to pursue opportunities in the business of insurance securitization. In this business, insurance risk is converted into financial instruments that can be traded by investors. Over time, insurance securitization will create an important new bridge between insurance and the capital markets. The staff of Hedge Financial is uniquely suited to launching this business successfully. Several of them played leading roles in the development of the catastrophe options traded on the Chicago Board of Trade. As in any organization of CNA's size, we experienced changes in some leadership positions during the past year. During 1997 several of our senior officers announced their retirements from CNA. We are grateful to Donald M. Lowry, senior CNA FINANCIAL CORPORATION ------------------------- 6 - -------------------------------------------------------------------------------- 1997 vice president, secretary and general counsel, Carolyn L. Murphy, senior vice president Commercial Operations, and Adrian M. Tocklin, senior vice president Diversified Operations for their years of committed service. Their leadership and expertise will be missed, but we have ensured an orderly transition of their responsibilities. On February 4, 1998, we announced the appointment of Bernard L. Hengesbaugh to the newly created position of executive vice president and chief operating officer. Hengesbaugh will have responsibility for overall operating performance of the Company's eight operating departments and 30 strategic business units. CNA celebrated its 100th anniversary in 1997 with Centennial activities designed to strengthen business relationships and reinforce the CNA values of financial strength, stability and commitment. In one of these activities, more than 700 CNA officers came together and built a playground at a Chicago public school in a neighborhood that had not had a safe place for children to play for many years. The experience was so positive that CNA decided to sponsor the KaBOOM! LET US PLAY campaign. Over the next three years, CNA employees will have an opportunity to build 50 playgrounds nationwide. By bringing new playgrounds to our communities, CNA will be supporting "America's Promise -- The Alliance for Youth", the campaign chaired by General Colin Powell to help at-risk children and teens. Beyond these initiatives, CNA continued to move ahead with strategies for leadership in a broad range of insurance and risk management businesses. PROPERTY/CASUALTY CNA is the premier provider of commercial insurance for small and medium size businesses in the United States. In 1997, we enhanced our leadership position by applying a proven strategy of industry segmentation and knowledge of the customer workplace. We identified profitable growth opportunities in both new and existing industry segments. Nine new Commercial Affiliation Marketing (CAM) programs were launched for targeted segments, while several current offerings were significantly enhanced. Many new programs were designed to meet a broader spectrum of insurance needs in such areas as surety, professional liability, warranty and international. This approach continued our emphasis on total customer satisfaction through collaboration among CNA business units and marketing across the full portfolio of CNA products and services. In addition, investments in automation strengthened our processing and marketing capabilities. New direct billing systems were introduced, small account processing was enhanced, and multiple Internet sites were established for marketing purposes. We also completed the groundwork for a state-of-the-art processing system that will improve service and efficiency. CNA FINANCIAL CORPORATION ------------------------- 7 A LETTER TO OUR SHAREHOLDERS - -------------------------------------------------------------------------------- 1997 In the risk management marketplace for large commercial accounts, CNA differentiates itself on the basis of customized programs that lower the customer's total cost of risk. We are unique in our ability to tailor programs for customers who want a package of insurance and services, as well as those who prefer to buy services on an unbundled, a la carte basis. In the very competitive risk management marketplace of 1997, CNA increased its market share of Fortune 100 customers and enhanced its reputation for serving the most demanding buyers of risk management products and services. Meanwhile, CNA is working to address a broader range of needs for large, multinational businesses. Our new, excess insurance product makes us a one-stop-shopping solution for covering very large liability risks. We are developing capabilities to insure and service large, complex property risks, as well as the international risks of U.S.-based companies. With these new capabilities, CNA's large commercial business will be well positioned for the global marketplace. CNA's strength in the commercial insurance marketplace extends to professional and specialty coverages. These businesses include liability insurance for healthcare providers, architects & engineers, lawyers, accountants, corporate officers and other professionals. CNA also is a major presence in excess and surplus lines insurance, fidelity, surety, marine insurance, credit, warranty and aviation insurance. CNA has developed leadership positions in many of these businesses by focusing on select customer groups, developing exceptional knowledge of their risks, and aligning its resources around their coverage needs. In several of these businesses, we have developed valuable marketing and processing advantages through partnerships with managing general underwriters, such as Victor O. Schinnerer, Aon Corporation and Poe & Brown. In 1997, CNA's professional and specialty businesses faced increasing competitive pressure. We strengthened this business through the purchase of Caronia Corporation, a leading third-party administrator for liability claims against health care organizations. In early 1998, we formed a fee-for-service risk management consulting business for the health care industry. These initiatives enable CNA to serve customers in whatever way they choose to manage their health-related liability risks. We also strengthened our capabilities in warranty, a rapidly growing field of insurance. Under a five-year agreement with Pre-Paid Legal Services Inc., CNA will market legal service insurance to employers, associations and other groups. In early 1998, we formed a joint venture with Specialty Underwriters, Inc., to develop business in commercial equipment maintenance programs. In the international insurance arena, CNA continued to make progress in building a strong, flexible franchise. We acquired majority control of Omega Aseguradora de Riesgo de Trabajo (ART), one of the largest CNA FINANCIAL CORPORATION ------------------------- 8 - ------------------------------------------------------------------------------- 1997 workers' compensation carriers in Argentina. CNA takes a conservative approach to international investment opportunities, and we focus our efforts on countries and markets where CNA's expertise responds to growing insurance needs. Our investment in Omega ART exemplifies this approach. CNA's leadership in workers' compensation insurance can add real value in Argentina's emerging workers' compensation system. CNA plans to introduce specialty products throughout the European Community through its London-based subsidiary, CNA Insurance Europe Ltd. In addition, we launched a global service facility to serve CNA's U.S.-based customers with international insurance needs. In reinsurance, CNA continued to grow its operations and add capabilities. A major area of progress was in facultative reinsurance, which provides clients with coverage for individual risks, rather than for entire classes of risks. After launching a facultative operation last year, we formed a global management structure in 1997 that will allow CNA to unify worldwide operations, increase communication and take advantage of the globalization trends of our customers. Facultative branches were established in seven U.S. locations, and property facultative capabilities were added in the United States and Latin America. Internationally, the reinsurance operations established offices in Toronto and Singapore. In the London market, we launched the Lloyd's Syndicate 1229, which will write short-tail direct insurance and facultative reinsurance. In addition, we continued to develop capabilities for providing more value to our reinsurance clients and business partners worldwide. A new client services unit in the United States will deliver these services, and we are moving ahead with plans to develop similar consulting capabilities in Europe. CNA's property/casualty operations also include individual long-term care insurance and personal lines, such as automobile and homeowners insurance. More than one million customers count on CNA for protection of their automobiles, homes and valuable personal possessions. In 1997, CNA had one of its best years ever in personal lines. Contributing factors included favorable loss reserve development, improvement in the area of expense management, greater ease of doing business for our agents and customers and lower than historical catastrophe losses. We continued to focus on a long-term strategy of building a major presence in personal insurance. Key elements of the strategy include internal growth, acquisitions and strategic partnerships to expand distribution channels and achieve economies of scale. Sales of long-term care insurance climbed 38 percent with $63 million of first-year paid premium. CNA introduced long-term care plans that meet the new federal definitions for tax-qualified long-term care insurance. In addition, we entered into an agreement with Vencor, the nation's largest full-service long-term care provider, which will maximize the value of insurance benefits for policyholders who select network facilities or services. CNA FINANCIAL CORPORATION ------------------------- 9 A LETTER TO OUR SHAREHOLDERS - -------------------------------------------------------------------------------- 1997 INDIVIDUAL LIFE In 1997, CNA restructured its individual life business around core product areas in life insurance and retirement services. CNA's track record of growth in individual life continued for the fourth year in a row, as life applications rose to 295,000 in 1997 from 235,000 in 1996. First-year premiums of $150 million for term insurance products were among the highest achieved by any insurer in the term marketplace. New products in 1997 included a unique series of term life products. We also enhanced our universal life products. These positive results reflect CNA's continued focus on product leadership, strong distribution relationships, expert underwriting approaches and the support of our reinsurers. Sales of individual annuities dropped off slightly in 1997. We are strengthening this business by revamping products and building distribution outlets to wholesale in the variable annuity markets. Our life reinsurance business had a good year, with sales up by more than 50 percent and solid profits. We capitalized on our expertise in group reinsurance as we shifted our focus to serving managed care and health care providers, while still being a major force in stop-loss coverage for self-insured employers. CNA's individual life businesses also include Viaticus, the leading U.S. viatical settlement company, and Convida, a Chilean life and annuity operation. CNA's viatical settlement business enables individuals with life-threatening diseases to tap the value of their life insurance benefits. Viaticus expanded its market outreach by contracting with employers, unions, and associations. Through the new contracts, Viaticus now has marketing access to 10 million lives. Meanwhile, Convida, the fourth largest annuity company in Chile, has built its asset base to more than $200 million. GROUP LIFE AND HEALTH CNA customers in the group life and health marketplace include employers, associations and other group purchasers of medical benefits, life and accident & disability insurance. We offer life and health reinsurance to insurance companies writing group coverages. In addition, CNA is active in the pension marketplace with guaranteed investment contracts, annuities and other wealth accumulation products. In 1997, we reorganized the group businesses to make it easier for customers to do business with CNA and to improve our ability to respond quickly and profitably to changing customer needs. A combined sales organization will maximize opportunities for cross-selling of CNA products. New sales of our non-medical products increased by more than 25 percent and profits continued to improve. In addition, CNA continued to build its market leadership position in insurance programs for associations and other affinity groups. CNA FINANCIAL CORPORATION ------------------------- 10 - ------------------------------------------------------------------------------- 1997 The $2 billion Federal Employees Health Benefits Program moved ahead with plans to regionalize its operations for more responsive and efficient services to government employees and their dependents. In addition, our investments in technology are streamlining customer service and enabling us to guide customers in using medical services more effectively. In private medical benefits, a new claim system has enhanced our ability to implement managed care features. We also implemented a data ware-house, an important tool for analyzing claims costs and identifying opportunities for cost saving. While operating results were disappointing in 1997, the new tools have sharpened our focus on strategies for improvement. CNA Health Partners took advantage of CNA's multiline capabilities by collaborating with our commercial insurance operations, to launch a product for employers who want combined coverage for workers' compensation and nonoccupational medical benefits. We sharpened our focus on pensions and other investment-oriented products by consolidating the management of CNA's group pension and individual annuity businesses. This reorganization concentrates our expertise in this class of products into a single management structure. In addition, CNA Trust, which provides pension services to small and medium-sized employers, is capitalizing on opportunities in one of the fastest growing segments of the pension marketplace. In summary, CNA performed well in its Centennial year. We produced solid earnings and positioned the Company for the future. Thanks to our business partners and the dedication of our employees, CNA continued its 100-year record of strength, stability and commitment. Looking ahead, 1998 will be a year of continued competitive pressure and rapid change in the insurance marketplace. CNA will intensify its emphasis on excellence in the operating performance of all its businesses. Taking advantage of our multiline capabilities will be another key priority. As we build an insurance organization for the future, 1998 will be the start of an even more successful second century. Sincerely, S/DENNIS H. CHOOKASZIAN Dennis H. Chookaszian Chairman and Chief Executive Officer CNA CNA FINANCIAL CORPORATION ------------------------- 11 CNA FINANCIAL SECTION CONTENTS - -------------------------------------------------------------------------------- 1997 14 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 40 CONSOLIDATED BALANCE SHEET 42 STATEMENT OF CONSOLIDATED OPERATIONS 43 STATEMENT OF CONSOLIDATED STOCKHOLDERS' EQUITY 44 STATEMENT OF CONSOLIDATED CASH FLOWS 46 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 90 INDEPENDENT AUDITORS' REPORT 91 COMMON STOCK INFORMATION 92 CORPORATE DIRECTORY CNA FINANCIAL CORPORATION ------------------------- 13 MANAGEMENT'S DISCUSSION AND ANALYSIS - -------------------------------------------------------------------------------- Consolidated Results Consolidated Results CNA is one of the largest 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 1996 market share estimates, CNA ranks first among domestic insurers in commercial affiliation marketing, commercial auto, commercial multiple peril, ocean marine, personal packages, and surety; second in general liability, medical malpractice, federal employees health benefit plans, term-life insurance; third in automobile warranty, directors & officers, individual long-term care and workers' compensation and fifth in reinsurance in the United States. In addition, CNA ranks first or second for various errors & omissions coverages for architects and engineers, accountants, lawyers and other professionals. CNA's focus is to create long-term enterprise value by pursuing a strategy of growth in market segments which will enhance that value. CNA will concentrate resources on businesses in which it has a proven expertise, providing insurance and risk management services. The Company will continue to enhance its leadership position by focusing on market segments and businesses in which CNA is the market leader or where it believes it can effectively compete. CNA actively manages its investment portfolios on a total return basis (investment income and capital gains) while maintaining the quality of its investment portfolio. In 1997, CNA's focus enabled the Company to produce solid results and maintain its leadership position in one of the most competitive market environments in recent history. CNA's results, as discussed in the following pages, reflect the effects of the current market environment. Total revenues, which consist of premium, net investment income, realized gains and other revenues, were $17.1 billion, up 0.5% from 1996 and up 16.1% from 1995. For 1997, revenues reflect a decrease of $117 million (0.9%) in earned premium resulting from reductions in involuntary markets premium and very competitive conditions in the commercial lines marketplace. Revenues in 1997 also reflect an increase in realized investment gains of $134 million (21.7%), which was the result of CNA taking advantage of favorable market conditions. Also impacting revenue was a decline of $67 million (2.9%) in net investment income as a result of lower yields compared to last year and reduction in the investment base reflecting signifi-cant claim payments related to Fibreboard (see Note F of the Consolidated Financial Statements). Other revenues increased by $134 million (21.8%) due primarily to growth in insurance related operations. Insurance related operations include claim adjusting services, auto-warranty sales, insurance agency software and the viatical settlement business. For 1997, CNA reported net operating income (which excludes net realized investment gains/losses) of $488 million, or $7.78 per share, compared to $578 million, or $9.25 per share, for 1996 and $463 million, or $7.37 per share, for 1995. Realized investment gains, net of tax, amounted to $478 million, or $7.74 per share in 1997 compared to $387 million, or $6.26 per share in 1996 and $294 million, or $4.77 per share, in 1995. These net realized gains represent 49.5%, 40.1% and 38.8% of net income for the last three years and, based on CNA's total return investment philosophy, are an integral part of CNA's investment results. Net income for 1997 was $966 million, or $15.52 per share, compared to $965 million, or $15.51 per share, for 1996 and $757 million, or $12.14 per share in 1995. CNA FINANCIAL CORPORATION ------------------------- 14 - -------------------------------------------------------------------------------- Results of Operations Results of Operations: - ---------------------- The following chart summarizes key components of consolidated operating results for each of the last three years.
CONSOLIDATED OPERATIONS - ------------------------------------------------------------------------------ Year Ended December 31 1997 1996 1995* - ------------------------------------------------------------------------------ (In millions of dollars) OPERATING REVENUE (excluding realized investment gains/losses) Premiums $13,362 $13,479 $11,735 Net investment income 2,209 2,276 2,077 Other 748 614 424 - ------------------------------------------------------------------------------ Total operating revenue (excluding realized investment gains/losses) 16,319 16,369 14,236 Benefits and expenses 15,699 15,628 13,650 - ------------------------------------------------------------------------------ Operating income before income tax 620 741 586 Income tax expense 132 163 123 - ------------------------------------------------------------------------------ Net operating income (excluding realized investment gains/losses) 488 578 463 Realized investment gains, net of tax 478 387 294 - ------------------------------------------------------------------------------ Net income $ 966 $ 965 $ 757 ============================================================================== SUPPLEMENTAL FINANCIAL DATA: Net operating income (loss) by group: Property/Casualty $ 501 $ 576 $ 457 Life 100 110 104 Other, primarily interest expense (113) (108) (98) - ------------------------------------------------------------------------------- Net operating income 488 578 463 - ------------------------------------------------------------------------------- Net realized investment gains (losses) by group: Property/Casualty 384 303 208 Life 96 96 85 Other (2) (12) 1 - ------------------------------------------------------------------------------ Realized investment gains, net of tax 478 387 294 - ------------------------------------------------------------------------------ Net income (loss) by group: Property/Casualty 885 879 665 Life 196 206 189 Other, primarily interest expense (115) (120) (97) ============================================================================== Net income $ 966 $ 965 $ 757 ============================================================================== *Includes the results of The Continental Corporation since the acquistion date.
CNA FINANCIAL CORPORATION ------------------------- 15 MANAGEMENT'S DISCUSSION AND ANALYSIS - ---------------------------------------------------------------------------- Property/Casualty Operations Property/Casualty Operations
PROPERTY/CASUALTY GROUP - ------------------------------------------------------------------------------ Year Ended December 31 1997 1996 1995* - ------------------------------------------------------------------------------ (In millions of dollars) Operating Revenue (excluding realized investment gains/losses) Premiums $ 9,927 $10,127 $ 8,724 Net investment income 1,790 1,881 1,699 Other 634 509 348 - ------------------------------------------------------------------------------ 12,351 12,517 10,771 Benefits and expenses 11,723 11,779 10,193 - ------------------------------------------------------------------------------ Operating income before income tax 628 738 578 Income tax expense 127 162 121 - ------------------------------------------------------------------------------ Net operating income (excluding realized investment gains/losses) 501 576 457 Realized investment gains, net of tax 384 303 208 - ------------------------------------------------------------------------------- Net income $ 885 $ 879 $ 665 =============================================================================== *Includes the results of The Continental Corporation since the acquisition date.
The property/casualty group is comprised of commercial business, personal lines of insurance, involuntary risk and other related business. Customers of the commercial business include large national corporations, small and medium-sized businesses, groups and associations, and professionals. Coverages are written primarily through traditional insurance contracts, under which risk is transferred to the insurer. Many large commercial account policies are written under retrospectively-rated contracts, which are experience-rated. Premiums for such contracts may be adjusted, subject to limitations set by contract, based on the loss experience of the insureds. Other experience-rated policies include provisions for dividends based on loss experience. Experience-rated contracts reduce but do not eliminate risk to the insurer. Commercial lines also includes reinsurance assumed from other insurance companies and certain group accident and health insurance coverages. The property/casualty group markets personal lines of insurance, primarily automobile and homeowners coverages sold to individuals under monoline and package policies. Involuntary risks include mandatory participation in residual markets, statutory assessments for insolvencies of other insurers, and other similar charges. The property/casualty group also provides other related services including loss control, policy admin-istration and claim administration services under service contracts for fees. Such services are provided primarily in the workers' compensation market. Property/casualty revenues, excluding net realized investment gains/losses were $12.4 billion, down approximately 1.3% from $12.5 billion in 1996 and up from $10.8 billion in 1995. Revenues include the results of The Continental Corporation subsequent to May 10, 1995 (see Note N to the Consolidated Financial Statements). CNA FINANCIAL CORPORATION ------------------------- 16 - -------------------------------------------------------------------------------- Property/Casualty Operations (cont.) Property/casualty earned premiums were $9.9 billion in 1997, down approximately 2.0% from the $10.1 billion earned in 1996 and up from $8.7 billion in 1995. Pre-tax operating income for property/casualty was $628 million in 1997 compared to $738 million and $579 million in 1996 and 1995, respectively. Underwriting results, which include insurance and insurance-related operations, deteriorated by 1.7%, primarily the result of an extremely competitive commercial market place exerting pressure on pricing. The underwriting loss for 1997 was $1,162 million, compared to $1,143 million and $1,122 million in 1996 and 1995, respectively. Catastrophe losses for 1997 on a pretax basis were approximately $92 million, compared with $315 million in 1996 and $149 million in 1995. CNA's 1997 and 1996 catastrophe losses were primarily weather related, including winter storms, tornadoes and flooding. CNA's 1995 catastrophe losses related primarily to tropical storms and hail storms in Texas. Property/casualty investment income for 1997 was $1.8 billion, down approximately 4.8% from the $1.9 billion in 1996 and up from $1.7 billion in 1995. Investment income was down from 1996 levels reflecting overall lower yields in the bond market and a lower investment base due to reduced operating cashflows. The bond segment of the investment portfolio yielded 6.5% in 1997 compared with 6.8% and 6.9% in 1996 and 1995, respectively. Net operating income excluding net realized investment gains/losses was $501 million for 1997 compared to $576 million and $457 million in 1996 and 1995, respectively. Net realized investment gains for 1997 were $384 million compared to $303 million and $208 million in 1996 and 1995, respectively. The increase in net realized investment gains in 1997 largely offset the decline in net investment income and reflects CNA's continued practice of managing its investment portfolio to maximize total after-tax return. CNA FINANCIAL CORPORATION -------------------------- 17 MANAGEMENT'S DISCUSSION AND ANALYSIS - ------------------------------------------------------------------------ Property/Casualty Operations (cont.) The following table shows the underwriting results for commercial lines:
PROPERTY/CASUALTY - COMMERCIAL - ----------------------------------------------------------------------------- Year Ended December 31 1997 1996 1995* - ----------------------------------------------------------------------------- (In millions of dollars) Premiums Earned: Professional and specialty $1,688 $1,845 $1,558 General liability and commercial automobile 1,682 1,754 1,649 Workers' compensation 1,845 1,543 1,476 Multiple peril 1,058 1,047 870 Accident and health 1,062 919 699 Reinsurance and other 1,083 1,189 974 - ------------------------------------------------------------------------------ 8,418 8,297 7,226 Losses and expenses 9,839 9,150 8,147 - ------------------------------------------------------------------------------ Net underwriting losses before investment income $(1,421) $ (853) $ (921) ============================================================================== *Includes the results of The Continental Corporation since the acquisition date.
Premiums for the property/casualty commercial segment increased 1.5% to $8.4 billion in 1997, up from $8.3 billion in 1996 and up from $7.2 billion in 1995. Professional and specialty earned premium decreased approximately 8.5% to $1.7 billion in 1997, down from $1.8 billion in 1996 and up from $1.6 billion in 1995. The 1997 premium decrease was attributable to a decline in financial insurance premium of approximately $90 million, as well as a decrease in agricultural insurance of approximately $85 million offset by small increases in various other lines. General liability and commercial automobile earned premium was approximately $1.7 billion in 1997, down approximately 4.1% from the $1.8 billion earned in 1996 and up from the $1.6 billion in 1995. The decrease in 1997 was the result of the soft market which made profitable premium growth difficult to achieve. Earned premium from workers' compensation increased approximately 19.6% to $1.8 billion in 1997, up from $1.5 billion in 1996 and 1995, respectively. The increase in workers' compensation earned premium resulted from a willingness on the part of the Company to write, in its voluntary book of business, business that would have otherwise been written by the involuntary market. This willingness was precipitated by improved loss experience trends in the involuntary market. Multiple peril earned premium was essentially level, increasing approximately $11 million to $1.1 billion in 1997, from $1.0 billion in 1996 and $0.9 billion in 1995. Accident and health earned premium was approximately $1.1 billion in 1997, increasing approximately 15.6% from the $0.9 billion earned in 1996 and up from the $0.7 billion in 1995. Accident and health premium increased primarily due to increases in mass market association premium. CNA FINANCIAL CORPORATION ------------------------- 18 - ------------------------------------------------------------------------------- Property/Casualty Operations (cont.) Earned premium from reinsurance and other decreased approximately 8.9% at $1.1 billion in 1997 from $1.2 billion in 1996, and up from the $1.0 billion earned in 1995. The decline in 1997 is attributable to lower premium from CNA's London business. Underwriting results in commercial lines in 1997 were a loss of $1.4 billion, a decline of approximately 66.6% from the $853 million loss in 1996 and 54.4% from the $921 million in 1995. This deterioration is primarily the result of the highly competitive commercial insurance market exerting pressure on pricing, unfavorable loss reserve development and increased operating expenses, partially offset by improved catastrophe loss experience and favorable premium development. Increased operating expenses stemmed from technology and system upgrades and consulting costs. The following table shows the underwriting results for personal lines:
PROPERTY/CASUALTY - PERSONAL - ----------------------------------------------------------------------- Year Ended December 31 1997 1996 1995* - ----------------------------------------------------------------------- (In millions of dollars) Premiums Earned: Personal lines packages $1,085 $1,063 $ 782 Monoline automobile and property coverages 440 367 325 Accident and health 126 106 108 - ----------------------------------------------------------------------- 1,651 1,536 1,215 Losses and expenses 1,527 1,720 1,317 - ------------------------------------------------------------------------ Net underwriting income (loss) before investment income $ 124 $ (184) $ (102) ========================================================================= *Includes the results of The Continental Corporation since the acquisition date.
Personal lines earned premium increased 7.5% to $1.7 billion from the $1.5 billion earned in 1996 and up from the $1.2 billion earned in 1995. The increase in personal lines premium resulted primarily from an increase in private passenger automobile business and individual long-term care. Personal lines posted net underwriting income of $124 million in 1997 compared to underwriting losses of $184 million and $102 million in 1996 and 1995, respectively. The change from 1996 to 1997 was primarily due to favorable loss reserve development of approximately $200 million primarily in personal auto coverages, as well as improved catastrophe loss experience of $79 million. Also contributing to the improvement were reduced claim adjustment expenses. CNA FINANCIAL CORPORATION ------------------------- 19 MANAGEMENT'S DISCUSSION AND ANALYSIS - ------------------------------------------------------------------------------- Property/Casualty Operations (cont.) The following table shows the underwriting results for involuntary risks:
PROPERTY/CASUALTY - INVOLUNTARY RISKS - ----------------------------------------------------------------- Year Ended December 31 1997 1996 1995* - ----------------------------------------------------------------- (In millions of dollars) Premiums Earned: Workers' compensation $(249) $ 198 $ 178 Private passenger automobile 66 58 80 Commercial automobile 25 36 20 Property and multiple peril 16 2 6 - ----------------------------------------------------------------- (142) 294 284 Losses and expenses (277) 400 383 - ----------------------------------------------------------------- Net underwriting income (loss) before investment income $ 135 $(106) $ (99) ================================================================= *Includes the results of The Continental Corporation since the acquisition date.
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 in residual markets on an accrual basis. Involuntary risk earned premium decreased substantially in 1997, primarily in the workers' compensation line of business, as estimates of premiums for prior years were reduced by approximately $340 million. The decrease in involuntary risk premium stems from a greater willingness on the part of the voluntary market, including CNA, to write these types of risks. Involuntary risk underwriting income reflects favorable loss reserve development of approximately $540 million, which was partially offset by $340 million of premium development, as noted above. This favorable loss reserve development is attributable to improved claim experience in the workers' compensation and private passenger automobile lines. CNA FINANCIAL CORPORATION ------------------------- 20 - -------------------------------------------------------------------------------- Property/Casualty Operations (cont.) Reserves CNA's property/casualty results of operations are significantly impacted by actuarial estimates of claim and claim expense reserves. These reserves represent an accumulation of the amounts the Company believes are necessary to settle all outstanding claims, including incurred but not reported claims. 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 adjust-ments becomes apparent. Management believes its reserves for environmental pollution and asbestos claims are appropriately established based upon known facts and current case law. However, due to the inconsistencies of court coverage decisions, the number of waste sites subject to clean-up, the standards for clean-up and liability, and other factors, the ultimate exposure to CNA for these claims may vary materially from the amounts currently recorded, resulting in a potential increase in the claim reserves recorded. In addition, issues related to, among other things, specific policy provisions and allocation of liability among insurers, consequences of conduct of the insured, missing policies and proof of coverage make quantification of liabilities exceptionally difficult and subject to adjustment based upon newly available data. Due to the uncertainties and factors described above, the ultimate exposure to CNA for environmental pollution claims may vary substantially from the amounts currently recorded. The following table reflects the component effects of management's ongoing evaluation of reserve levels: RESERVE DEVELOPMENT - (adverse)/favorable) - ------------------------------------------------------- Year Ended 1997 1996 1995 December 31 - ------------------------------------------------------- (In millions of dollars) Asbestos $(105) $(51) $(274) Environmental Pollution -- (65) (226) Other lines 361 207 378 - ------------------------------------------------------- Total $ 256 $ 91 $(122) ======================================================= The 1997 favorable loss reserve development of $256 million noted in the table above was offset in part by unfavorable premium development of $170 million. Unfavorable 1997 asbestos reserve development of $105 million results from CNA's on-going monitoring of current payment and settlement patterns, current pending cases and potential future claims. 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 involuntary risks, primarily in workers' compensation, and $200 million of favorable loss development in personal lines. These favorable developments were offset in part by unfavorable development in commercial lines of $379 million. The favorable loss development in involuntary risks is attributable to better than expected results in workers' CNA FINANCIAL CORPORATION ------------------------- 21 MANAGEMENT'S DISCUSSION AND ANALYSIS - -------------------------------------------------------------------------------- Property/Casualty Operations (cont.) 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 similarly reduced. The favorable loss development in personal lines was attributable to improved trends particularly in personal auto lines. The unfavorable development in commercial lines was attributable to approximately $240 million in general liability lines, $130 million in commercial multiperil, and $215 million in loss adjustment expense reserves, offset in part by favorable development of $206 million primarily in workers' compensation and reinsurance lines. This unfavorable loss development in commercial lines was offset in part by favorable premium development of $170 million related to experience-rated contracts. Other lines' 1996 and 1995 favorable reserve development which aggregated $207 million and $378 million, respectively, was principally due to favorable claim frequency (rate of claim occurrence) and severity (average cost per claim) experience in the workers' compensation line of business. These trends reflect the positive effects of changes in workers' compensation laws, more moderate increases in medical costs, and a generally strong economy in which individuals return to the workplace more quickly. CNA utilizes reinsurance arrangements to limit its maximum loss while providing greater diversification of risks and minimizing exposures on larger risks. The types of reinsurance coverages are tailored to the specific type of risk underwritten with the amount retained by CNA varying by type of coverage. These reinsurance arrangements do not discharge the primary liability of the Company to the original insureds. To minimize the Company's exposure that a reinsurer may not be able to reimburse the Company under the terms of the reinsurance agreement, CNA places reinsurance with other insurance companies after a thorough assessment of the reinsurer's credit quality and claim settlement performance. Additionally, for reinsurers that are not authorized reinsurers, CNA receives collateral primarily in the form of bank letters of credit. CNA's reinsurance recoverable on paid and unpaid claim and claim expenses was approximately $5.4 billion at December 31, 1997 and approximately $6.3 billion at December 31, 1996. CNA FINANCIAL CORPORATION ------------------------- 22 - ------------------------------------------------------------------------------ Life Operations (cont.) Life Operations
LIFE GROUP - --------------------------------------------------------------------- Year Ended December 31 1997 1996 1995 - --------------------------------------------------------------------- (In millions of dollars) Operating Revenue (excluding realized investment gains/losses) Group Premium Accident and health $2,527 $2,548 $2,190 Life and annuity 263 195 313 - ---------------------------------------------------------------------- Total group 2,790 2,743 2,503 - ---------------------------------------------------------------------- Individual Premium Life and annuity 642 629 497 Accident and health 3 2 33 - ---------------------------------------------------------------------- Total individual 645 631 530 - ---------------------------------------------------------------------- Total premiums 3,435 3,374 3,033 Net investment income 419 400 369 Other 114 106 76 - ---------------------------------------------------------------------- Total operating revenues 3,968 3,880 3,478 Total benefits and expenses 3,815 3,709 3,318 - ---------------------------------------------------------------------- Operating income before income tax 153 171 160 Income tax expense 53 61 56 - ---------------------------------------------------------------------- Net operating income (excluding realized investment gains/losses) 100 110 104 Realized investment gains, net of tax 96 96 85 ======================================================================= Net income $ 196 $ 206 $ 189 ========================================================================
During 1997, CNA's life operations experienced continued growth, building on the momentum from the past two years. CNA sells a variety of individual and group insurance products. The individual insurance products consist primarily of term, universal life, and fixed and variable annuity products. Group insurance products include life, accident and health consisting primarily of major medical and hospitalization, and pension products, such as guaranteed investment contracts and annuities. Life insurance revenues, excluding net realized investment gains, were up 2.3% to $4.0 billion for 1997 as compared to $3.9 billion for 1996 and up from $3.5 billion for 1995. Life premium for 1997 was up 1.8% or $61 million from $3.4 billion in 1996 and up from 1995 premiums of $3.0 billion. CNA has undertaken a number of initiatives to enhance service, manage health care utilization demand and quality, and strengthen CNA's networks of physicians, hospitals and other providers. In group accident and health, CNA CNA FINANCIAL CORPORATION ------------------------- 23 MANAGEMENT'S DISCUSSION AND ANALYSIS - ------------------------------------------------------------------------------- Life Operations (cont.) underwrites the Federal Employees Health Benefits Program FEHBP) which had revenues of $2.1 billion, $2.1 billion and $1.9 billion in 1997, 1996 and 1995, respectively. Group life and annuity business increased $68 million, or approximately 35% to $263 million in 1997. This increase is primarily due to a $45 million increase in single premium guaranteed annuity business. Traditional guaranteed investment contract sales were lower by approximately 41% due to the strong performance of the equity market which caused customers to transfer 401(k) investments to stock mutual funds and away from the stable value of guaranteed funds. Individual life premium continues to increase as demand for CNA's Viaterm product remains strong, with premium increasing approximately $55 million over 1996's level. This increase was tempered by a drop in CNA's foreign operations of approximately $41 million due to an increasingly competitive market. Total individual premium increased approximately $14 million, or 2.2%, over 1996, and $115 million, or 21.7%, over 1995. Individual policies in-force increased 26% in 1997 to 1,010,000 policies from 799,000 policies in 1996. Individual accident and health premium remained low due to CNA selling its individual disability income business in late 1995. Life investment income increased by approximately 4.8% due to a larger asset base generated from the increased cashflows resulting from premium growth. The bond segment of the life investment portfolio yielded 6.4% in 1997 compared with 6.5% and 6.9% in 1996 and 1995, respectively. CNA's life insurance net operating income, excluding net realized investment gains, was $100 million for 1997, compared to $110 million and $104 million for 1996 and 1995, respectively. The decline in net operating income is primarily due to poor experience in certain group accident and health contracts and increased expenses related to new business initiatives. CNA FINANCIAL CORPORATION -------------------------- 24 - ------------------------------------------------------------------------------- Investments Investments: 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 1997 % 1996 % 1995 % 1994 % 1993 % - -------------------------------------------------------------------------------------- (In millions of dollars) Fixed maturities: Bonds: Taxable $24,419 69% $22,631 65% $25,832 75% $17,484 63% $11,933 48% Tax-exempt 4,534 13 4,860 14 3,453 10 3,717 13 4,725 19 Redeemable preferred stocks 67 -- 49 -- 100 -- 423 2 445 2 Equity securities: Common stocks 567 2 478 1 734 2 729 3 433 2 Non-redeemable preferred stocks 128 -- 224 1 3 -- 8 -- -- -- Mortgage loans and real estate 85 -- 123 -- 122 -- 47 -- 62 -- Policy loans 177 -- 174 -- 177 1 176 1 174 1 Other invested assets 544 2 617 2 483 1 103 -- 69 -- Short-term investments 4,884 14 5,854 17 3,725 11 5,036 18 6,944 28 - -------------------------------------------------------------------------------------- Investments $35,405 100% $35,010 100% $34,629 100% $27,723 100% $24,785 100% ====================================================================================== Investments at Carrying Value* $36,203 $35,412 $35,886 $26,943 $25,363 ====================================================================================== *As reported in the Consolidated Balance Sheet
CNA FINANCIAL CORPORATION -------------------------- 25 MANAGEMENT'S DISCUSSION AND ANALYSIS - -------------------------------------------------------------------------------- Investments (cont.) The following table summarizes CNA's general and separate account investments at carrying value, by group, as of December 31, 1997.
DISTRIBUTION OF INVESTMENTS - ------------------------------------------------------------------------------- Property/ Life Other Separate Casualty Group % Group % Group % Accounts % - ------------------------------------------------------------------------------- (In millions of dollars) Fixed maturities: Bonds: Taxable $19,015 65% $ 5,712 89% $ -- -- $4,769 83% Tax-exempt 4,724 16 -- -- -- -- -- -- Redeemable preferred stocks 97 -- -- -- -- -- -- -- Equity securities: -- -- Common stocks 657 2 22 -- 1 1 181 3 Non-redeemable preferred 134 1 -- -- -- -- 25 1 stocks Mortgage loans and real estate 60 -- 25 -- -- -- -- -- Policy loans -- -- 177 3 -- -- -- -- Other invested assets 687 2 6 -- 2 1 117 2 Short-term investments 4,224 14 478 8 182 98 629 11 - ------------------------------------------------------------------------------- Investments at Carrying Value $29,598 100% $ 6,420 100% $185 100% $5,721 100% ================================================================================
CNA's general account 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 operations. 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 emphasize high credit quality and diversification by industry, issue and issuer. Assets supporting interest rate sensitive liabilities are segmented within the general account to facilitate asset/liability duration management. At December 31, 1997, total Separate Account cash and investments amounted to $5.7 billion with taxable fixed maturities representing approximately 83.4% of the total. Approximately 73.8%of Separate Account investments 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 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 to the original customer deposit and investing the remaining cash primarily in high quality investments. CNA FINANCIAL CORPORATION ----------------------------- 26 - -------------------------------------------------------------------------------- Investments (cont.) The number of contracts is adjusted regularly to approximate the future liability to the contractholder. The gross notional amounts of these instruments totaled $860 million and $394 million at December 31, 1997 and 1996, respectively.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 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. In addition, CNA's investment in mortgage loans and real estate as a percentage of total assets, is substantially below the industry average. The general account portfolio consists primarily of high quality (BBB or higher) marketable fixed maturities, 95.0% and 94.2% of which are rated as investment grade at December 31, 1997 and 1996, respectively. The following table summarizes the ratings of CNA's general account fixed maturity bond portfolio at carrying value (market):
- ------------------------------------------------------------------------------- December 31 1997 % 1996 % 1995 % - ------------------------------------------------------------------------------- (In millions of dollars) U.S. government and affiliated securities $13,679 46.4% $11,623 42.0% $18,905 62.3% Other AAA rated 8,801 29.9 9,277 33.5 4,625 15.3 AA and A rated 3,796 12.9 3,786 13.7 3,512 11.6 BBB rated 1,695 5.8 1,387 5.0 1,424 4.7 Below investment grade 1,480 5.0 1,582 5.8 1,862 6.1 - ------------------------------------------------------------------------------- Total $29,451 100% $27,655 100% $30,328 100% - -------------------------------------------------------------------------------
The following table summarizes the ratings of CNA's guaranteed investment contract separate account fixed maturity bond portfolio at carrying value (market):
- ------------------------------------------------------------------------------- December 31 1997 % 1996 % 1995 % - ------------------------------------------------------------------------------- (In millions of dollars) U.S. government and affiliated securities $ 148 3.9% $ 192 5.0% $ 1,743 36.4% Other AAA rated 2,401 62.6 2,279 59.0 828 17.3 AA and A rated 569 14.8 723 18.7 914 19.1 BBB rated 406 10.6 345 8.9 361 7.5 Below investment grade 310 8.1 324 8.4 944 19.7 - ------------------------------------------------------------------------------- Total $ 3,834 100% $3,863 100% $ 4,790 100% - -------------------------------------------------------------------------------
At year end 1997, 1996 and 1995, respectively, 89.8%, 92.0% and 93.0% of the general account portfolio and 82.1%, 85.7% and 95.0% of the guaranteed investment contract portfolio, in the table 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 CNA FINANCIAL CORPORATION ------------------------- 27 MANAGEMENT'S DISCUSSION AND ANALYSIS - -------------------------------------------------------------------------------- Investments (cont.) 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. CNA's concentration in high yield bonds including Separate Account business was approximately 3.2% of total assets as of December 31, 1997 and 1996, respectively. Included in CNA's fixed maturity securities at December 31, 1997 (general and guaranteed investment contract portfolios) are $7.2 billion of asset-backed securities, consisting of approximately 11.2% in U.S. government agency issued pass-through certificates, 40.0% in collateralized mortgage obligations (CMOs), 29.8% in corporate asset-backed obligations and 19.0% 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, 1997, the fair value of asset-backed securities was greater than the amortized cost by approximately $114 million, compared to net unrealized losses of approximately $5 million at December 31, 1996. At December 31, 1997 and 1996, 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 1997 1996 - ----------------------------------------------- (In millions of dollars) Commercial paper $1,850 $3,207 U.S. Treasuries in escrow* 1,065 1,062 Money markets 624 746 U.S. Treasuries 558 56 Security repurchase collateral 154 101 Other 633 682 - ----------------------------------------------- Total short-term investments $4,884 $5,854 =============================================== *See Note A to the Consolidated Financial Statements CNA invests from time to time in certain derivative financial instruments primarily to reduce its exposure to market risk (principally interest rate, equity price and foreign currency risk). CNA also uses derivatives to mitigate the risk associated with its indexed group annuity contract by purchasing S&P 500 futures contracts in a notional amount equal to the original customer deposit. 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. See Note C of the Consolidated Financial Statements for further information regarding derivatives. CNA FINANCIAL CORPORATION ------------------------- 28 - -------------------------------------------------------------------------------- Investments (cont.) CNA's general account investments in bonds and redeemable preferred stocks were carried at their fair value of $29.5 billion at December 31, 1997, compared with $27.7 billion at December 31, 1996. At December 31, 1997 and 1996, net unrealized gains on fixed maturity securities amounted to approximately $528 million and $181 million, respectively. The gross unrealized gains and losses for the fixed maturity securities portfolio at December 31, 1997 were $644 million and $116 million, respectively, compared to $444 million and $263 million, respectively, at December 31, 1996. Net unrealized gains on general account bonds include net unrealized losses on high yield securities of $2 million and gains of $34 million, at December 31, 1997 and 1996, respectively. Carrying values of high yield securities in the general account were $1.5 billion and $1.6 billion at December 31, 1997 and 1996, respectively. At December 31, 1997, fixed maturity securities in the guaranteed investment contract portfolio are carried at fair value and amounted to $3.8 billion. At December 31, 1997, net unrealized gains on fixed maturity securities in these Separate Accounts amounted to approximately $71 million. This compares to $1 million in net unrealized losses at December 31, 1996. The gross unrealized gains and losses for the fixed maturity securities portfolio at December 31, 1997, were $87 million and $16 million, respectively, compared to $55 million and $56 million, respectively, at December 31, 1996. At December 31, 1997, high yield securities in the guaranteed investment contract portfolio which are carried at fair value amounted to $310 million, compared to $324 million at December 31, 1996. Net unrealized losses on high yield securities held in such Separate Accounts were $1 million and $8 million at December 31, 1997 and 1996, respectively. CNA FINANCIAL CORPORATION -------------------------- 29 MANAGEMENT'S DISCUSSION AND ANALYSIS - ------------------------------------------------------------------------------ Market Risk Market Risk: - ------------ The Securities and Exchange Commission (SEC) issued new disclosure rules related to economic exposure to market risk from financial instruments. 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. The SEC's market risk rule focuses 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 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 32 and 33 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 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, Deutsche Marks, and Japanese Yen. This exposure is mitigated by the Company's asset/liability matching strategy and through the use of fowards for those instruments which are not matched. CNA FINANCIAL CORPORATION ------------------------- 30 - -------------------------------------------------------------------------------- Market Risk (cont.) 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 analysis assumes that the composition of the Company's interest rate sensitive assets and liabilities existing at the beginning of the period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the time to maturity. 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, 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 net financial instrument position of $1.6 billion and $2.4 billion, respectively. 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. The Company's long-term debt, including certain related interest rate swap agreements, as of December 31, 1997, is denominated in U.S. dollars. Approximately 91% 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 $117 million and $176 million, respectively. The impact of a 100 and 150 basis point increase in interest rates on the variable rate debt would result in an additional $3 million and $4 million, respectively, in interest expense per year. A 100 and 150 basis point decrease in interest rates would lower interest expense by $3 million and $4 million, respectively, 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, 1997, with all other variables held constant. The Company's equity holdings were assumed to be perfectly correlated with this Index. A 10% and 25% decrease in the Index would result in a $179 million and $448 million decrease, respectively, in the net financial instrument position. Of these amounts, $66 million and $166 million, respectively would be offset by decreases in liabilities to customers under variable annuity contracts. Similarly, increases CNA FINANCIAL CORPORATION ------------------------- 31 MANAGEMENT'S DISCUSSION AND ANALYSIS - -------------------------------------------------------------------------------- Market Risk (cont.) in the Index would result in like increases in the net financial instrument position and increases in liabilities to customers 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, 1997, with all other variables held constant. A 10% and 20% strengthening of the U.S. dollar versus other currencies would result in decreases of $48 million and $96 million, respectively, in the net financial instrument position. Weakening of the U.S. dollar versus all other currencies would result in like increases in the net financial instrument position. The following table reflects the estimated effects on the market value of the Company's financial instruments 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, 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) (81) Short term investments 4,884 (11) (21) - Interest rate swaps (4) 20 - - - ------------------------------------------------------------------------------ Total general account 35,242 (1,400) (48) (91) - ------------------------------------------------------------------------------ Separate Accounts 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 accounts 5,604 (193) - (88) ============================================================================== Total all securities $40,846 $(1,593) $(48) $(179) ============================================================================== Long term debt $(2,897) $ 117 $ - $ - ============================================================================== CNA FINANCIAL CORPORATION ------------------------- 32 - ------------------------------------------------------------------------------- Market Risk (cont.) The following table reflects the estimated effects on the market value of the Company's financial instruments 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 - ------------------------------------------------------------------------------ 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 (4) 30 - - - ------------------------------------------------------------------------------ Total general account 35,242 (2,100) (96) (228) - ------------------------------------------------------------------------------ Separate Accounts 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 accounts 5,604 (289) - (220) ============================================================================== Total all securities $40,846 $(2,389) $ (96) $ (448) ============================================================================== Long term debt $(2,897) $ 176 $ - $ - ============================================================================== CNA FINANCIAL CORPORATION ------------------------- 33 MANAGEMENT'S DISCUSSION AND ANALYSIS - ------------------------------------------------------------------------------- Risks and Uncertainties Risks and Uncertainties: - ------------------------ The following section discusses other risks and uncertainties to which the Company is subject. Credit Risk Credit risk arises from the potential inability of counterparties to perform on an obligation in accordance with the terms of a contract. CNA is exposed to credit risk in its capacity as a counterparty in financial and insurance contracts, reinsurance arrangements, and as a holder of securities. The company accepts risk whenever a counterparty is obligated to perform under a contract. As a holder of securities, CNA is exposed to default by the issuer or to the possibility of market price deterioration. As a purchaser of reinsurance, CNA has exposure that a reinsurer may not be able to reimburse the Company under the terms of a reinsurance agreement. CNA has established policies and procedures to manage credit risk, including collateral requirements, and master "netting arrangements". Legal/Regulatory Risk Legal/regulatory risk is the risk that changes in the legal or regulatory environment in which the Company operates will create additional expenses not anticipated by the Company in pricing its products. Regulatory initiatives, tax law changes, new legal theories or insurance company insolvencies, through guaranty fund assessments, may create costs for the insurer beyond those currently recorded in the consolidated financial statements. CNA mitigates this risk by offering a wide range of products and by operating throughout the United States, thus reducing its exposure to any single product or region, and also by employing underwriting practices which identify and minimize the adverse impact of this risk. Impact of Year 2000 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 after 1999. Such malfunctions could lead to business delays and disruptions. The Company is in the process of replacing many of its legacy systems and is upgrading its systems to accommodate business for the year 2000 and beyond. The Company believes that it is on plan to resolve the year 2000 issue in a timely manner. Based upon its current assessment, the Company estimates that the incremental cost to replace and upgrade its systems to accommodate year 2000 processing will be approximately $50 million. However, due to the interdependent nature of computer systems, the Company may be adversely impacted depending upon whether it or other entities not affiliated with the Company (vendors and business partners) address this issue successfully. To mitigate this impact, the Company is communicating with its vendors and business partners to coordinate the year 2000 conversion. In addition, property/casualty insurance companies may have an underwriting exposure related to year 2000. Although the Company has not received any claims for coverage from its policyholders based on losses resulting from year 2000 issues, there can be no assurance that policyholders will not suffer losses of this type and seek compensation under the Company's insurance policies. If any claims are made, coverage, if any, will depend on the facts and circumstances of the claim and the provisions of the policy. At this time, 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 ------------------------- 34 - ------------------------------------------------------------------------------- LIQUIDITY AND CAPITAL RESOURCES Liquidity and Capital Resources: - ------------------------------- The liquidity requirements of CNA have been met by funds generated from operating, investing and financing activities. In early 1998, CNA was able to take advantage of favorable market conditions to refinance, on a fixed rate basis, a portion of its existing debt under the Company's revolving credit facility. Additionally, CNA expects to take advantage of the current low interest rate environment to raise additional capital to support new business initiatives in 1998. The principal cash flow sources of CNA's property/casualty and life insurance subsidiaries are premiums, investment income, and sales and maturities of investments. 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, 1997, CNA's operating cash flows were a negative $193 million, compared to positive $620 million in 1996, and $875 million in 1995. As discussed previously, the Company had substantially lower operating cash flow, primarily due to claim payments made resulting from the settlement of the Fibreboard litigation. The cash flow impact of such claim payments was approximately $1 billion in 1997 (see Note F of the Consolidated Financial Statements). To finance the acquisition of The Continental Corporation (Continental), including the refinancing of $205 million of Continental debt, CNA entered into a $1.325 billion revolving credit facility which expires in May 2001. The interest rate for the facility is based on the one, two, three, or six month 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 was 6.16% and 5.72% at December 31, 1997 and 1996, respectively. Under the terms of the facility, CNA may prepay the debt without penalty, giving CNA flexibility to arrange longer-term financing on more favorable terms. In 1997, CNA filed a Registration Statement on Form S-3 with the Securities and Exchange Commission relating to $1 billion in senior and subordinated debt and preferred stock that became effective on October 22, 1997. This new shelf registration incorporated $250 million of securities remaining available for issuance from a prior shelf registration. On January 8, 1998, the Company issued $150 million principal amount of 6.45% senior notes due January 15, 2008 and $150 million principal amount of 6.95% senior notes due January 15, 2018. The net proceeds were used to pay down bank loans drawn under the Company's revolving credit facility. Concurrent with the reduction in bank debt, the Company terminated $300 million notional amount of interest rate swaps. As a result of this additional debt issuance, the borrowing capacity under the revolving credit facility was reduced. On March 2, 1998 CNA paid at the due date $150 million of 8 7/8% senior notes with funds drawn against the revolving credit facility. On November 15, 1996, CNA issued $250 million, 6.75% 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 under the revolving credit facility. CNA FINANCIAL CORPORATION ------------------------- 35 MANAGEMENT'S DISCUSSION AND ANALYSIS - ------------------------------------------------------------------------------- Liquidity and Capital Resources (cont.) As a result of this debt issuance, the borrowing capacity under the revolving credit facility was reduced by $250 million to $1.075 billion. On March 1, 1996, CNA paid at the due date $250 million of 8 5/8% senior notes. In 1995, CNA entered into five year interest rate swap agreements with several banks. These agreements convert variable rate debt into fixed rate debt resulting in fixed rates on notional amounts of $1.2 billion as of December 31, 1995. In conjunction with the pay down of $250 million of the revolving credit facility, the Company terminated swaps with a like notional amount. The weighted-average fixed swap rate was 6.20% at December 31, 1997 and 1996. The effect of these interest rate swaps was to increase interest expense by approximately $4 million, $7 million and $2 million for the years ended December 31, 1997, 1996 and 1995, respectively. During 1995, to take advantage of favorable interest rates, CNA established a commercial paper program, borrowing from investors and replacing a like amount of bank financing. As of December 31, 1997 and 1996, the commercial paper program borrowing totaled $675 million. The weighted-average interest rate on commercial paper was 6.05% and 5.67% at December 31, 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 6.35% and 6.28% at December 31, 1997 and 1996, respectively. As of December 31, 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 as described above. 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 the senior debt of CNA and Continental and CNA's preferred stock.
|-----------------|=====================||---------------------------------------| | | INSURANCE RATINGS || DEBT AND STOCK RATINGS | | |=====================||---------------------------------------| | | Financial Strength|| | CNA | |Continental| --------------------------------------------------------------- | | CAC | CAC | CIC ||Senior|Commercial|Preferred| Senior | | | | | || Debt | Paper | Stock | Debt | | |-----|--------|------||------|----------|---------|-----------| |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.
CNA FINANCIAL CORPORATION ------------------------- 36 - ------------------------------------------------------------------------------- Accounting Standards Accounting Standards: - -------------------- Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities In June 1996, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 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 has not and will not have a significant impact on CNA. Reporting Comprehensive Income In June 1997, the FASB issued SFAS No. 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. Disclosures About Segments of An Enterprise and Related Information In June 1997, the FASB issued SFAS No. 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. CNA is currently evaluating the effect of this statement on its business segment disclosure. 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", which provides guidance on accounting by entities that are subject to insurance-related assessments. It requires that entities recognize liabilities for insurance-related assessments when all of the following criteria have been met: an assessment has been imposed or a probable 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 CNA FINANCIAL CORPORATION ------------------------- 37 MANAGEMENT'S DISCUSSION AND ANALYSIS - -------------------------------------------------------------------------------- Accounting Standards (cont.) for financial statements for fiscal years beginning after December 15, 1998. CNA is currently evaluating the effects of this SOP on its accounting for insurance-related assessments. Employers' Disclosures about Pensions and Other Postretirement Benefits In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits", which standardizes disclosure requirements for pension and other postretirement benefits to the extent practicable and requires additional information on changes in the benefit obligations and fair values of plan assets that will facilitate financial analysis. The Statement also suggests combined formats for presentation of pension and other postretirement benefit disclosures. The Statement changes disclosure only and does not address measurement or recognition. It is effective for fiscal years beginning after December 15, 1997. CNA is currently evaluating the effects of this Statement on its benefit plan disclosures. CNA FINANCIAL CORPORATION -------------------------- 38 - ------------------------------------------------------------------------------- Forward-Looking Statements Forward-Looking Statements: - --------------------------- When included in management's discussion and analysis, the words "believes", "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, general economic and business conditions, competition, changes in financial markets (interest rate, credit, currency, commodities and stocks), changes in foreign, political, social and economic conditions, regulatory initiatives and compliance with governmental regulations, judicial decisions and rulings, and various other matters, many of which are beyond the Company's control. See the Company's discussions elsewhere in this report on how these various risks may affect CNA. 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 state-ment 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 ------------------------- 39 CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEET
ASSETS - -------------------------------------------------------------------------------------------------- December 31 1997 1996 - -------------------------------------------------------------------------------------------------- (In millions of dollars) Investments: Fixed maturities available for sale (cost: $29,020 and $27,540) $29,548 $27,721 Equity securities available for sale (cost: $695 and $702) 814 859 Mortgage loans and real estate (less accumulated depreciation: $1 and $4) 85 123 Policy loans 177 174 Other invested assets 695 681 Short-term investments 4,884 5,854 - -------------------------------------------------------------------------------------------------- TOTAL INVESTMENTS 36,203 35,412 - -------------------------------------------------------------------------------------------------- Cash 383 257 Receivables: Reinsurance 5,726 6,530 Insurance 6,086 5,888 Other trade 248 192 Less allowance for doubtful accounts (303) (277) Deferred acquisition costs 2,142 1,854 Accrued investment income 389 508 Receivables for securities sold 744 264 Federal income taxes recoverable (includes $26 and $151 due from Loews) 18 134 Deferred income taxes 1,070 1,347 Property and equipment at cost (less accumulated depreciation: $553 and $436) 747 645 Prepaid reinsurance premiums 202 295 Intangibles 620 418 Other assets 1,182 867 Separate Account business 5,812 6,121 - -------------------------------------------------------------------------------------------------- TOTAL ASSETS $61,269 $60,455 ================================================================================================== See accompanying Notes to Consolidated Financial Statements.
CNA FINANCIAL CORPORATION ------------------------- 40 - -------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEET (cont.)
LIABILITIES AND STOCKHOLDERS' EQUITY - -------------------------------------------------------------------------------------------------- December 31 1997 1996 - -------------------------------------------------------------------------------------------------- (In millions of dollars) Liabilities: Insurance reserves: Claim and claim expense $29,227 $30,395 Unearned premiums 4,700 4,659 Future policy benefits 4,829 4,181 Policyholders' funds 742 746 Securities sold under repurchase agreements 153 100 Payables for securities purchased 648 405 Participating policyholders' equity 132 119 Long-term debt 2,897 2,765 Other liabilities 3,820 3,904 Separate Account business 5,812 6,121 - -------------------------------------------------------------------------------------------------- TOTAL LIABILITIES 52,960 53,395 - -------------------------------------------------------------------------------------------------- Commitments and contingent liabilities-Notes E, F and G Stockholders'equity: Common stock $2.50 par value; Authorized - 200,000,000 shares; Issued - 61,841,969 shares; Outstanding - 61,798,262 shares; 155 155 Money market cumulative preferred stock 150 150 Additional paid-in capital 435 435 Retained earnings 6,983 6,024 Net unrealized investment gains 589 299 Treasury stock, at cost (3) (3) - -------------------------------------------------------------------------------------------------- TOTAL STOCKHOLDERS' EQUITY 8,309 7,060 - -------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $61,269 $60,455 ================================================================================================== See accompanying Notes to Consolidated Financial Statements.
CNA FINANCIAL CORPORATION ------------------------- 41 CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- STATEMENT OF CONSOLIDATED OPERATIONS
- -------------------------------------------------------------------------------------------------- Year Ended December 31 1997 199+ 1995 - -------------------------------------------------------------------------------------------------- (In millions of dollars, except per share data) Revenues: Premiums $13,362 $13,479 $11,735 Net investment income 2,209 2,276 2,077 Realized investment gains 753 619 464 Other 748 614 424 - -------------------------------------------------------------------------------------------------- 17,072 16,988 14,700 - -------------------------------------------------------------------------------------------------- Benefits and expenses: Insurance claims and policyholders' benefits 11,268 11,371 9,952 Amortization of deferred acquisition costs 2,383 2,192 1,844 Other operating expenses 1,865 1,880 1,680 Interest expense 198 200 182 - -------------------------------------------------------------------------------------------------- 15,714 15,643 13,658 - -------------------------------------------------------------------------------------------------- Income before income tax 1,358 1,345 1,042 Income tax expense 392 380 285 - -------------------------------------------------------------------------------------------------- NET INCOME $ 966 $ 965 $ 757 - -------------------------------------------------------------------------------------------------- EARNINGS PER SHARE $ 15.52 $ 15.51 $ 12.14 ================================================================================================== WEIGHTED AVERAGE OUTSTANDING SHARES OF COMMON STOCK 61.8 61.8 61.8 ================================================================================================== See accompanying Notes to Consolidated Financial Statements.
CNA FINANCIAL CORPORATION ------------------------- 42 - -------------------------------------------------------------------------------- STATEMENT OF CONSOLIDATED STOCKHOLDERS' EQUITY
- ------------------------------------------------------------------------------------------------------------ Net Unrealized Additional Investment Common Preferred Treasury Paid-In Retained Gains Stock Stock Stock Captital Earnings (Losses) Total - ------------------------------------------------------------------------------------------------------------ In millions of dollars) Balance, January 1, 1995 $155 $150 $(3) $435 $4,316 $ (507) $4,546 Net income - - - - 757 - 757 Change in net unrealized gains/(losses) - - - - - 1,440 1,440 Preferred dividends - - - - (7) - (7) - ---------------------------------------------------------------------------------------------------------- Balance December 31, 1995 $155 $150 $(3) $435 $5,066 $ 933 $6,736 Net income - - - - 965 - 965 Change in net unrealized gains/(losses) - - - - - (634) (634) Preferred dividends - - - - (7) - (7) - ---------------------------------------------------------------------------------------------------------- Balance, December 31, 1996 $155 $150 $(3) $435 $6,024 $ 299 $7,060 Net income - - - - 966 - 966 Change in net unrealized gains/(losses) - - - - - 290 290 Preferred dividends - - - - (7) - (7) - ---------------------------------------------------------------------------------------------------------- BALANCE, DECEMBER 31, 1997 $155 $150 $(3) $435 $6,983 $ 589 $8,309 ========================================================================================================== See accompanying Notes to Consolidated Financial Statements.
CNA FINANCIAL CORPORATION ------------------------- 43 CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- STATEMENT OF CONSOLIDATED CASH FLOWS
- ------------------------------------------------------------------------------------------------ Year Ended December 31 1997 1996 1995 - ------------------------------------------------------------------------------------------------ (In millions of dollars) CASH FLOWS FROM OPERATING ACTIVITIES: - ------------------------------------- Net income $ 966 $ 965 $ 757 ---------------------------------- Adjustments to reconcile net income to net cash flows from operating activities: Net realized investment gains, pre-tax (753) (619) (464) Amortization of intangibles 30 25 19 Amortization of bond discount (100) (178) (143) Depreciation 158 138 101 Changes in: Receivables, net 576 84 (803) Deferred acquisition costs (288) (361) (161) Accrued investment income 119 38 (30) Federal income taxes 116 (1) (39) Deferred income taxes 146 353 221 Prepaid reinsurance premiums 93 200 130 Insurance reserves (464) (358) 427 Other liabilites (566) 790 974 Other, net (226) (456) (114) - ------------------------------------------------------------------------------------------------ Total adjustments (1,159) (345) 118 - ------------------------------------------------------------------------------------------------ NET CASH FLOWS FROM OPERATING ACTIVITIES $ (193) $ 620 $ 875 - ------------------------------------------------------------------------------------------------ See accompanying Notes to Consolidated Financial Statements.
CNA FINANCIAL CORPORATION ------------------------ 44 - -------------------------------------------------------------------------------- Statement of Consolidated Cash Flows (Cont.)
- ------------------------------------------------------------------------------------------------ Year Ended December 31 1997 1996 1995 - ------------------------------------------------------------------------------------------------ (In millions of dollars) CASH FLOWS FROM INVESTING ACTIVITIES: - -------------------------------------- Purchases of fixed maturities $(42,492) $(34,312) $(29,255) Proceeds from fixed maturities: Sales 38,429 34,864 24,065 Maturities, calls and redemptions 2,997 1,796 2,855 Purchases of equity securities (1,319) (972) (1,094) Proceeds from sale of equity securities 1,406 1,077 1,317 Change in short-term investments 1,112 (2,029) 2,942 Purchases of property and equipment (280) (205) (126) Change in securities sold under repurchase agreements 53 (674) (1,705) Change in other investments 421 146 158 Purchase of The Continental Corporation, net of cash acquired - - (961) Other acquisitions, net (108) - (72) Other, net (7) 21 (39) - ------------------------------------------------------------------------------------------------ NET CASH FLOWS FROM INVESTING ACTIVITIES 212 (288) (1,915) - ------------------------------------------------------------------------------------------------ CASH FLOWS FROM FINANCING ACTIVITIES: - ------------------------------------- Dividends paid to preferred shareholders (6) (6) (7) Receipts from investment contracts credited to policyholder account balances 7 11 23 Return of policyholder account balances on investment contracts (26) (41) (34) Change in short-term debt - (257) 3 Principal payments on long-term debt (5) (254) (208) Proceeds from issuance of long-term debt 137 250 1,337 - ------------------------------------------------------------------------------------------------ NET CASH FLOWS FROM FINANCING ACTIVITIES 107 (297) 1,114 - ------------------------------------------------------------------------------------------------ NET CASH FLOWS 126 35 74 Cash at beginning of period 257 222 148 - ------------------------------------------------------------------------------------------------ CASH AT END OF PERIOD $ 383 $ 257 $ 222 ================================================================================================
CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Statement of Consolidated Cash Flows (cont.)
Noncash investing activities that are not reflected in the Statement of Cash Flows are listed below. - ------------------------------------------------------------------------------------------------- The Continental Year Ended December 31, 1995 Corporation Other - ------------------------------------------------------------------------------------------------- (In millions of dollars) Fair value of assets acquired, excluding cash acquired $ 15,094 $ 231 Liabilities assumed (14,133) (159) - ------------------------------------------------------------------------------------------------- Cash paid, net of cash acquired $ 961 $ 72 ================================================================================================= See accompanying Notes to Consolidated Financial Statements.
CNA FINANCIAL CORPORATION ------------------------- 45 NOTES CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Note A -- Significant Accounting Policies (cont.) Note A -- Significant Accounting Policies - ----------------------------------------- BASIS OF PRESENTATION - ------------------------------------------------------------------------------- The Consolidated Financial Statements include CNA Financial Corporation and its subsidiaries (CNA or the Company) 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). Loews Corporation (Loews) owns approximately 84% of the outstanding common stock of CNA. 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 1997. All 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 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 customers, including small, medium and large businesses; associations; professionals; groups 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. INSURANCE - ------------------------------------------------------------------------------- Premium Revenue 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 annu-ities are recognized as revenue when due after deductions for ceded insurance. Claim and claim expense reserves Claim and claim expense reserves, except reserves for structured settlements, workers' compensation lifetime claims and 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 losses, (c) estimates of losses on assumed insurance, and (d) CNA FINANCIAL CORPORATION ------------------------- 46 - ------------------------------------------------------------------------------ Note A - Significant Accounting Policies (cont.) 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 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 claim expense reserves and carried at the present values determined using interest rates ranging from 6.25% to 7.50%. At December 31, 1997 and 1996, the total of these unfunded structured settlements was $913 million and $924 million, respectively (reflecting a discount of $1,527 million and $1,556 million, respectively). Workers' compensation lifetime claim reserves and 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, 1997 and 1996, such reserves totaled $2,196 million and $2,165 million, respectively (reflecting a discount of $882 million and $903 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 11% 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 6.78% to 7.45% for the three years ended December 31, 1997. 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 in residual markets on an accrual basis. CNA records assessments for insolvencies as they are paid. Accruals for such assessments have not been practical as the availability of information, in sufficient detail, regarding industry insolvences and related assessments has been limited. CNA FINANCIAL CORPORATION ------------------------- 47 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Note A - Significant Accounting Policies (cont.) 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 quota share, yearly renewable term and facultative programs. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability. 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, which are regularly evaluated and cumulatively adjusted as appropriate. Participating business Participating business represented 0.7%, 0.5% and 0.6% of gross life insurance in force and 0.7%, 0.7% and 0.8% of life insurance premium income for 1997, 1996, and 1995, 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. 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 contract holders on approximately 74% of the Separate Account business. Substantially all assets of the Separate Account business are carried at fair value. Separate account liabilities are carried at contract values. CNA FINANCIAL CORPORATION ------------------------- 48 - ------------------------------------------------------------------------------- Note A - Significant Accounting Policies (cont.) INVESTMENTS - ------------------------------------------------------------------------------- Valuation of investments CNA classifies its fixed maturity securities (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 maturity securities is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and accretion are included in investment income. CNA accounts for its derivative securities under the fair value method, except for interest rate swaps associated with certain corporate borrowings. Under this method the derivative securities are recorded 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 to 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, 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 are reflected in investment income, realized investment gains/losses and unrealized investment gains/losses, as appropriate. 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, net of applicable deferred income taxes and participating policyholders' interest. Equity affiliates CNA uses the equity method of accounting for investments in companies in which its ownership interest is as least twenty percent but not greater than fifty percent and upon which it cannot assert significant control. 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. Securities sold under repurchase agreements 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 CNA FINANCIAL CORPORATION ------------------------- 49 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. Restricted investments On December 30, 1993, CNA deposited $987 million in an escrow account, pursuant to the Fiberboard 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 $1,098 million and $1,071 million at December 31, 1997 and 1996, respectively. ADDITIONAL CASH FLOW STATEMENT INFORMATION - -------------------------------------------------------------------------------- The Company's supplemental disclosure of cash flow information: - ----------------------------------------------------- Year Ended December 31 1997 1996 1995 - ----------------------------------------------------- (In millions of dollars) Cash (paid) received: Interest $(201) $(211) $(170) Federal income taxes (95) 16 (103) ====================================================== 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), unearned premium reserves, net unrealized investment gains/losses, deferred acquisition costs and net operating loss carry forwards, net of valuation allowances. 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 for management services, travel and similar expenses, and expenses of investment facilities and services provided to CNA. Such expenses amounted to approximately $11 million, $15 million and $11 million in 1997, 1996 and 1995, respectively. EARNINGS PER SHARE - -------------------------------------------------------------------------------- Earnings per share applicable to common stock is based on weighted average outstanding shares of common stock of 61,798,000 in 1997, 1996 and 1995, respectively. The Company has no stock options or warrants, as such, basic and diluted earnings per share are the same. CNA FINANCIAL CORPORATION ------------------------- 50 - ----------------------------------------------------------------------------- Note B -- Investments Note B -- Investments: - ---------------------- NET INVESTMENT INCOME - ------------------------------------------------------------------------------ Year Ended December 31 1997 1996 1995 - ------------------------------------------------------------------------------- (In millions of dollars) Fixed maturities: Bonds: Taxable $1,522 $1,716 $1,512 Tax-exempt 288 273 263 Redeemable preferred stocks 7 2 4 Equity securities 37 25 47 Mortgage loans and Real estate 10 11 14 Policy loans 6 12 12 Short-term investments 321 231 215 Security repurchase transactions-income 90 77 167 Other 56 45 46 - ------------------------------------------------------------------------------ 2,337 2,392 2,280 Investment expense (47) (43) (46) Security repurchase transactions-expenses and fees (81) (73) (157) - ------------------------------------------------------------------------------- NET INVESTMENT INCOME $2,209 $2,276 $2,077 =============================================================================== CNA FINANCIAL CORPORATION ------------------------- 51 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Note B -- Investments (cont.) ANALYSIS OF INVESTMENT GAINS (LOSSES) - ---------------------------------------------------------------------------- Year Ended December 31 1997 1996 1995 - ---------------------------------------------------------------------------- (In millions of dollars) Realized investment gains and (losses): Fixed maturities $ 452 $ 293 $ 222 Equity securities 103 216 140 Derivative securities (7) 18 19 Other, including Separate Account business 205* 92 83 - ---------------------------------------------------------------------------- 753 619 464 Allocated to participating policyholders (15) (14) (8) Income tax expense (260) (218) (162) - ---------------------------------------------------------------------------- Net realized investment gains 478 387 294 - ---------------------------------------------------------------------------- Change in net unrealized investment gains and (losses): Fixed maturities 347 (875) 1,855 Equity securities (38) (26) 163 Other, including Separate Account business 122 (45) 323 - ---------------------------------------------------------------------------- 431 (946) 2,341 Allocated to participating policyholders (4) 18 (44) Income tax (expense) benefit (137) 294 (857) - ---------------------------------------------------------------------------- Change in net unrealized investment gains (losses) 290 (634) 1,440 - ---------------------------------------------------------------------------- NET REALIZED AND UNREALIZED INVESTMENT GAINS (LOSSES) $ 768 $(247) $1,734 ============================================================================ *(Includes $95 million related to CNA surety transaction)
SUMMARY OF GROSS REALIZED INVESTMENT GAINS (LOSSES) FOR FIXED MATURITIES AND EQUITY SECURITIES - ----------------------------------------------------------------------------------------------------------------- 1997 1996 1995 --------------------------- -------------------------- -------------------------- Fixed Equity Fixed Equity Fixed Equity Year Ended December 31 Maturities Securities Maturities Securities Maturities Securities - ----------------------------------------------------------------------------------------------------------------- (In millions of dollars) Proceeds from sales $ 38,429 $ 1,406 $ 34,864 $ 1,077 $ 24,065 $ 1,317 ================================================================================================================= Gross realized gains $ 651 $ 137 $ 412 $ 241 $ 412 $ 199 Gross realized losses $ (199) (34) (119) (25) (190) (59) - ----------------------------------------------------------------------------------------------------------------- Net realized gains on sales $ 452 $ 103 $ 293 $ 216 $ 222 $ 140 =================================================================================================================
CNA FINANCIAL CORPORATION ------------------------- 52 ------------------------------------------------------------------------------ Note B - Investments ANALYSIS OF NET UNREALIZED INVESTMENT GAINS (LOSSES) INCLUDED IN STOCKHOLDERS' EQUITY - ------------------------------------------------------------------------------- 1997 1996 ---------------------- ----------------------- December 31 GAINS LOSSES NET Gains Losses Net - ------------------------------------------------------------------------------- (In millions of dollars) Fixed maturities $ 644 $ (116) $ 528 $ 444 $(263) $ 181 Equity securities 190 (71) 119 254 (97) 157 Other, including Separate Account business 334 (110) 224 171 (69) 102 ------------------------------------------------------ $1,168 $ (297) 871 $ 869 $(429) 440 ======= ======== ====== ======= Allocated to participating policyholders (4) -- Deferred income tax expense (278) (141) - ------------------------------------------------------------------------------- NET UNREALIZED INVESTMENT GAINS $ 589 $ 299 =============================================================================== 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 =============================================================================== CNA FINANCIAL CORPORATION ------------------------- 53 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Note B - Investments (cont.) SUMMARY OF INVESTMENTS IN FIXED MATURITIES AND EQUITY SECURITIES AVAILABLE FOR SALE - ------------------------------------------------------------------------------ Gross Gross Amortized Unrealized Unrealized Market December 31, 1996 Cost Gains Losses Value - ------------------------------------------------------------------------------- (In millions of dollars) United States Treasury securities and obligations of government agencies $ 9,855 $ 72 $ 92 $ 9,835 Asset-backed securities 6,298 53 59 6,292 States, municipalities and political subdivisions - tax-exempt 4,860 121 30 4,951 Corporate securities 4,730 121 63 4,788 Other debt securities 1,748 60 19 1,789 Redeemable preferred stocks 49 17 - 66 - ------------------------------------------------------------------------------- Total fixed maturities 27,540 444 263 27,721 Equity securities 702 254 97 859 - ------------------------------------------------------------------------------- Total $28,242 $ 698 $ 360 $ 28,580 =============================================================================== SUMMARY OF INVESTMENTS IN FIXED MATURITIES BY CONTRACTUAL MATURITY - ------------------------------------------------------------------------------- 1997 1996 ------------------- -------------------- AMORTIZED MARKET Amortized Market December 31 COST VALUE Cost Value - ------------------------------------------------------------------------------- (In millions of dollars) Due in one year or less $ 2,058 $ 2,077 $ 2,494 $ 2,506 Due after one year through five years 11,520 11,525 8,377 8,295 Due after five years through ten years 3,323 3,373 4,811 4,829 Due after ten years 7,403 7,769 5,560 5,799 Asset-backed securities not due at a single maturity date 4,716 4,804 6,298 6,292 - ------------------------------------------------------------------------------- TOTAL $29,020 $29,548 $27,540 $27,721 =============================================================================== Actual maturities may differ form contractual maturities because securities may be called or prepaid with our without call or prepayment penalties. The carrying value of investments (other than equity securities) that have not produced income for last twelve months is $35 million at December 31, 1997. At December 31, 1997, there were no investments in a single issuer, other than the U.S. government, that when aggregated, exceeded 10% of stockholders' equity. CNA FINANCIAL CORPORATION -------------------------- 54 - ------------------------------------------------------------------------------- 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 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. Any difference would not be expected to be material. All nonfinancial instruments such as 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 approximate fair value for cash, short-term investments, other trade receivables, accrued investment income, receivables for securities sold, 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 tables below. The carrying amounts and estimated fair values of CNA's other financial instrument assets and liabilities are listed below. Derivative instruments are shown in a separate table. CNA FINANCIAL CORPORATION ------------------------- 55 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - --------------------------------------------------------------------------- Note C - Financial Statements (cont.) FINANCIAL ASSETS - --------------------------------------------------------------------------- 1997 1996 ----------------------- ------------------- CARRYING ESTIMATED Carrying Estimated December 31 AMOUNT FAIR VALUE Amount Fair Value - ---------------------------------------------------------------------------- (In millions of dollars) Investments: Fixed maturities $29,548 $29,548 $27,721 $27,721 Equity securities 814 814 859 859 Mortgage loans 80 83 113 115 Policy loans 177 172 174 163 Other invested assets 695 695 681 681 Separate Account business: Fixed maturities 4,769 4,769 4,608 4,608 Equity securities 206 206 169 169 Other 117 117 437 437 - ------------------------------------------------------------------------------ The following methods and assumptions were used by CNA in estimating the fair value for the above financial instruments. Fixed maturity securities and equity securities are based on quoted market prices, where available. 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. The fair values for mortgage loans and policy loans are estimated using discounted cash flow analysis at interest rates currently offered for similar loans to borrowers with comparable credit ratings. Loans with similar characteristics are aggregated for purposes of the calculations. Valuation techniques to determine fair value of other invested assets and other Separate Account business assets consist of discounted cash flows and quoted market prices of (a) the investments, (b) comparable instruments, or (c) underlying assets of the investments. CNA FINANCIAL CORPORAITON ------------------------- 56 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Note C -- Financial Instruments (cont.) FINANCIAL LIABILITIES - ------------------------------------------------------------------------------- 1997 1996 ----------------------------------------------- CARRYING ESTIMATED Carrying Estimated December 31 AMOUNT FAIR VALUE Amount Fair Value - -------------------------------------------------------------------------------- (In millions of dollars) Premium deposits and annuity contracts $1,194 $1,145 $1,065 $1,018 Long-term debt 2,897 2,928 2,765 2,762 Financial guarantee contracts 382 373 382 378 Separate Account business: Guaranteed investment contracts 3,414 3,448 3,990 4,012 Deferred annuities 73 90 73 84 Variable separate accounts 997 997 569 569 Other 614 614 896 896 - ------------------------------------------------------------------------------ Premium deposits and annuity contracts are valued based on cash surrender values and the outstanding fund balances. CNA's Senior Notes and debentures are valued based on quoted market prices. The fair value for other long-term debt is estimated using discounted cash flow analysis, based on current incremental borrowing rates for similar types of borrowing arrangements. The fair value of the liability for financial guarantee contracts is 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 are 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 approximates their carrying value. CNA FINANCIAL CORPORATION ------------------------- 57 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note C - Financial Instruments (cont.) DERIVATIVE FINANCIAL INSTRUMENTS - ------------------------------------------------------------------------------ CNA invests from time to time in certain derivative financial instruments 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 original customer deposit. The gross notional principal or contractual amounts of derivative financial instruments in the general account at December 31, 1997 and 1996, totaled $1,567 million and $1,730 million, respectively. The gross notional principal or contractual amounts of derivative financial instruments in the Separate Accounts totaled $860 million and $394 million at December 31, 1997 and 1996, respectively. The contract 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 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 ------------------------- 58 ------------------------------------------------------------------------------ Note C - Financial Instruments (cont.) A summary of the aggregate notional or contractual amounts and estimated fair values of these instruments at December 31, 1997 and 1996, are presented below. - -------------------------------------------------------------------------------- CONTRACTUAL/ ASSET/(LIABILITY) NOTIONAL AMOUNT FAIR VALUE GAIN(LOSS) December 31, 1997 - -------------------------------------------------------------------------------- (In millions of dollars) General Account Interest rate swaps-corporate borrowings $ 950 $ (4) $ -- Futures (21) -- (1) Forwards 11 -- 7 Interest rate swaps 59 (8) (8) Commitments to purchase government and municipal securities -- -- 1 Options purchased 51 2 (5) Options written 1 -- -- Other options 16 -- -- Interest rate caps 500 4 (1) - ------------------------------------------------------------------------------- TOTAL $1,567 $ (6) $ (7) =============================================================================== Separate Accounts Futures $ 615 $ -- $ 112* Forwards 1 -- -- Commitments to purchase government and municipal securities 80 -- 1 Options purchased 91 -- (1) Options written 73 -- 2 - ------------------------------------------------------------------------------- TOTAL $ 860 $ -- $ 114 =============================================================================== * This amount is offset by an increase in the liability to participants. CNA FINANANCIAL CORPORATION --------------------------- 59 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note C - Financial Instruments (cont.) - ------------------------------------------------------------------------------- Contractual/ Asset/(Liability) Recognized Notional Amount Fair Value Gain (Loss) December 31, 1996 - ------------------------------------------------------------------------------- (In millions of dollars) General Account Interest rate swaps-corporate $ 950 $ 3 $ (5) borrowings Futures 38 1 (1) Forwards 194 (2) (13) Interest rate swaps 85 -- 29 Commitments to purchase government and municipal securities 406 (1) -- Options purchased 57 2 7 Options written -- -- 1 - ------------------------------------------------------------------------------- Total $ 1,730 $ 3 $ 18 =============================================================================== Separate Accounts Futures $ 319 $ (6) $ 29* Forwards 7 -- -- Commitments to purchase government and municipal securities 17 -- -- Options purchased 26 -- -- Options written 25 -- 1 - ------------------------------------------------------------------------------- Total $ 394 $ (6) $ 30 ================================================================================ * This amount is offset by an increase in the liability to participants. CNA FINANCIAL CORPORATION ------------------------- 60 ------------------------------------------------------------------------------ Note C - Financial Instruments (cont.) 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. CNA 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, 1997, CNA had outstanding interest rate swap agreements with several banks having a total notional principal amount of $950 million. Those agreements, which terminate from May 2000 to December 2000, effectively fix the Company's interest rate exposure on $950 million of variable rate debt. CNA also has outstanding trading interest rate swaps which primarily represent an exchange of the 90-day treasury bill rate for the total 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 contact inception, with delivery and settlement at a specified future date. Commitments to purchase government and municipal securities are a commitment 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. The notional principal amount is not actually borrowed or repaid. CNA FINANCIAL CORPORATION ------------------------- 61 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- Note D - Income Taxes Note D -- Income Taxes: - ----------------------- CNA and its eligible subsidiaries (CNA Tax Group) are included in the consolidated Federal income tax return of Loews and its eligible subsidiaries. Loews and CNA 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 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, CNA may be required to repay tax recoveries previously received from Loews. This agreement between Loews and CNA may be canceled by either party upon thirty days written notice. For 1997 and 1996, the inclusion of the CNA Tax Group in the consolidated Federal income tax return of Loews has resulted in an increased Federal income tax liability for Loews. Accordingly, CNA has paid or will pay to Loews approximately $210 million for 1997 and has paid $99 million for 1996. In 1995, the inclusion of the CNA Tax Group reduced the Federal income tax liability for Loews. Accordingly, CNA received from Loews approximately $78 million for 1995. At December 31, 1997, CNA had net operating loss carryforwards of approximately $870 million for income tax purposes that expire in years 2000 through 2017. The loss carryforwards are related to acquisitions. CNA FINANCIAL CORPORATION ------------------------- 62 - ------------------------------------------------------------------------------ Note D -- Income Taxes (cont.) Significant components of CNA's deferred tax assets and liabilities as of December 31, 1997 and 1996 are shown in the table below. COMPONENTS OF DEFERRED TAX ASSETS AND LIABILITIES - ----------------------------------------------------------------------- December 31 1997 1996 - ----------------------------------------------------------------------- (In millions of dollars) Insurance reserves: Property/casualty claim reserves $1,101 $1,145 Unearned premium reserves 283 268 Life reserves 157 141 Other insurance reserves 22 31 Deferred acquisition costs (667) (570) Investment valuation 30 32 Postretirement benefits other than pensions 149 143 Net unrealized gains (278) (141) Net operating loss carryforwards 305 280 Other, net 226 268 - ---------------------------------------------------------------------- Total deferred tax assets and liabilities 1,328 1,597 Valuation allowance (258) (250) - ---------------------------------------------------------------------- NET DEFERRED TAX ASSETS $1,070 $1,347 ====================================================================== At December 31, 1997, gross deferred tax assets and liabilities amounted to approximately $2.7 billion and $1.6 billion, respectively. At December 31, 1996, gross deferred tax assets and liabilities amounted to approximately $2.6 billion and $1.3 billion, respectively. Based upon anticipated future taxable income, Company management believes it is more likely than not that the net deferred tax asset will be realized. A valuation allowance is maintained due to the uncertainty regarding the realizability of certain deferred tax assets. CNA FINANCIAL CORPORATION ------------------------- 63 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Note D - Income Taxes (cont.) The components of income tax expense are as follows: - -------------------------------------------------------------------------- Year Ended December 31 1997 1996 1995 - -------------------------------------------------------------------------- (In millions of dollars) Current tax expense $248 $ 28 $ 64 Deferred tax expense 144 352 221 - -------------------------------------------------------------------------- TOTAL INCOME TAX EXPENSE $392 $380 $285 ========================================================================== The components of total income tax expense are allocated between operating income and realized capital gains and losses in the following table. - --------------------------------------------------------------------------- Year Ended December 31 1997 1996 1995 - --------------------------------------------------------------------------- (In millions of dollars) Income tax expense on: Operating income $132 $163 $123 Realized capital gains and losses 260 217 162 =========================================================================== TOTAL INCOME TAX EXPENSE $392 $380 $285 =========================================================================== A reconciliation of the statutory federal income tax rate on income is as follows: - ------------------------------------------------------------------------------ % of % of % of Pretax Pretax Pretax Year Ended December 31 1997 Income 1996 Income 1995 Income - ------------------------------------------------------------------------------ (In millions of dollars) Income taxes at statutory rate $475 35.0% $471 35.0% $365 35.0% Tax exempt income and dividend received deduction (91) (6.7) (86) (6.4) (79) (7.6) Other 8 .6 (5) (.3) - - - ------------------------------------------------------------------------------- INCOME TAXES AT EFFECTIVE RATE $392 28.9% $380 28.3% $286 27.4% =============================================================================== CNA FINANCIAL CORPORATION ------------------------- 64 - -------------------------------------------------------------------------------- NOTE E - Liability for Unpaid Claims and Claim Adjustment Expenses Note E - Liability for Unpaid Claims and Claim Adjustment Expenses (cont.) - ------------------------------------------------------------------------------- CNA's property/casualty insurance claims and claims 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 predictable than long-tail claims, such as general liability and professional liability claims. CNA FINANCIAL CORPORATION -------------------------- 65 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 expense reserve balances for 1997, 1996 and 1995. CHANGES IN RESERVES FOR PROPERTY/CASUALTY CLAIMS AND CLAIM EXPENSES - ----------------------------------------------------------------------------- Year Ended December 31 1997 1996 1995 - ----------------------------------------------------------------------------- (In millions of dollars) Reserves at beginning of year: Gross $29,395 $31,044 $21,639 Ceded reinsurance 5,660 6,089 2,705 - ----------------------------------------------------------------------------- Net reserves at beginning of year 23,735 24,955 18,934 Reserves of acquired insurance company 57 --- 6,063 - ----------------------------------------------------------------------------- Total net reserves 23,792 24,955 24,997 - ----------------------------------------------------------------------------- Net incurred claims and claim expenses: Provision for insured events of current year 7,942 7,922 6,787 Increase (decrease) in provision for insured events of prior years (256) (91) 122 Amortization of discount 143 149 106 - ----------------------------------------------------------------------------- Total net incurred 7,829 7,980 7,015 - ----------------------------------------------------------------------------- Net payments attributable to: Current year events 2,514 2,676 2,000 Prior year events 5,862 6,524 5,057 - ----------------------------------------------------------------------------- Total net payments 8,376 9,200 7,057 - ----------------------------------------------------------------------------- Net reserves at end of year 23,245 23,735 24,955 Ceded reinsurance at end of year 4,995 5,660 6,089 - ----------------------------------------------------------------------------- GROSS RESERVES AT END OF YEAR* $28,240 $29,395 $31,044 ============================================================================= * Excludes life claim and claim expense reserves and intercompany eliminations of $987 million, $1 billion and $988 million as of December 31, 1997, 1996 and 1995, respectively, included in the Consolidated Balance Sheet. Reserve development is comprised of the following components: RESERVE DEVELOPMENT - (adverse)/favorable) - -------------------------------------------------------------- Year Ended December 31 1997 1996 1995 - -------------------------------------------------------------- (In millions of dollars) Asbestos $(105) $ (51) $(274) Environmental pollution -- (65) (226) Other 361 207 378 - --------------------------------------------------------------- TOTAL $ 256 $ 91 $(122) =============================================================== CNA FINANCIAL CORPORATION ------------------------- 66 - ------------------------------------------------------------------------------- Note E -- Liability for Unpaid Claims and Claim Adjustment Expenses (cont.) ENVIRONMENTAL 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 CNA insurance subsidiaries for defense costs and indemnification in connection with environmental pollution matters. 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, 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 1997 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, 1997 and 1996, CNA carried approximately $773 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. CNA FINANCIAL CORPORATION ------------------------- 67 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Note E - Liability for Unpaid Claims and Claim Adjustment Expenses (cont.) CNA'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, 1997 and 1996, CNA carried approximately $1,400 million and $1,506 million, respectively, of claim and claim expense reserves, net of reinsurance recoverables, for reported and unreported asbestos-related claims. The results of operations in future years may continue to be adversely affected by environmental pollution and asbestos claims and claim expenses. Management will continue to monitor these liabilities and make further adjustments as warranted. CNA FINANCIAL CORPORATION ------------------------- 68 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 and asbestos-related claims activity. RESERVE SUMMARY - ------------------------------------------------------------------------------- December 31 1997 1996 ------------------------ ---------------------- ENVIRONMENTAL Environmental POLLUTION ASBESTOS Pollution Asbestos - ----------------------------------------- ------------------ ------------------ (In millions of dollars) Reported claims: Gross reserves $ 279 $ 1,384 $ 289 $ 1,551 Less reinsurance recoverable (36) (117) (95) (139) --------------------------------------------- Net reported claims 243 1,267 194 1,412 Net unreported claims 530 133 714 94 - ------------------------------------------------------------------------------- NET RESERVES $ 773 $ 1,400 $ 908 $ 1,506 =============================================================================== ENVIRONMENTAL POLLUTION CHANGES IN RESERVES - ------------------------------------------------------------------------ 1997 1996 1995 Year Ended December 31 - ------------------------------------------------------------------------ (In millions of dollars) Net reserves at beginning of year $ 908 $1,063 $ 949* Reserve strengthening -- 65 226 Less: Gross payments 258 304 183 Reinsurance recoveries (123) (84) (71) ------------------------------------ Net payments 135 220 112 - ------------------------------------------------------------------------ NET RESERVES AT END OF YEAR $ 773 $ 908 $1,063 ======================================================================== * Includes Continental net reserves of $443 million at acquisition date. ASBESTOS CHANGES IN RESERVES - ------------------------------------------------------------------------------ Year Ended December 31 1997 1996 1995 - ------------------------------------------------------------------------------ (In millions of dollars) Net reserves at beginning of year $1,506 $2,191 $2,109** Reserve strengthening 105 50 274 Less: Gross payments 268 787 268 Reinsurance recoveries (57) (52) (76) ------------------------------------------- Net payments 211 735 192 - ------------------------------------------------------------------------------ NET RESERVES AT END OF YEAR $1,400 $1,506 $2,191 ============================================================================== ** Includes Continental net reserves of $170 million at acquisition date. CNA FINANCIAL CORPORATION 69 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Note E - Liability for Unpaid Claims and Claim Adjustment Expenses (cont.) OTHER PROPERTY AND CASUALTY RESERVES - -------------------------------------------------------------------------------- Other lines favorable loss and loss adjustment expense reserve development for 1997 of $361 million was due to favorable loss develop-ment of $540 million in involuntary risks, primarily in workers' compensation, and $200 million of favorable loss development in personal lines, offset in part by unfavorable devel-opment in 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 favor-able loss development was offset in part by unfavorable premium development of $340 million as estimates of premiums for prior years were similarly reduced. The favorable loss development in personal lines was attributable to improved trends particularly in personal auto lines. The unfavorable development in commercial lines was attributable to approximately $240 million in general liability lines, $130 million in commercial multiperil, and $215 million in loss adjustment expense reserves offset in part by favorable development of $206 million primarily in workers' compensation and reinsurance lines. This unfavorable loss development in commercial lines was offset in part by favorable premium development of $170 million related to experi-ence- rated contracts. The other lines favorable development during 1996 and 1995 of $207 million and $378 million, respectively, was principally due to favorable experience in the workers' compensation line of business. CNA FINANCIAL CORPORATION ------------------------- 70 ---------------------------------------------------------------------------- Note F -- Legal Proceedings and Contingent Liabilities Note F -- Legal Proceedings and Contingent Liabilities - ------------------------------------------------------ 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 provide 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 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 2-1 vote. Objectors have ninety days after the judgment is entered by the Fifth Circuit to file a Petition for Certiorari to the Supreme Court. 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. 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 $1.5 billion to a trust fund for a class of all future asbestos claimants, defined generally as those CNA FINANCIAL CORPORATION -------------------------- 71 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Note F - Legal Proceedings and Contingent Liabilities (cont.) 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 hereinabove, although the Global Settlement approval has so far been affirmed on appeal, further review may be sought. There is limited precedent with settlements which determine the rights of future claimants to seek relief. Through December 31, 1997, Casualty, Fibreboard and plaintiff attorneys had reached settlements with respect to approximately 135,400 claims, for an esti-mated settlement amount of approximately $1.6 billion plus any applicable interest. Final court approval of the Trilateral Agreement obligates Casualty to pay under these settlements. Approximately $1.6 billion (including interest of $130 million) was paid through December 31, 1997. Such payments are partially recoverable from Pacific Indemnity. Casualty may negotiate other agreements with various classes of claimants, including groups who may have previously reached agreement with Fibreboard. Final court approval of the Trilateral Agreement and its implementation has resolved Casualty's exposure with respect to Fibreboard asbestos claims. Casualty does not anticipate further material exposure with respect to the Fibreboard matter, and subsequent adverse reserve adjustments, if any, are not expected to materially affect the 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, et al., 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. 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. CNA FINANCIAL CORPORATION ------------------------- 72 - ------------------------------------------------------------------------------- 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 $857 million and $801 million at December 31, 1997 and 1996, respectively. CNA's largest recoverable from a single reinsurer, including prepaid reinsurance premiums, is with Lloyds of London and approximated $451 million and $440 million at December 31, 1997 and 1996, respectively. Insurance claims and policyholder benefits are net of reinsurance recoveries of $1,309 million, $1,220 million and $935 million for 1997, 1996 and 1995, respectively. In the tables below, life premium revenue is from long duration contracts, property/casualty premium revenue is from short duration contracts, and approximately 75% of accident and health premium revenue is from short duration contracts. The effects of reinsurance on earned premiums are shown in the following schedules: - ------------------------------------------------------------------------------- Earned Assumed/ Premiums Net ------------------------------------------------- Year Ended December 31 Direct Assumed Ceded Net % - ------------------------------------------------------------------------------- (In millions of dollars) 1997 Property/casualty $ 8,408 $ 1,101 $ 612 $ 8,897 12.4% Accident and health 3,603 111 154 3,560 3.1 Life 908 128 131 905 14.1 - ------------------------------------------------------------------------------- TOTAL PREMIUMS $12,919 $ 1,340 $ 897 $13,362 10.0% =============================================================================== 1996 Property/casualty $ 8,957 $ 1,123 $ 989 $ 9,091 12.4% Accident and health 3,575 187 176 3,586 5.2 Life 736 121 55 802 15.1 - ------------------------------------------------------------------------------- Total premiums $13,268 $ 1,431 $ 1,220 $13,479 10.6% =============================================================================== 1995 Property/casualty $ 7,868 $ 1,335 $ 1,293 $ 7,910 16.9% Accident and health 3,017 125 106 3,036 4.1 Life 701 109 21 789 13.8% - ------------------------------------------------------------------------------- Total premiums $11,586 $ 1,569 $ 1,420 $11,735 13.4% =============================================================================== CNA FINANCIAL CORPORATION ------------------------- 73 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Note G -- Reinsurance (cont.) The effects of reinsurance on written premiums are shown in the following schedules: - ------------------------------------------------------------------------------ Written Premiums ---------------------------------------------------- Assumed/ Year Ended December 31 Direct Assumed Ceded Net Net % - ------------------------------------------------------------------------------ (In millions of dollars) 1997 Property/casualty $ 8,456 $ 1,262 $ 693 $ 9,025 14.0% Accident and health 3,592 133 155 3,570 3.7 Life 908 128 131 905 14.1 - ------------------------------------------------------------------------------ TOTAL PREMIUMS $12,956 $ 1,523 $ 979 $13,500 11.3% ============================================================================== 1996 Property/casualty $ 9,032 $ 1,197 $ 852 $ 9,377 12.8% Accident and health 3,708 188 183 3,713 5.1 Life 736 121 55 802 15.1 - ------------------------------------------------------------------------------ Total premiums $13,476 $ 1,506 $ 1,090 $13,892 10.8% ============================================================================== 1995 Property/casualty $ 9,421 $ 1,408 $ 1,814 $ 9,015 15.6% Accident and health 3,159 126 137 3,148 4.0 Life 701 109 21 789 13.8 - ------------------------------------------------------------------------------ Total premiums $13,281 $ 1,643 $ 1,972 $12,952 12.7% ============================================================================== 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, 1997 $235,468 $ 76,130 $ 74,262 $237,336 32.1% December 31, 1996 171,715 65,294 32,561 204,448 31.9 December 31, 1995 111,917 54,129 8,578 157,468 34.4 =========================================================================== CNA FINANCIAL CORPORATION ------------------------- 74 - --------------------------------------------------------------------------- Note H -- Debt Note H -- Debt: - --------------- Long-term borrowings consisted of the following: LONG-TERM DEBT - --------------------------------------------------------------------------- December 31 1997 1996 - --------------------------------------------------------------------------- (In millions of dollars) Variable Rate Debt: Credit Facility $ 400 $ 400 Commercial Paper 675 675 Credit Facility - CNA Surety 118 - Senior Notes: 87/8%, due March 1, 1998 150 150 81/4%, due April 15, 1999 102 102 71/4%, due March 1, 2003 146 146 61/4%, due November 15, 2003 249 248 63/4%, due November 15, 2006 248 248 83/8%, due August 15, 2012 98 98 71/4% Debenture, due November 15, 2023 247 247 11% Secured Mortgage Notes, due June 30, 2013 389 387 6.9% - 16.29% Secured Capital Leases, due through December 31, 2011 47 47 Other debt, due 1998 through 2019 (rates of 1% to 12.71%) 28 17 - ---------------------------------------------------------------------------- TOTAL LONG-TERM DEBT $ 2,897 $2,765 ============================================================================ The Company has in place a revolving credit facility that was used to finance the acquisition of Continental. The interest rate on 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 December 31, 1997 and 1996, respectively was 6.16% and 5.72%. To take advantage of favorable interest rates, CNA established a commercial paper program to replace borrowings under the revolving credit facility. 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 interest rate on commercial paper at December 31, 1997 was 6.05% compared to 5.67% at December 31, 1996. At year end 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. 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, which terminate from May 2000 to December 2000. These agreements provide that CNA pay interest at a fixed rate, averaging 6.20% at December 31, 1997 and 1996, 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 $4 million and $7 million for the years ended December 31, 1997 and 1996, respectively. CNA FINANCIAL CORPORATION ------------------------- 75 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Note H - Debt (cont.) 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 6.35% and 6.28% at December 31, 1997 and 1996, respectively. This rate reflects the effect of the interest rate swaps. On August 18, 1997, CNA filed a Registration Statement on form S-3 with the Securities and Exchange Commission relating to $1 billion of senior and subordinated debt and preferred stock that became effective on October 22, 1997. This new shelf registration incorporated $250 million of securities remaining available for issuance from a prior shelf registration. On January 8, 1998, the Company issued $150 million principal amount of 6.45% senior notes due January 15, 2008 and $150 million principal amount of 6.95% senior notes due January 15, 2018. The net proceeds were used to pay down bank loans drawn under the Company's revolving credit facility. Concurrent with the reduction in bank debt, the Company terminated $300 million in notional amount of interest rate swaps. On September 30, 1997, CNA Surety, a 62% owned subsidiary of CNA, 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 year end 1997, the outstanding borrowings under this facility were $118 million and the weighted average interest rate was 6.17%. The following table shows the future aggregate minimum principal payments on debt and capitalized lease obligations: On March 2, 1998 CNA paid at the due date $150 million of 8 7/8% senior notes with funds drawn against the revolving credit facility (unaudited). - ------------------------------------------------------ Future Aggregate Minimum Principal Payments - ------------------------------------------------------ (In millions of dollars) 1998 $ 155 1999 106 2000 6 2001 1,083 2002 126 Thereafter 1,431 Less: discount (10) - ------------------------------------------------------ TOTAL $ 2,897 ====================================================== CNA FINANCIAL CORPORATION ------------------------- 76 - ------------------------------------------------------------------------------- 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. Effective December 31, 1997, The Continental Corporation retirement plans were merged into the CNA Employees' Retirement Plan. 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. The funded status is determined using assumptions at the end of the year. Underfunded plans are those plans for which the accumulated benefit obligation is in excess of plan assets. Overfunded plans are those plans for which plan assets exceed the accumulated benefit obligations. Pension cost is determined using assumptions at the beginning of the year.
ACCUMULATED BENEFIT OBLIGATION - --------------------------------------------------------------------------------------- December 31 1997 1996* 1995* - --------------------------------------------------------------------------------------- Underfunded Overfunded Underfunded Overfunded Underfunded Plans Plans Plans Plans Plans - --------------------------------------------------------------------------------------- (In millions of dollars) Actuarial present value of accumulated plan benefits: Vested $1,340 $517 $623 $491 $646 Nonvested 77 38 32 28 14 - --------------------------------------------------------------------------------------- ACCUMULATED BENEFIT OBLIGATION $1,417 $555 $655 $519 $660 =======================================================================================
CNA FINANCIAL CORPORATION ------------------------- 77
- ------------------------------------------------------------------------------------------- Note I - Benefit Plans (cont.) NET PENSIONS ASSET (LIABILITY) - -------------------------------------------------------------------------------------------- December 31 1997 1996 1995 - -------------------------------------------------------------------------------------------- Underfunded Overfunded Underfunded Overfunded Underfunded Plans Plans Plans Plans Plans - -------------------------------------------------------------------------------------------- (In millions of dollars) Projected benefit obligation $1,780 $778 $ 788 $ 770 $ 809 Plan assets at fair value 1,313 702 503 630 496 - -------------------------------------------------------------------------------------------- Plan assets less than projected benefit obligation (467) (76) (285) (140) (313) Unrecognized net asset at January 1, 1986 being recognized over 12 years (2) (7) -- (12) -- Unrecognized prior service costs 88 19 78 21 104 Unrecognized net loss/(gain) 218 122 (12) 165 13 - -------------------------------------------------------------------------------------------- NET PENSION ASSET (LIABILITY) $ (163) $ 58 $ (219) $ 34 $ (196) ============================================================================================
NET PERIODIC PENSION COST - -------------------------------------------------------------------------------------------- December 31 1997 1996 1995* - -------------------------------------------------------------------------------------------- Underfunded Overfunded Underfunded Overfunded Underfunded Plans Plans Plans Plans Plans - -------------------------------------------------------------------------------------------- (In millions of dollars) Net periodic pension cost: Service cost - benefits attributed to employee service during the year $54 $36 $19 $32 $12 Interest cost on projected benefit 119 54 57 51 33 obligation Actual return on plan assets (103) (31) (29) (115) (43) Net amortization and deferral 17 (16) (6) 72 19 - -------------------------------------------------------------------------------------------- NET PERIODIC PENSION COST $ 87 $43 $41 $40 $21 ============================================================================================ * The 1995 data includes The Continental Corporation Retirement Plans from acquisition date.
Actuarial assumptions are set forth in the following table. Assumptions - ------------------------------------------------------------------------------- December 31 1997 1996 1995 1994 - ------------------------------------------------------------------------------- Discount rate 7.25% 7.50% 7.25% 8.50% Rate of increase in compensation levels* 2.75 2.75 2.75 4.00 Expected long-term rate of return on plan assets7.50 7.75-8.50 7.50-8.50 8.75 - ------------------------------------------------------------------------------- *Excludes age/service related merit and productivity increases. CNA FINANCIAL CORPORATION ------------------------- 78 - ------------------------------------------------------------------------------- Note I -- Benefit Plans (cont.) 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. Additionally, in conjunction with the Continental merger, CNA is administering a separate plan for the postretirement health care and life insurance benefits for Continental employees who retired prior to January 1, 1996. CNA funds benefit costs principally on the basis of current benefit payments. ACCRUED POSTRETIREMENT BENEFIT COST - ------------------------------------------------------------------------------ December 31 1997 1996 1995 - ------------------------------------------------------------------------------ (In millions of dollars) Accumulated postretirement benefit obligation: Retirees $202 $172 $186 Fully eligible, active plan participants 72 89 59 Other active plan participants 87 88 63 - ------------------------------------------------------------------------------ Total accumulated postretirement benefit obligation 361 349 308 Unrecognized net (gain) loss (8) (12) 7 - ------------------------------------------------------------------------------- ACCRUED POSTRETIREMENT BENEFIT COST $353 $337 $315 =============================================================================== NET PERIODIC POSTRETIREMENT BENEFIT COST - ------------------------------------------------------------------------------ Year Ended December 31 1997 1996 1995* - ------------------------------------------------------------------------------ (In millions of dollars) Net periodic postretirement benefit cost: Service cost - benefits attributed to employee service during the year $10 $12 $ 6 Interest cost on accumulated postretirement benefit obligation 25 24 18 Amortization -- -- (1) - ------------------------------------------------------------------------------- NET PERIODIC POSTRETIREMENT BENEFIT COST $35 $36 $23 =============================================================================== *The 1995 data includes The Continental Corporation Retirement Plans from the acquisition date. CNA FINANCIAL CORPORATION ------------------------- 79 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Note I - Benefit Plans (cont.) ASSUMPTIONS - --------------------------------------------------------------------------- December 31 1997 1996 1995 - ---------------------------------------------------------------------------- Discount rate: Assumptions used in determining net periodic benefit cost: 7.50% 7.25% 8.50% Assumptions used in determining projected benefit obligation (liability) 7.25 7.50 7.25 - --------------------------------------------------------------------------- The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 9% in 1997, 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, 1997 by $24 million and the aggregate net periodic postretirement benefit cost for 1997 by $3 million. SAVINGS PLANS - ------------------------------------------------------------------------------- The CNA Employees' Savings Plan is a contributory plan which allows 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. In 1995, CNA made contributions to the Continental Incentive Savings Plan using an equivalent formula to that used for the CNA Employees' Savings Plan. Effective January 1, 1996, the Continental Incentive Savings Plan was merged with the CNA Employees' Savings Plan. Contributions by the Company to the savings plans were $23 million, $24 million and $22 million in 1997, 1996 and 1995, respectively. CNA FINANCIAL CORPORATION ------------------------- 80 - ------------------------------------------------------------------------------ Note J -- Leases Note J -- Leases: - ----------------- CNA occupies facilities under lease agreements that expire at various dates throughout 2013. CNA's home office is partially situated on grounds under leases expiring in 2058. In addition, data processing, office and transportation equipment are leased under agreements that expire at various dates through 2001. Most leases contain renewal options that may provide for rent increases based on prevailing market conditions. Some leases contain purchase options based on fair market values or contractual values, if greater. Lease expense, net of sublease income, for the years ended December 31, 1997, 1996 and 1995 was $100 million, $85 million and $92 million, respectively. The table below shows the future minimum lease payments to be made under noncancelable leases at December 31, 1997. Future Minimum Lease Payments - -------------------------------------------- (in millions of dollars) 1998 $141 1999 117 2000 95 2001 82 2002 58 Thereafter 99 - ------------------------------------------- TOTAL $592 =========================================== CNA FINANCIAL CORPORATION ------------------------- 81 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 1997 1996 - --------------------------------------------------------------------------- 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 Common stock with par value of $2.50-voting stock: Authorized 200,000,000 200,000,000 Issued 61,841,969 61,841,969 Outstanding 61,798,262 61,798,262 Treasury stock 43,707 43,707 - ------------------------------------------------------------------------------- The dividend rate on money market preferred stock is determined approximately every 49 days by auction. The money market preferred stock is redeemable at CNA's option, as a whole or in part, at $100,000 per share plus accrued and unpaid dividends. CNA FINANCIAL CORPORATION ------------------------- 82 ------------------------------------------------------------------------------ Note K - Stockholders' Equity and Statutory Financial Information (cont.) STATUTORY ACCOUNTING PRACTICES - ------------------------------------------------------------------------------- CNA Financial Corporation's insurance affiliates are domiciled in various jurisdictions. These affiliates prepare statutory financial statements in accordance with accounting practices prescribed or otherwise permitted by their 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 affiliates have no material permitted accounting practices. CNA Financial Corporation's ability to pay dividends to its stockholders is affected, in part, by receipt of dividends from its affiliates. The payment of current year dividends to CNA Financial Corporation by its insurance affiliates without prior approval of the insurance department of each affiliate's domiciliary jurisdic-tion is limited to prior year formula amounts. As of December 31, 1997, approximately $677 million of dividend payments were not subject to prior insurance department approval for 1998 dividend payments. 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 ----------------------------- ---------------------- December 31 Year Ended December 31 - ------------------------------------------------------------------------------ 1997 1996 1997 1996 1995 - ------------------------------------------------------------------------------ (In millions of dollars) Property/Casualty Insurance Subsidiaries $7,123 $6,349 $1,043 $1,208 $1,208 Life Insurance Subsidiaries 1,224 1,163 43 58 30 - ------------------------------------------------------------------------------- CNA FINANCIAL CORPORATION ------------------------- 83 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- Note L -- Discontinued Operations Note L -- Discontinued Operations: - ---------------------------------- Certain discontinued operations were acquired as part of the Continental merger. Operating results of the discontinued operations were as follows: - ------------------------------------------------------------------------------- Year Ended December 31 1997 1996 1995 - ------------------------------------------------------------------------------- (In millions of dollars) Revenues: Premiums $13 $ 2 $ 5 Net investment income 63 47 26 Realized investment gains 3 6 1 Other 1 4 -- - ------------------------------------------------------------------------------- Total revenues 80 59 32 Benefits and expenses 80 59 32 - ------------------------------------------------------------------------------- Income (loss) before income taxes -- -- -- Income taxes -- -- -- - ------------------------------------------------------------------------------- Income (loss) from discontinued operations $-- $-- $-- =============================================================================== Net assets of discontinued operations are included in Other Assets, net of intercompany eliminations, and are as follows: - ------------------------------------------------------------------------- December 31 1997 1996 - ------------------------------------------------------------------------- (In millions of dollars) Assets: Investments $ 726 $ 669 Cash 54 22 Insurance receivables (net) 363 408 Other 156 234 - ------------------------------------------------------------------------- Total assets 1,299 1,333 - ------------------------------------------------------------------------- Liabilities: Claim and claim expenses 751 847 Other 325 272 - ------------------------------------------------------------------------- Total liabilities 1,076 1,119 - ------------------------------------------------------------------------- Net assets $ 223 $ 214 ========================================================================= CNA FINANCIAL CORPORATION ------------------------- 84 ------------------------------------------------------------------------------ Note M -- Business Segments Note M -- Business Segments: - ---------------------------- REVENUES - ------------------------------------------------------------------------------ Year Ended December 31 1997 1996 1995* - ------------------------------------------------------------------------------ (In millions of dollars) Property/Casualty-commercial $10,590 $10,371 $ 8,939 Property/Casualty-personal 1,860 1,758 1,445 Property/Casualty-involuntary risks (99) 388 388 Life-individual 943 923 777 Life-group 3,025 2,957 2,701 ------------------------------ 16,319 16,397 14,250 Other and intercompany eliminations -- (28) (14) - ------------------------------------------------------------------------------- Revenues excluding realized investment gains (losses) 16,319 16,369 14,236 - ------------------------------------------------------------------------------- Realized investment gains (losses): Property/Casualty 593 474 321 Life 164 164 139 Other (4) (19) 4 - ------------------------------------------------------------------------------- Total realized investment gains (losses) 753 619 464 - ------------------------------------------------------------------------------- TOTAL REVENUES $17,072 $16,988 $14,700 =============================================================================== *Includes the results of Continental since the acquisition date. INCOME (LOSS) BEFORE INCOME TAX - ----------------------------------------------------------------------------- Year Ended December 31 1997 1996 1995* - ----------------------------------------------------------------------------- (In millions of dollars) Property/Casualty-commercial $ 180 $ 770 $ 556 Property/Casualty-personal 271 (18) 25 Property/Casualty-involuntary risks 177 (14) (2) Life-individual 88 101 65 Life-group 65 70 95 ----------------------------- CNA Insurance 781 909 739 Interest, other and intercompany eliminations (161) (168) (153) - ---------------------------------------------------------------------------- Income excluding realized investment gains (losses) 620 741 586 - ----------------------------------------------------------------------------- Realized investment gains (losses) net of policyholder's interest: Property/Casualty 593 474 321 Life 149 149 131 Other (4) (19) 4 - ------------------------------------------------------------------------------ Total realized investment gains (losses) net of policyholders' interest 738 604 456 - ------------------------------------------------------------------------------ TOTAL INCOME BEFORE INCOME TAX $1,358 $1,345 $1,042 ============================================================================== *Includes the results of Continental since the acquisition date. CNA FINANCIAL CORPORATION ------------------------- 85 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------------------------------------------ Note M - Business Segments (cont.) NET INCOME (LOSS) - ------------------------------------------------------------------------------- Year Ended December 31 1997 1996 1995* - ------------------------------------------------------------------------------- (In millions of dollars) Property/Casualty-commercial $ 200 $ 586 $ 431 Property/Casualty-personal 184 (6) 22 Property/Casualty-involuntary risks 117 (4) 4 Life-individual 58 66 43 Life-group 42 44 61 -------------------------- 601 686 561 Interest, other and intercompany eliminations (113) (108) (98) - ------------------------------------------------------------------------------- Net income excluding net realized investment gains (losses) 488 578 463 - ------------------------------------------------------------------------------- Net realized investment gains (losses): Property/Casualty 384 303 208 Life 96 96 85 Other (2) (12) 1 - -------------------------------------------------------------------------------- Total net realized investment gains (losses) 478 387 294 - ------------------------------------------------------------------------------- TOTAL NET INCOME $ 966 $ 965 $ 757 =============================================================================== *Includes the results of Continental since acquisition date. ASSETS - ------------------------------------------------------------------------------- December 31 1997 1996 1995 - ------------------------------------------------------------------------------- (In millions of dollars) Property/Casualty-commercial $39,952 $40,082 $40,622 Property/Casualty-personal 4,282 4,230 4,590 Property/Casualty-involuntary risks 1,955 2,407 2,446 Life-individual 5,206 4,740 3,997 Life-group 9,534 9,274 9,004 --------------------------- 60,929 60,733 60,659 Other and intercompany eliminations 340 (278) (299) - ----------------------------------------------------------------------------- TOTAL ASSETS $61,269 $60,455 $60,360 ============================================================================= CNA FINANCIAL CORPORATION ------------------------- 86 - ---------------------------------------------------------------------------- Note M -- Business Segments (cont.) Assets and investment income of the property/casualty group are allocated to business segments on the basis of insurance reserves after attribution of separately identifiable assets. Life group assets and investment income are allocated to business segments based on cash flows after attribution of separately identifiable assets. Income taxes have been allocated on the basis of taxable income of the respective insurance segments. Property/casualty involuntary risks include mandatory participation in residual markets, statutory assessments for insolvencies of other insurers and other involuntary charges. CNA's share of involuntary risks is generally a function of its share of the voluntary market by line of insurance in each state. 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, 1997 and 1996, gross exposure of financial guarantee insurance contracts amounted to $181 million and $582 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 54% and 47% of the risks were ceded to reinsurers at December 31, 1997 and 1996. Total exposure, net of reinsurance, amounted to $83 million and $311 million at December 31, 1997 and 1996, respectively. At December 31, 1997 and 1996, collateral consisting of letters of credit and debt service reserves amounted to $22 million and $28 million, respectively. Gross unearned premium reserves for financial guarantee contracts were $5 million and $11 million at December 31, 1997 and 1996, respectively. Gross claim and claim expense reserves totaled $377 million and $371 million at December 31, 1997 and 1996, respectively. Life revenues include $2.1 billion, $2.1 billion and $1.9 billion in 1997, 1996 and 1995, respectively, under contracts covering U.S. government employees and their dependents (FEHBP). CNA FINANCIAL CORPORATION ------------------------- 87 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ----------------------------------------------------------------------------- Note N -- Acquisitions Note N -- Acquisitions: - ----------------------- CONTINENTAL ACQUISITION - ------------------------------------------------------------------------------- On December 6, 1994, CNA entered into a merger agreement to acquire all the outstanding common stock of The Continental Corporation (Continental) for a total purchase price of $1.1 billion. The merger was consummated on May 10, 1995. The acquisition of Continental has been accounted for as a purchase; therefore, Continental's operations were included in the Consolidated Financial Statements since May 10, 1995. Based on CNA's final evaluation and appraisal of the net assets, goodwill approximated $316 million before amortization. The goodwill is being amortized over twenty years at an annual charge to income of approximately $16 million. 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, in which CNA has an approximate 62% interest. The transaction closed on September 30, 1997. The transaction was accounted for as a sale of approximately 38% of CNA's previous surety business and a purchase of 62% of Capsure. In conjunction with the closing of the surety 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 Corporation 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 ------------------------- 88 - ----------------------------------------------------------------------------- Note O -- Unaudited Quarterly Financial Data Note O -- Unaudited Quarterly Financial Data: - --------------------------------------------- - ------------------------------------------------------------------------------- First Second Third Fourth Year - ------------------------------------------------------------------------------- (In millions of dollars, except per share data) 1997 QUARTERS Revenues $4,132 $4,243 $4,309 $4,388 $17,072 Net operating income 136 126 121 105 488 Net realized investment gains 42 109 153 174 478 ------ ------ ------ ----- ------ Net income 178 235 274 279 966 ------ ------ ------ ----- ------ Earnings per share 2.85 3.78 4.41 4.48 15.52 1996 Quarters Revenues $4,315 $4,095 $4,256 $4,322 $16,988 Net operating income 145 152 161 120 578 Net realized investment gains 184 50 78 75 387 ------ ------ ------ ------ ------ Net income 329 202 239 195 965 ------ ------ ------ ------ ------ Earnings per share 5.30 3.25 3.83 3.13 15.51 1995 Quarters Revenues $3,053 $3,659 $4,001 $3,987 $14,700 Net operating income 132 127 103 101 463 Net realized investment gains 21 130 63 80 294 ------ ------ ------ ------ ----- Net income 153 257 166 181 757 Earnings per share 2.44 4.12 2.66 2.91 12.14 - ------------------------------------------------------------------------------- CNA FINANCIAL CORPORATION ------------------------- 89 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, 1997 and 1996, and the related statements of consolidated operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. 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 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, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. S/DELOITTE & TOUCHE LLP Chicago, Illinois February 18, 1998 CNA FINANCIAL CORPORATION ------------------------- 90 COMMON STOCK INFORMATION - ---------------------------------------------------------------------------- CNA's common stock is listed on the New York, Chicago and Pacific Stock Exchanges and is also traded on the Philadelphia Stock Exchange. The number of holders of record of CNA's common stock as of March 2, 1998, was 2,816. As of March 2, 1998, Loews Corporation owned approximately 84 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 - ------------------------------------------------------------------- 1997 1996 ----------------------------------------------- Quarter HIGH LOW High Low - ------------------------------------------------------------------- Fourth 131 3/4 119 1/8 108 5/8 95 7/8 Third 130 107 7/8 104 1/2 95 7/8 Second 105 7/16 96 7/8 112 95 3/4 First 114 3/4 103 117 1/2 109 1/2 - --------------------------------------------------------------------- INVITATION TO THE ANNUAL MEETING - ------------------------------------------------------------------------------- Shareholders are cordially invited to attend the annual meeting at 10 a.m. Wednesday, May 6, 1998, 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, Secretary and General Counsel CNA Financial Corporation CNA Plaza, 43 South Chicago, Illinois 60685 CNA FINANCIAL CORPORATION ------------------------- 91 CORPORATE DIRECTORY - ------------------------------------------------------------------------------- DIRECTORS - ------------------------------------------------------------------------------- Antoinette Cook Bush Partner; Skadden, Arps, Slate, Meagher & Flom, Chairperson, Incentive Compensation Committee Dennis H. Chookaszian Chairman and Chief Executive Officer, CNA Philip L. Engel President, CNA Robert P. Gwinn Retired Chairman and Chief Executive Officer, Encyclopaedia Britannica 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 Chairperson, Audit Committee; Retired Chairman of the Board, First Chicago NBD Corporation and The First National Bank of Chicago James S. Tisch Chairperson, Finance Committee; President and Chief Operating Officer, Loews Corporation Laurence A. Tisch Chief Executive Officer of CNA Financial Corporation; Co-Chairman of the Board and Co-Chief Executive Officer, Loews Corporation Preston R. Tisch Chairperson, Executive Committee; Co-Chairman and Co-Chief Executive Officer, Loews Corporation Marvin Zonis Professor of International Political Economy, Graduate School of Business University of Chicago EXECUTIVE COMMITTEE - ------------------------------------------------------------------------------- Preston R. Tisch, Chairperson Antoinette Cook Bush Dennis H. Chookaszian Philip L. Engel Robert P. Gwinn 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 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 CNA FINANCIAL CORPORATION ------------------------- 92 OFFICERS - ------------------------------------------------------------------------------- Laurence A. Tisch Chief Executive Officer, CNA Financial Corporation Dennis H. Chookaszian Chairman and Chief Executive Officer, CNA Philip L. Engel President, CNA William J. Adamson, Jr. Senior Vice President, Reinsurance, CNA Peter P. Conway, Jr. Senior Vice President, Risk Management, CNA James P. Flood Senior Vice President, Claims, CNA Michael C. Garner Senior Vice President, CNA Consulting Group and Human Resources, CNA Bernard L. Hengesbaugh Executive Vice President and Chief Operating Officer,* CNA Peter E. Jokiel Senior Vice President, Life Operations, CNA Jonathan D. Kantor Senior Vice President, Secretary and General Counsel,*** CNA Financial Corporation Patricia L. Kubera Group Vice President and Controller, CNA Financial Corporation Donald M. Lowry**** Senior Vice President, Secretary and General Counsel, CNA Financial Corporation W. James MacGinnitie Senior Vice President and Chief Financial Officer, CNA Financial Corporation Michael McGavick Senior Vice President, Commercial Operations, CNA Carolyn L. Murphy** Senior Vice President, Commercial Operations, CNA William H. Sharkey, Jr. Senior Vice President, Marketing, CNA Thomas F. Taylor Senior Vice President,* Specialty Operations, CNA Adrian M. Tocklin** Senior Vice President, Diversified Operations, CNA Robert T. Van Gieson Senior Vice President, Global Operations, CNA Jae L. Wittlich Senior Vice President, Group Operations, CNA David W. Wroe Senior Vice President, Information Technology, CNA - --------------------------- *Effective February 4, 1998 **Retires effective April 1, 1998 ***Effective March 6, 1998 ****Retired effective March 6, 1998 CNA FINANCIAL CORPORATION -------------------------- 93 CORPORATE DIRECTORY - ------------------------------------------------------------------------------- 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, NY 07303-2500 INDEPENDENT AUDITORS - ------------------------------------------------ Deloitte & Touche LLP 180 North Stetson Avenue Chicago, Illinois 60601 CNA FINANCIAL CORPORATION ------------------------- 94 CNA FINANCIAL CORPORATION APPENDIX OMITTED GRAPH MATERIAL AND OTHER Exhibit 13.1 - CNA Financial Corporation Annual Report: * Bar graphs of: - Revenues for the period 1987 through 1997. - Assets for the period 1987 through 1997. - Stockholders' equity for the period 1987 through 1997. - Book value per common share 1987 through 1997. (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 9 of the annual report. Page Outquotes 4 We see an insurance environment of rapid change with major opportunities... 5 CNA is on course to build on the opportunities of change and increase the value of the enterprise. 6 CNA continued as a profitable market leader under some of the most competitive conditions ever seen in the commercial insurance marketplace. 7 CNA is the premier provider of commercial insurance for small and medium size businesses in the United States. 8 CNA's strength in the commercial insurance marketplace extends to professional and speciality coverages. 9 We continued to develop capabilities for providing more value to our reinsurance clients and business partners worldwide. 10 CNA's track record of growth in individual life continued for the fourth year in a row. 11 As we build an insurance organization for the future, 1998 will be the start of an even more successful second century. Pages 4 and 5 are quotes from CNA Financial Chairman Edward J. Noha, and pages 6 through 11 are quotes from CNA Chairman and Chief Executive Officer Dennis H. Chookaszian EX-27 3 ARTICLE 7 FDS FOR 10-K
7 0000021175 CNA FINANCIAL CORPORATION 1,000,000 12-MOS DEC-31-1997 JAN-1-1997 DEC-31-1997 29,548 0 0 814 80 5 36,203 383 5,726 2,142 61,269 34,056 4,700 132 742 2,897 0 150 155 8,004 61,269 13,362 2,209 753 748 11,268 2,383 1,865 1,358 392 966 0 0 0 966 15.52 15.52 23,792 7,942 (113) 2,514 5,862 23,245 (256)
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