-----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, G4vP7BPy+o9Vd5Sj4IYdun1KgeQZEIx6rKLv/Ov0zcb67k5I3ey408Wc5lMsAHMW s8mXcPn1EotPIoHcAu3bTg== 0000021175-98-000016.txt : 19981116 0000021175-98-000016.hdr.sgml : 19981116 ACCESSION NUMBER: 0000021175-98-000016 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CNA FINANCIAL CORP CENTRAL INDEX KEY: 0000021175 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 366169860 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-05823 FILM NUMBER: 98748851 BUSINESS ADDRESS: STREET 1: CNA PLZ CITY: CHICAGO STATE: IL ZIP: 60685 BUSINESS PHONE: 3128225000 MAIL ADDRESS: STREET 1: CNA PLAZA CITY: CHICAGO STATE: IL ZIP: 60685 10-Q 1 THIRD QUARTER 10-Q - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 -------------------------- FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 1998 Commission File Number 1-5823 -------------------------- CNA FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) Delaware 36-6169860 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) CNA Plaza Chicago, Illinois 60685 (Address of principal executive offices) (Zip Code) (312) 822-5000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No... Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at November 2, 1998 - ------------------------------------- ------------------------------- Common Stock, Par value $2.50 183,889,569 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Page (1) of (41) CNA FINANCIAL CORPORATION INDEX PART I. FINANCIAL INFORMATION PAGE NO. - ------- --------------------- -------- CONDENSED CONSOLIDATED FINANCIAL STATEMENTS: CONDENSED CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 1998 (Unaudited) and DECEMBER 31, 1997.................. 3 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997....... 4 CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited) FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997..... 5 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997................. 6 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) SEPTEMBER 30, 1998............................. 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS............................................. 18 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................. 37 SIGNATURES....................................................... 38 EXHIBIT 11 COMPUTATION OF NET INCOME PER COMMON SHARE.................. 39 EXHIBIT 12.1 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES..................................... 40 EXHIBIT 12.2 COMPUTATION OF RATIO OF NET INCOME, AS ADJUSTED, TO FIXED CHARGES..................................... 40 EXHIBIT 27 FINANCIAL DATA SCHEDULE..................................... 41 (2) CNA FINANCIAL CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------------------------------- SEPTEMBER DECEMBER 31 1998 1997 (In millions of dollars, except share data) (UNAUDITED) - --------------------------------------------------------------------------------------------------------- ASSETS Investments: Fixed maturities available for sale (cost: $28,446 and $29,020).............. $29,322 $29,548 Equity securities available for sale (cost: $970 and $695)................... 1,362 814 Mortgage loans and real estate (less accumulated depreciation: $1 and $1).... 65 85 Policy loans................................................................. 176 177 Other invested assets........................................................ 831 695 Short-term investments ...................................................... 4,549 4,884 -------- -------- TOTAL INVESTMENTS......................................................... 36,305 36,203 Cash........................................................................... 135 383 Receivables: Reinsurance.................................................................. 6,235 6,057 Insurance ................................................................... 6,686 6,086 Other ....................................................................... 270 208 Less allowance for doubtful accounts......................................... (305) (303) Deferred acquisition costs..................................................... 2,359 2,142 Accrued investment income...................................................... 418 389 Receivables for securities sold................................................ 1,289 744 Federal income taxes recoverable (includes $102 and $26 due from Loews)........ 82 18 Deferred income taxes.......................................................... 899 1,070 Property and equipment at cost (less accumulated depreciation: $676 and $553).. 790 747 Prepaid reinsurance premiums................................................... 292 202 Intangibles.................................................................... 595 620 Other assets................................................................... 1,135 1,222 Separate Account business...................................................... 5,381 5,812 ------ ------ - ---------------------------------------------------------------------------------------------------------- TOTAL ASSETS $62,566 $61,600 ==========================================================================================================
CNA FINANCIAL CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS - continued
- --------------------------------------------------------------------------------------------------------- SEPTEMBER DECEMBER 31 1998 1997 (In millions of dollars, except share data) (UNAUDITED) - --------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Insurance reserves: Claim and claim expense .................................................... $29,369 $29,558 Unearned premiums........................................................... 5,084 4,700 Future policy benefits...................................................... 5,262 4,829 Policyholders' funds........................................................ 767 742 Securities sold under repurchase agreements.................................... 58 153 Payables for securities purchased.............................................. 1,072 648 Participating policyholders' equity............................................ 150 132 Long-term debt................................................................. 2,967 2,897 Other liabilities.............................................................. 3,483 3,820 Separate Account business...................................................... 5,381 5,812 -------- -------- TOTAL LIABILITIES......................................................... 53,593 53,291 -------- -------- Commitments and contingent liabilities - Notes C and D Stockholders' equity: Common stock ($2.50 par value; Authorized - 200,000,000 shares; Issued - 185,525,907 shares; Outstanding - 183,704,086 shares)............................................ 464 464 Money market cumulative preferred stock........................................ 150 150 Additional paid-in capital..................................................... 126 126 Retained earnings.............................................................. 7,408 6,983 Accumulated other comprehensive income......................................... 892 589 Treasury stock, at cost........................................................ (67) (3) -------- -------- TOTAL STOCKHOLDERS' EQUITY................................................ 8,973 8,309 - ----------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $62,566 $61,600 =========================================================================================================== See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited)
(3) CNA FINANCIAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
- ------------------------------------------------------------------------------------------------- PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS (In millions of dollars, except per share data) 1998 1997 1998 1997 - ------------------------------------------------------------------------------------------------- Revenues: Premiums........................................ $ 3,300 $ 3,336 $10,135 $10,031 Net investment income........................... 521 530 1,641 1,641 Realized investment gains ...................... 97 237 512 475 Other........................................... 211 206 598 537 --------- --------- --------- -------- Total Revenues 4,129 4,309 12,886 12,684 --------- --------- --------- -------- Benefits and expenses: Insurance claims and policyholders' benefits.... 2,774 2,854 8,561 8,607 Amortization of deferred acquisition costs...... 545 621 1,804 1,738 Other operating expenses(Note H)................ 783 384 1,764 1,223 Interest expense................................ 53 57 168 153 --------- --------- --------- -------- Total Benefits and Expenses 4,155 3,916 12,297 11,721 --------- --------- --------- -------- Income (loss) before income tax................. (26) 393 589 963 Income tax expense (benefit)..................... (12) 119 160 276 --------- --------- --------- -------- Net (loss) income $ (14) $ 274 $ 429 $ 687 ================================================================================================= EARNINGS PER SHARE Net (loss) income ............................... $ (0.09) $ 1.47 $ 2.29 $ 3.68 ========= ========= ========= ======== Weighted average outstanding shares of common stock (in millions of shares)............. 185.2 185.4 185.2 185.4 ================================================================================================= See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited)
(4) CNA FINANCIAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)
- -------------------------------------------------------------------------------------------------------------------- ACCUMULATED ADDITIONAL OTHER TOTAL COMMON PREFERRED TREASURY PAID IN COMPREHENSIVE RETAINED COMPREHENSIVE STOCKHOLDERS' (In millions of dollars) STOCK STOCK STOCK CAPITAL INCOME EARNINGS INCOME EQUITY - -------------------------------------------------------------------------------------------------------------------- BALANCE,JANUARY 1, 1997 $ 464 $ 150 $ (3) $ 126 $6,024 $ 299 $ 7,060 Comprehensive income: Net income................. - - - - $ 687 687 - 687 Other comprehensive income: Change in other comprehensive income...................... - - - - 175 - 175 175 -------- Total comprehensive income $ 862 ======== Preferred dividends.......... - - - - (5) - (5) - ----------------------------- ------- ------- ------- -------- -------- -------- ---------- BALANCE, SEPTEMBER 30, 1997 $ 464 $ 150 $ (3) $ 126 $ 6,706 $ 474 $ 7,917 ================================================================== ================================ BALANCE, DECEMBER 31, 1997 $ 464 $ 150 $ (3) $ 126 $ 6,983 $ 589 $ 8,309 Comprehensive income: Net income.................. - - - - $ 429 429 - 429 Other comprehensive income: Change in other comprehensive income...................... - - - - 303 - 303 303 -------- Total comprehensive income $ 732 ======== Purchase of Treasury Stock - - (64) - - - (64) Preferred dividends........ - - - - (4) - (4) - ----------------------------- ------- ------- ------- -------- -------- -------- ---------- BALANCE, SEPTEMBER 30, 1998 $ 464 $ 150 $ (67) $ 126 $ 7,408 $ 892 $ 8,973 ================================================================== ================================ See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited)
(5) CNA FINANCIAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
- ---------------------------------------------------------------------------------------------------------- NINE MONTHS ENDED SEPTEMBER 30 1998 1997 (In millions of dollars) - ---------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income ...................................................................... $ 429 $ 687 Adjustments to reconcile net income to net cash flows from operating activities: Net realized investment gains, pre-tax ......................................... (512) (475) Participating policyholders' interest........................................... 15 2 Amortization of intangibles..................................................... 85 20 Amortization of bond discount................................................... (165) (81) Depreciation.................................................................... 124 132 Changes in: Insurance receivables, net..................................................... (838) (413) Deferred acquisition costs..................................................... (217) (369) Accrued investment income...................................................... (29) 98 Federal income taxes........................................................... (64) 165 Deferred income taxes.......................................................... (2) 156 Prepaid reinsurance premiums................................................... (90) (77) Insurance reserves............................................................. 666 993 Reinsurance payables........................................................... (111) (60) Other liabilities.............................................................. 67 (991) Other, net..................................................................... (88) (146) ------------ ---------- Total adjustments ......................................................... (1,159) (1,046) ------------ ---------- NET CASH FLOWS FROM OPERATING ACTIVITIES .................................. (730) (359) ------------ ---------- - ----------------------------------------------------------------------------------------------------------
CNA FINANCIAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS- continued (Unaudited)
- ---------------------------------------------------------------------------------------------------------- NINE MONTHS ENDED SEPTEMBER 30 1998 1997 (In millions of dollars) - ---------------------------------------------------------------------------------------------------------- Cash flows from investing activities: Purchases of fixed maturities.................................................... (28,438) (28,756) Proceeds from fixed maturities: Sales........................................................................... 26,686 27,545 Maturities, calls and redemptions............................................... 2,655 1,668 Purchases of equity securities................................................... (792) (854) Proceeds from sale of equity securities.......................................... 509 937 Change in short-term investments................................................. 419 (993) Purchases of property and equipment ............................................. (175) (195) Change in securities sold under repurchase agreements............................ (95) 1,075 Change in other investments...................................................... (229) 173 Investment in affiliates......................................................... - (65) Other, net....................................................................... (47) (151) ------------ --------- NET CASH FLOWS FROM INVESTING ACTIVITIES .................................. 493 384 ------------ --------- CASH FLOWS FROM FINANCING ACTIVITIES: Dividends paid to preferred stockholders......................................... (5) (5) Acquisition of treasury stock.................................................... (65) - Receipts from investment contracts credited to policyholder account balances..... 19 7 Return of policyholder account balances on investment contracts.................. (30) (18) Principal payments on long-term debt............................................. (942) (4) Proceeds from issuance of long-term debt......................................... 1,012 109 ------------ --------- NET CASH FLOWS FROM FINANCING ACTIVITIES.................................. (11) 89 ------------ --------- Net cash flows........................................................ (248) 114 Cash at beginning of period....................................................... 383 257 - ---------------------------------------------------------------------------------------------------------- CASH AT END OF PERIOD $ 135 $ 371 ========================================================================================================== Supplemental disclosures of cash flow information: Cash (paid)received: Interest ........................................................................$ (147) $ (148) Federal income taxes............................................................. (187) 50 ========================================================================================================== See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited)
(6) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998 (Unaudited) NOTE A. Basis of Presentation: The condensed consolidated financial statements (unaudited) include CNA Financial Corporation (CNAF) and its subsidiaries which include property/casualty insurance companies (principally Continental Casualty Company and The Continental Insurance Company) and life insurance companies (principally Continental Assurance Company and Valley Forge Life Insurance Company), collectively CNA, or the Company. As of September 30, 1998, Loews Corporation (Loews) owns approximately 85% of the outstanding common stock of CNAF. 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. The operating results for the interim periods are not necessarily indicative of the results to be expected for the full year. These statements should be read in conjunction with the financial statements and notes thereto included in CNAF's Annual Report to Shareholders (incorporated by reference in Form 10-K) for the year ended December 31, 1997 (filed with the Commission on March 31, 1998) and the information shown below. The accompanying condensed consolidated financial statements have been prepared in conformity with generally accepted accounting principles. Certain amounts applicable to prior periods have been reclassified to conform to classifications followed in 1998. 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. In the opinion of CNA's management, these statements include all adjustments, consisting of normal recurring accruals, which are necessary for the fair presentation of the consolidated financial position, results of operations and cash flows. NOTE B. Restricted Investments: On December 30, 1993, CNAF deposited $987 million in an escrow account, pursuant to the Fibreboard Global Settlement Agreement, as discussed in Note C below. The escrow account amounted to approximately $1.08 billion at September 30, 1998 and $1.10 billion at December 31, 1997. The majority of the funds are included in short-term investments and are invested substantially in U. S. Treasury securities. (7) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued NOTE C. 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") to resolve all future asbestos-related bodily injury claims involving Fibreboard, which is subject to court approval. Casualty, Fibreboard and Pacific Indemnity have also reached an agreement (the "Trilateral Agreement") on a settlement to resolve the coverage litigation in the event the Global Settlement 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 United States Fifth Circuit Court of Appeals again approved the Global Settlement Agreement by a 2 to 1 vote. Two sets of Objectors filed petitions for certiorari, which were docketed on April 16 and 17, 1998, by the United States Supreme Court. On June 22, 1998, the Supreme Court granted the petition for certiorari filed by one of the sets of objectors. The Supreme Court has set oral argument for December 8, 1998. No further appeal was filed with respect to the Trilateral Agreement; therefore, court approval of the Trilateral Agreement has become final. SETTLEMENT AGREEMENTS On April 9, 1993, Casualty and Fibreboard entered into an agreement pursuant to which, among other things, the parties agreed to use their best efforts to negotiate and finalize a global class action settlement with asbestos-related bodily injury and death claimants. (8) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued On August 27, 1993, the Settling Parties reached an agreement in principle for an omnibus settlement to resolve all future asbestos-related bodily injury claims involving Fibreboard. The Global Settlement Agreement was executed on December 23, 1993. The agreement calls for contribution by Casualty and Pacific Indemnity of an aggregate of $1.53 billion to a trust fund for a class of all future asbestos claimants, defined generally as those persons whose claims against Fibreboard were neither filed nor settled before August 27, 1993. An additional $10 million is to be contributed to the fund by Fibreboard. As indicated above, the Global Settlement Agreement has been approved by the Fifth Circuit a second time, but the Supreme Court has granted a petition for certiorari filed by one of the sets of objectors to the settlement. On October 12, 1993, Casualty, Pacific Indemnity and Fibreboard entered into the Trilateral Agreement to settle the coverage litigation to operate in the event that the Global Settlement Agreement is disapproved. The Trilateral Agreement calls for payment by Casualty and Pacific Indemnity of an aggregate $2.0 billion, of which Casualty's portion is approximately $1.46 billion, to Fibreboard to resolve all claims by Fibreboard and all future and unsettled present asbestos claimants arising under the policy issued to Fibreboard by Casualty. Under either the Global Settlement Agreement or the Trilateral Agreement, Casualty is also obligated to pay prior settlements of present asbestos claims. As a result of the final approval of the Trilateral Agreement, such obligation has become final. Through September 30, 1998, Casualty, Fibreboard and plaintiff attorneys had reached settlements with respect to approximately 135,200 claims, for an estimated settlement amount of approximately $1.63 billion plus any applicable interest. Final court approval of the Trilateral Agreement obligates Casualty to pay under these settlements. Approximately $1.67 billion (including interest of $184 million) was paid through September 30, 1998. Such payments have been partially recovered from Pacific Indemnity. Casualty may negotiate other agreements for unsettled claims. Final court approval of the Trilateral Agreement and its implementation resolved Casualty's exposure with respect to the Fibreboard asbestos claims. Casualty's management 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 results of operations or equity of CNAF. TOBACCO LITIGATION Several of CNA's 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" procedure 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. (9) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued In June of 1997, 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 CNAF. OTHER LITIGATION CNAF and its subsidiaries are also parties to other litigation arising in the ordinary course of business. The outcome of such other litigation will not, in the opinion of management, materially affect the results of operations or equity of CNAF. ENVIRONMENTAL AND ASBESTOS The CNA property/casualty insurance companies have potential exposures related to environmental pollution and asbestos claims. Environmental pollution clean-up is the subject of both federal and state regulation. By some estimates, there are thousands of potential waste sites subject to clean-up. The insurance industry is involved in extensive litigation regarding coverage issues. Judicial interpretations in many cases have expanded the scope of coverage and liability beyond the original intent of the policies. The Comprehensive Environmental Response Compensation and Liability Act of 1980 (Superfund) and comparable state statutes (mini-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 (Environmental Clean-up Laws or ECLs) 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 1998 and it is unclear as to what positions the Congress or the Administration will take and what legislation, if any, will result. If there is legislation, and in some circumstances even if there is no legislation, the federal role in environmental clean up may be significantly reduced in favor of state action. Substantial changes in the federal statute or the activity of (10) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued the EPA may cause states to reconsider their environmental clean up statutes and regulations. There can be no meaningful prediction of the pattern of regulation that would result. Due to the inherent uncertainties described above, including the inconsistency of court decisions, the number of waste sites subject to clean-up, and the standards for clean-up and liability, the ultimate liability of CNA for environmental pollution claims may vary substantially from the amount currently recorded. As of September 30, 1998 and December 31, 1997, CNA carried $646 million and $773 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, after which CNA adopted the Simplified Commercial General Liability coverage form which includes an absolute pollution exclusion. Unfavorable environmental pollution reserve development for the nine months ended September 30, 1998 was $58 million. There was no environmental pollution reserve development for the nine months ended September 30, 1997. CNA's property/casualty insurance subsidiaries have exposure to asbestos claims, including those attributable to CNA's litigation with Fibreboard Corporation. Estimation of asbestos claim reserves involves many of the same limitations discussed above for environmental pollution claims such as inconsistency of court decisions, specific policy provisions, allocation of liability among insurers, missing policies and proof of coverage. As of September 30, 1998 and December 31, 1997, CNA carried $1.46 billion and $1.40 billion, respectively, of claim and claim expense reserves, net of reinsurance recoverables, for reported and unreported asbestos-related claims. Unfavorable asbestos claim reserve development for the nine months ended September 30, 1998 and 1997 totaled $205 million and $40 million, respectively. The unfavorable reserve development on environmental and asbestos reserves in 1998 was more than offset by favorable reserve development in other lines, primarily commercial and specialty coverages. Excluding environmental and asbestos reserves, favorable loss and allocated loss adjustment expense reserve development approximated $380 million and $340 million for the nine months ended September 30, 1998 and 1997, respectively. Premium development for these same periods approximated $30 million favorable and $165 million unfavorable, respectively. The large unfavorable premium development in 1997 is primarily attributable to reductions in residual market premiums.
|-------------------------------------------------------------------------------------| |RESERVE SUMMARY SEPTEMBER 30, 1998 DECEMBER 31, 1997 | | -------------------------- ----------------------| | ENVIRONMENTAL ENVIRONMENTAL | |(In millions of dollars) POLLUTION ASBESTOS POLLUTION ASBESTOS | |-------------------------------------------------------------------------------------| |Reported claims: | | Gross Reserves $ 279 $ 1,308 $ 279 $ 1,198 | | Less reinsurance recoverable (52) (101) (36) (117)| | ------ ------- ------- ---------| | Net reported claims 227 1,207 243 1,081 | |Net unreported claims 419 248 530 319 | |-------------------------------------------------------------------------------------| |NET RESERVES $ 646 $ 1,455 $ 773 $ 1,400 | |=====================================================================================|
(11) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued 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. NOTE D. Reinsurance: CNA assumes and cedes insurance with other insurers and reinsurers and members of various reinsurance pools and associations. CNA utilizes reinsurance arrangements to limit its maximum loss, to provide greater diversification of risk, and to minimize exposures on larger risks. The reinsurance coverages are tailored to the specific risk characteristics of each product line with CNA's retained amount varying by type of coverage. Generally, reinsurance coverage for property risks is on an excess of loss, per risk basis. Liability coverages are generally reinsured on a quota share basis in excess of CNA's retained risk. The ceding of insurance does not discharge the primary liability of the original insurer. CNA places reinsurance with other carriers only after careful review of the nature of the contract and a thorough assessment of the reinsurers' credit quality and claim settlement performance. Further, for carriers that are not authorized reinsurers in its states of domicile, CNA receives collateral, primarily in the form of bank letters of credit, securing a large portion of the recoverables.
|------------------------------------------------------------------------------| |NINE MONTHS ENDED SEPTEMBER 30 EARNED PREMIUMS ASSUMED/| | ------------------------------------- | | NET | |(In millions of dollars) DIRECT ASSUMED CEDED NET % | |------------------------------------------------------------------------------| |1998 | |------------------------------------------------------------------------------| |Property and Casualty $ 6,261 $ 1,114 $ 481 $ 6,894 16.2 %| |Accident and Health 2,624 153 202 2,575 5.9 %| |Life 742 112 188 666 16.8 %| |------------------------------------------------------------------------------| | TOTAL PREMIUMS $ 9,627 $ 1,379 $ 871 $10,135 13.6 %| |==============================================================================| |1997 | |------------------------------------------------------------------------------| |Property and Casualty $ 6,087 $ 1,078 $ 549 $ 6,616 16.3 %| |Accident and Health 2,806 73 115 2,764 2.6 %| |Life 649 92 90 651 14.1 %| |------------------------------------------------------------------------------| | TOTAL PREMIUMS $ 9,542 $ 1,243 $ 754 $10,031 12.4 %| |==============================================================================|
In the table above, life premium revenue is principally from long duration contracts, property/casualty earned premium is from short duration contracts, and approximately three-quarters of accident and health earned premiums are from short duration contracts. Insurance claims and policyholders' benefits are net of reinsurance recoveries of $721 and $618 million for the nine months ended September 30, 1998 and September 30, 1997, respectively. (12) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued NOTE E. Debt: Borrowings consisted of the following: |---------------------------------------------------------------------------| | LONG-TERM DEBT SEPTEMBER 30 DECEMBER 31 | | (In millions of dollars) 1998 1997 | |---------------------------------------------------------------------------| | | | Variable Rate Debt: | | Credit Facility - CNAF $ 85 $ 400 | | Commercial Paper 650 675 | | Credit Facility - CNA Surety 118 118 | | Senior Notes: | | 8.875%, due March 1, 1998 - 150 | | 8.25%, due April 15, 1999 101 102 | | 7.25%, due March 1, 2003 147 146 | | 6.25%, due November 15, 2003 249 249 | | 6.50%, due April 15, 2005 497 - | | 6.75%, due November 15, 2006 248 248 | | 6.45%, due January 15, 2008 149 - | | 8.375%, due August 15, 2012 98 98 | | 6.95%, due January 15, 2018 148 - | | 7.25%, Debenture, due November 15, 2023 247 247 | | 11% Secured Mortgage Notes, due June 1, 2013 158 389 | | 6.90% - 16.29% Secured Capital Leases, | | due December 31, 2011 46 47 | | Other debt, due 1998 through 2019 | | (rates of 1% to 12.71%) 26 28 | |---------------------------------------------------------------------------| | TOTAL LONG-TERM DEBT $ 2,967 $ 2,897 | |===========================================================================| CNAF has in place an $875 million committed revolving credit facility, under which borrowing capacity is reduced by CNAF's commercial paper program. As of November 2, 1998, outstanding loans under the credit facility were $235 million and outstanding commercial paper was $500 million. At November 2, 1998, there was $140 million of unused borrowing capacity under the facility. The interest rate for the credit 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 loans under the credit facility at September 30, 1998 was 5.72% compared to 5.82% at September 30, 1997. The commercial paper borrowings are classified as long-term as the program is fully supported by the committed credit facility. The weighted-average interest rate on commercial paper at September 30, 1998 and 1997, respectively, was 5.79 % and 5.82%. (13) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- continued To offset the variable rate characteristics of the credit facility, CNAF entered into interest rate swap agreements with several banks. The agreements terminate from May 2000 to December 2000. These agreements provide that CNAF pays interest at a fixed rate, averaging 6.07% at September 30, 1998, 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 $1 million and $3 million for the nine months ended September 30, 1998 and September 30, 1997, respectively. The weighted average interest rate (interest and facility fees) on CNAF's revolving credit facility and commercial paper, which reflects the effect of the interest rate swaps, was 6.19% at September 30, 1998 and 6.28% at September 30, 1997. On August 18, 1997, CNAF filed a Registration Statement on Form S-3 with the Securities and Exchange Commission relating to the issuance of $1.0 billion of senior and subordinated debt and preferred stock that became effective on October 22, 1997. This shelf registration incorporated $250 million of securities remaining available for issuance from a prior shelf registration. On January 8, 1998, CNAF 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 repay a portion of the revolving credit facility. On April 15, 1998, CNAF issued $500 million principal amount of 6.50% senior notes, due April 15, 2005. The net proceeds were used to prepay a portion of the secured mortgage notes, pay down a portion of the existing bank debt outstanding under CNAF's revolving credit facility, provide refinancing of senior notes and provide funds for acquisitions. On September 30, 1997, CNA Surety Corporation, a 62% owned subsidiary of CNA, entered into a $130 million, 5 year revolving credit facility. The interest on credit facility borrowings is based on LIBOR plus 20 basis points. Additionally, there is a credit facility fee of 10 basis points annually. At September 30, 1998, the outstanding borrowings under this credit facility were $118 million and the weighted average interest rate was 5.73%. (14) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued NOTE F. Accumulated Other Comprehensive Income: Comprehensive income is comprised of all changes to stockholders' equity, including net income, except those changes resulting from investments by owners and distributions to owners. The change in the components of accumulated other comprehensive income are shown below: |------------------------------------------------------------------------------| | TAX | |THREE MONTHS ENDED SEPTEMBER 30, 1998 PRE-TAX (EXPENSE) NET | |(In millions of dollars) AMOUNT BENEFIT AMOUNT| |------------------------------------------------------------------------------| |Net unrealized gains (losses) on investment securities: | | Net unrealized holding gains (losses) arising | | during the period $ 414 $ (159) $ 255 | | Adjustment for gains(losses) included in | | net income (4) 1 (3) | |Foreign currency translation adjustments 10 (1) 9 | |Adjustment for participating policyholder liabilities 7 (3) 4 | |==============================================================================| |TOTAL OTHER COMPREHENSIVE INCOME $ 427 $ (162) $ 265 | |==============================================================================| |------------------------------------------------------------------------------| | TAX | |THREE MONTHS ENDED SEPTEMBER 30, 1997 PRE-TAX (EXPENSE) NET | |(In millions of dollars) AMOUNT BENEFIT AMOUNT| |------------------------------------------------------------------------------| |Net unrealized gains (losses) on investment securities: | | Net unrealized holding gains (losses) arising | | during the period $ 484 $ (176) $ 308 | | Adjustment for gains(losses) included in | | net income - - - | |Foreign currency translation adjustments (1) - (1) | |Adjustment for participating policyholder liabilities (4) 1 (3) | |==============================================================================| |TOTAL OTHER COMPREHENSIVE INCOME $ 479 $ (175) $ 304 | |==============================================================================| |------------------------------------------------------------------------------| | TAX | |NINE MONTHS ENDED SEPTEMBER 30, 1998 PRE-TAX (EXPENSE) NET | |(In millions of dollars) AMOUNT BENEFIT AMOUNT| |------------------------------------------------------------------------------| |Net unrealized gains (losses) on investment securities: | | Net unrealized holding gains (losses) arising | | during the period $ 752 $ (277) $ 475 | | Adjustment for gains(losses) included in | | net income (281) 98 (183) | |Foreign currency translation adjustments 6 - 6 | |Adjustment for participating policyholder liabilities 8 (3) 5 | |==============================================================================| |TOTAL OTHER COMPREHENSIVE INCOME $ 485 $ (182) $ 303 | |==============================================================================| |------------------------------------------------------------------------------| | TAX | |NINE MONTHS ENDED SEPTEMBER 30, 1997 PRE-TAX (EXPENSE) NET | |(In millions of dollars) AMOUNT BENEFIT AMOUNT| |------------------------------------------------------------------------------| |Net unrealized gains (losses) on investment securities: | | Net unrealized holding gains (losses) arising | | during the period $ 455 $ (166) $ 289 | | Adjustment for gains(losses) included in | | net income (175) 61 (114) | |Foreign currency translation adjustments - - - | |Adjustment for participating policyholder liabilities - - - | |==============================================================================| |TOTAL OTHER COMPREHENSIVE INCOME $ 280 $ (105) $ 175 | |==============================================================================| (15) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - continued NOTE G. Stockholders' Equity On May 6, 1998, CNA's Board of Directors approved a three-for-one split of CNAF's common shares of stock, and authorized a commensurate increase in the outstanding common shares from 61,798,262 to 185,394,786. The shares were distributed on June 1, 1998 at a rate of three shares for each one held by shareholders of record at the close of business on May 22, 1998. The table below reflects the effect of this stock split as if it had occurred on December 31, 1997. |-----------------------------------------------------------------------------| |SUMMARY OF CAPITAL STOCK | |-----------------------------------------------------------------------------| | NUMBER OF SHARES | | ------------------------------------------| | SEPTEMBER 30 DECEMBER 31 | |AS OF 1998 1997 | |-----------------------------------------------------------------------------| |Preferred stock, without par value, non-voting: | | Authorized 12,500,000 12,500,000 | |Money market cumulative preferred stock, | | without par value, non-voting: | | Issued and outstanding: | | Series E (stated value $100,000 per share) 750 750 | | Series F (stated value $100,000 per share) 750 750 | |Common stock, par value of $2.50 voting stock: | | Authorized 200,000,000 200,000,000 | | Issued 185,525,907 185,525,907 | | Outstanding 183,704,086 185,394,786 | | Treasury stock 1,821,821 131,121 | | | |-----------------------------------------------------------------------------| The dividend rate on money market preferred stock is determined approximately every 49 days by auction. The money market preferred stock is redeemable at CNAF's option, as a whole or in part, at $100,000 per share plus accrued and unpaid dividends. As of September 30, 1998 preferred dividends declared were approximately $4 million. On August 5, 1998, CNAF's board of directors approved a plan to purchase, in the open market or through privately negotiated transactions, its outstanding common stock from time to time, as the company's management deems appropriate. During the third quarter of 1998, pursuant to its announced Share Repurchase Program, CNAF purchased 1,690,700 shares of its common stock for approximately $64 million. Total shares purchased by CNAF and classified on the September 30, 1998 balance sheet as treasury stock are 1,821,821 for a decrease in stockholders' equity of approximately $67 million. As of November 2, 1998, CNAF has repurchased 2,734,800 shares of its common stock at an aggregate cost, including commissions, of $102 million. (16) CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS- concluded NOTE H. Restructuring and Other Related Charges In the third quarter of 1998, the Company finalized and approved a plan to restructure its operations. In connection with this plan, the Company recorded pre-tax restructuring and other related charges totaling $220 million. The restructuring plan focused primarily on a net reduction in current workforce, the consolidation of certain processing centers, the closing of various facilities and the exiting of certain businesses. The Company's plan calls for a reduction in the current workforce of approximately 4,500 employees resulting in a net reduction of approximately 2,400 employees upon completion of the plans activities. The charges recorded in the third quarter relate to employee termination benefits ($72 million), the writedown of certain assets to their fair values ($74 million), lease abandonment costs ($42 million) and losses related to the exiting of businesses ($32 million). NOTE I. Subsequent Events On October 9, 1998, CNAF filed a Registration Statement on Form S-8 with the Securities and Exchange Commission registering $60 million of $2.50 par value common stock, to be offered pursuant to the CNAF Officer Stock Ownership Plan. On October 9, 1998, prior to the opening of the trading session on the New York Stock Exchange, CNAF sold 1,229,583 shares of common stock that was held in treasury stock to certain senior officers of CNAF at the average of the highest and lowest sale price on the New York Stock Exchange, composite transactions, which was a price of $34.91 per share. The purchases were financed by full recourse collateralized loans from CNAF totaling approximately $43 million. The loans are ten year notes which bear interest at the Applicable Federal Rate for October 1998 (5.39%), compounding semi-annually. (17) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements and notes thereto found on pages 3 to 17, which contain additional information helpful in evaluating operating results and financial condition. CNA Financial Corporation (CNAF) is a holding company whose primary subsidiaries consist of property/casualty and life insurance companies, collectively CNA or the Company. CNAF's primary subsidiaries include Continental Casualty Company, primarily a commercial lines writer, Continental Assurance Company and Valley Forge Life Insurance Company, life insurance subsidiaries, and The Continental Insurance Company, primarily a personal lines and ocean marine writer. 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, loss control and claims administration. CNA products and services are marketed through agents, brokers, general agents and direct sales. (18) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued RESULTS OF OPERATIONS: The following chart summarizes key components of operating results for the three and nine months ended September 30, 1998 and 1997.
|-------------------------------------------------------------------------------------------------------| |PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS | |(In millions of dollars) 1998 1997 1998 1997 | |-------------------------------------------------------------------------------------------------------| |OPERATING SUMMARY (EXCLUDING REALIZED | |INVESTMENT GAINS/LOSSES): | |Revenues: | | Premiums: | | Property/Casualty $ 2,514 $ 2,489 $ 7,707 $ 7,489 | | Life 786 847 2,428 2,542 | | -------- ------- ------- ------- | | 3,300 3,336 10,135 10,031 | | Net investment income 521 530 1,641 1,641 | | Other 211 206 598 537 | | -------- ------- ------- ------- | | 4,032 4,072 12,374 12,209 | |Benefits and expenses 4,152 3,911 12,287 11,712 | | -------- ------- ------- ------- | | Operating (loss) income before income tax (120) 161 87 497 | |Income tax benefit (expense) 50 (40) 24 (114) | | -------- ------- ------- ------- | | Net operating (loss) income $ (70) $ 121 $ 111 $ 383 | | ======== ======= ======= ======= | | | | | |SUPPLEMENTAL FINANCIAL DATA: | |Net operating income (excluding restructuring | |and other related charges) by group: | | Property/Casualty $ 100 $ 121 $ 300 $ 385 | | Life 6 24 44 71 | | Other, primarily interest expense (25) (24) (82) (73) | | ======== ======= ======= ======= | | $ 81 $ 121 $ 262 $ 383 | |Net operating (loss) income by group: | | Property/Casualty $ (25) $ 121 $ 175 $ 385 | | Life (20) 24 18 71 | | Other, primarily interest expense (25) (24) (82) (73) | | -------- ------- ------- ------- | | $ (70) $ 121 $ 111 $ 383 | | -------- ------- ------- ------- | |Net realized investment gains (losses) by group: | | Property/Casualty $ 55 $ 126 $ 263 $ 221 | | Life 1 29 56 73 | | Other - (2) (1) 10 | | -------- ------- ------- ------- | | $ 56 $ 153 $ 318 $ 304 | | -------- ------- ------- ------- | |Net (loss) income by group: | | Property/Casualty $ 30 $ 247 $ 438 $ 606 | | Life (19) 53 74 144 | | Other, primarily interest expense (25) (26) (83) (63) | | -------- ------- ------- ------- | | $ (14) $ 274 $ 429 $ 687 | |=======================================================================================================|
(19) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued On August 5, 1998, CNA announced estimates of the financial implications of its initiatives to achieve world-class performance. "World-class performance", as defined by the Company, refers to the Company's intention to position each of its strategic business units (SBUs) as a market leader by sharpening its focus on customers and employing new technology to work smarter and faster. As a result of these initiatives, the Company is reorganizing a number of its SBUs and corporate support areas. In the third quarter of 1998, the Company finalized and approved a plan to restructure its operations. In connection with this plan, the Company recorded pre-tax restructuring and other related charges totaling $220 million. The restructuring plan focused on a net reduction in the current workforce of approximately 4,500 employees resulting in a net reduction of approximately 2,400 employees, the consolidation of certain processing centers, the closing of various facilities, and the exiting of certain businesses. The charges recorded in the third quarter relate to employee termination benefits ($72 million), the writedown of certain assets to their fair values ($74 million), lease abandonment costs ($42 million) and losses related to the exiting of businesses ($32 million). These activities and changes are more fully discussed below. Within its risk management business, pre-tax restructuring and other related charges totaled approximately $79 million for the third quarter. The charges relate to costs associated with the consolidation of claim offices in approximately 36 market territories totaling approximately $8 million (lease abandonment costs), employee termination benefits related to the net reduction in workforce of approximately 200 employees at a cost of approximately $7 million and the writedown of fixed and intangible assets of approximately $64 million. Within its commercial insurance business, pre-tax restructuring and other related charges for the third quarter totaled approximately $57 million. The charges relate primarily to the consolidation of four regional offices into two zone offices and a reduction of claim processing offices from 24 to 8 at a cost of approximately $21 million (lease abandonment costs). The charges also consist of approximately $31 million of employee termination benefits related to the net reduction in workforce of approximately 1,200 employees and an additional $5 million relating to fixed asset writedowns. Within its group insurance business, pre-tax restructuring and other related charges for the third quarter totaled approximately $38 million. The charges relate primarily to the Employer Health and Affinity lines of business that the Company decided to exit and include the employee termination benefit costs related to the net reduction in its current workforce of approximately 400 employees. For various other departments within the Company, pre-tax restructuring and other related charges totaled approximately $25 million and relate primarily to the closing of leased facilities and employee termination benefits related to the reductions in the current workforce. Additionally, the Company recorded approximately $21 million in incremental benefit plan expenses associated with the reductions in the Company's workforce. The Company expects to record an additional $125 million to $175 million in charges over the next 12 to 15 months, primarily relate to employee related expenses, computer systems, consulting fees and other related costs. While such costs relate to the Company's overall plans of reorganization, generally accepted accounting principles do not allow for accrual of these in the period the plan is adopted. Rather, such costs will be recorded in the period which they are incurred. (20) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued While the Company has not yet completed its analysis of anticipated cost savings, it estimates that its world-class initiatives, which include the restructuring plan as well as revenue enhancements and operating efficiencies, will result in anticipated reductions of approximately 200 basis points in the Company's expense ratio and savings of approximately $300 to $350 million on an annualized basis. The Company expects a portion of the anticipated savings will be realized beginning in the latter part of 1998 and to achieve the full expense ratio reduction within 15 months. As part of the risk management business initiatives, the Company introduced its new risk management service organization, RSKCoSM in the fourth quarter of 1998. This new organization was created through the unification of its existing claims service organizations and the integration of the new claims group with loss control, medical cost management and information services businesses. RSKCoSM will employ one of the largest claims technical staff in the insurance industry, and expects to achieve cost savings through economies of scale. Related to its decision to exit the Employer Health and Affinity Health lines of business, the Company actively explored the sale of these lines of business. In the fourth quarter, the Company entered into two separate agreements to sell a majority of its Employer Health book of business. Consolidated Results - -------------------- Consolidated revenues, which consist of premium, net investment income, realized investment gains and other revenue, were $12.89 billion for the first nine months of 1998, up slightly from $12.68 billion for the same period in 1997. For the first nine months of 1998, revenues, as compared to the same period in 1997, reflect an increase in earned premium of $104 million, resulting from an increase in property/casualty premiums of $218 million, offset by a decline in life premium of $114 million. Investment income was approximately $1.64 billion for both the first nine months of 1998 and 1997. Other revenues were $598 million for the first nine months of 1998 as compared to $537 million for the same period in 1997, primarily due to increased revenues from several subsidiaries of the Company. Net operating income, which excludes net realized investment gains, was $111 million, or $0.57 per share, for the first nine months of 1998, compared to net operating income of $383 million, or $2.04 per share, for the same period in 1997. Net operating income for the first nine months of 1998 includes after-tax restructuring and other related charges of $151 million, or $0.82 per share. Excluding these charges, net operating income for the period ended September 30, 1998 was $262 million, or $1.39 per share. The Company recorded a net operating loss of $70 million, or $0.39 per share, for the third quarter of 1998, compared to net operating income of $121 million, or $0.64 per share, for the same quarter in 1997. The net operating loss for the third quarter of 1998 includes the after-tax restructuring and other related charges of $151 million. Excluding these charges, net operating income for the period was $81 million, or $0.43 per share. (21) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued Realized investment gains, net of tax, for the first nine months of 1998 were $318 million, or $1.72 per share, compared to net realized investment gains for the first nine months of 1997 of $304 million, or $1.64 per share. Realized investment gains, net of tax, for the third quarter of 1998 were $56 million, or $0.30 per share, compared to net realized investment gains for the third quarter of 1997 of $153 million, or $0.83 per share. The components of the net realized investment gains (losses) are as follows: |-----------------------------------------------------------------------------| |NET REALIZED INVESTMENT GAINS(LOSSES) | |NINE MONTHS ENDED SEPTEMBER 30 1998 1997 | |(In millions of dollars) | |-----------------------------------------------------------------------------| |Bonds: | | U.S. Government $ 165 $ 103 | | Tax exempt 58 26 | | Asset-backed 30 18 | | Taxable 83 102 | | --------- ----- | | Total bonds 336 249 | |Stocks 12 57 | |Derivative security investments 28 2 | |Separate Accounts and other 136 167 *| | --------- ----- | | Realized investment gains reported in revenues 512 475 | |Participating policyholders' interest (9) (8) | |Income tax expense (185) (163) | | --------- ----- | | NET REALIZED INVESTMENT GAINS $ 318 $ 304 | |=============================================================================| *INCLUDES A REALIZED INVESTMENT GAINS OF $89 MILLION ON THE MERGER OF CNA SURETY CORPORATION AND CAPSURE HOLDINGS CORP. Net income for the first nine months of 1998 was $429 million, or $2.29 per share, compared to $687 million, or $3.68 per share, for the first nine months of 1997. Net income for the first nine months of 1998, excluding the after-tax restructuring and other related charges of $151 million, or $0.82 per share, was $580 million, or $3.11 per share. The Company recorded a net loss for the third quarter of $14 million, or $0.09 per share, compared to net income of $274 million, or $1.47 per share, for the third quarter of 1997. Excluding the restructuring and other related charges, net income for the third quarter was $137 million, or $0.73 per share. The Company's net income for the first nine months of 1998 includes after-tax catastrophe losses of $141 million; after-tax catastrophe losses in the first nine months of 1997 were $51 million. After-tax catastrophe losses were $43 million for the third quarter of 1998 as compared to $2 million for the same period in 1997. (22) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued Property/Casualty Operations - ----------------------------
|-------------------------------------------------------------------------------------| |PROPERTY/CASUALTY GROUP | |PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS | |(In millions of dollars) 1998 1997 1998 1997 | |-------------------------------------------------------------------------------------| |Operating Summary (excluding realized | |investment gains/losses): | |Revenues: | | Premiums $2,514 $ 2,489 $7,707 $ 7,489 | | Net investment income 412 432 1,313 1,343 | | Other 181 173 516 448 | | ------ ------- ------ -------| | 3,107 3,094 9,536 9,280 | |Benefits and expenses 3,161 2,936 9,351 8,781 | | ------ ------- ------ -------| | (Loss) income before income tax (54) 158 185 499 | |Income tax recovery (expense) 29 (37) (10) (114)| | ------ ------- ------ -------| | NET OPERATING (LOSS) INCOME (EXCLUDING REALIZED | | INVESTMENT GAINS/LOSSES) $ (25) $ 121 $ 175 $ 385 | |=====================================================================================|
Property/casualty revenues for the nine months ended September 30, 1998, excluding net realized investment gains/losses, increased 2.8%, to $9.54 billion compared to $9.28 billion in the same period a year ago. Property/casualty earned premium increased $218 million, or 2.9% from the comparable period in the prior year. The increase in earned premium is due primarily to increases in involuntary risk premium of approximately $207 million, personal lines premium of $92 million, $80 million of premium from CNA Surety Corporation which was formed in September of 1997, and $48 million of premium from Omega Aseguradora de Reisgo de Trabajo, an Argentinean worker's compensation carrier that was acquired in June of 1997. These increases were partially offset by a decrease in commercial lines premium of approximately $150 million and group lines of approximately $92 million. Lower involuntary premium levels in 1997 reflected reductions in estimates of premium for 1996 and prior periods, primarily in the workers' compensation line of business, and a greater willingness on the part of the voluntary market, including CNA, to write these types of risks. The 1998 estimated premiums reflect a return to historical levels. The increase in personal lines premium is attributable to increases in California Earthquake Authority premium of $34 million as well as an increase of $45 million across various lines. The decrease in commercial lines is primarily due to competitive pricing pressures throughout the industry. The decrease in group lines is mainly due to the decision to exit the Employer Health and Affinity Health lines of business. Investment income decreased $30 million or 2.2% for the nine months ended September 30, 1998 as compared to the same period for 1997 due primarily to lower yielding investments. The fixed maturities segment of the investment portfolio yielded 6.1% in the first nine months of 1998 as compared to 6.3% for the first nine months of 1997. Other revenues increased to $516 million or 15.2% for the nine months ended September 30, 1998, as compared to $448 million for the same period in 1997. This increase is primarily due to increased revenues from CNA's computer leasing, professional employers organization and automobile warranty businesses. (23) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued Pre-tax operating income, excluding net realized gains/losses, for the property/casualty insurance subsidiaries was $185 million for the nine months ended September 30, 1998, compared to $499 million for the same period one year ago. Underwriting losses for the nine and three months ended September 30, 1998, were $1.1 billion and $465 million, compared to $844 million and $273 million for the same periods in 1997. The increase in 1998 underwriting losses is primarily due to the restructuring and other related charges recorded during the third quarter, as well as an increase in pre-tax catastrophe losses for the first nine months of 1998 of approximately $138 million. Pre-tax catastrophe losses for the nine months ended September 30, 1998 were $217 million, as compared to $79 million for the same period in 1997. The increase in catastrophe losses is mainly due to spring storms throughout the United States and hurricane damage sustained during the third quarter. Pre-tax catastrophe losses for the three months ended September 30, 1998 and September 30, 1997 were $66 million and $3 million, respectively. CNA's property/casualty insurance subsidiaries recorded net operating income, excluding net realized investment gains/losses, of $175 for the nine months ended September 30, 1998, and a net operating loss of $25 million for the three months ended September 30, 1998. This compares to net operating income of $385 million and $121 million for the nine and three months ended September 30, 1997, respectively. Net realized investment gains for the nine and three months ended September 30, 1998 were $263 million and $55 million, compared to $221 million and $126 million in the comparable periods of 1997. (24) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued Life Operations - ---------------
|---------------------------------------------------------------------------------------------| |LIFE GROUP | |PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS | |(In millions of dollars) 1998 1997 1998 1997 | |---------------------------------------------------------------------------------------------| |OPERATING SUMMARY (EXCLUDING REALIZED | | INVESTMENT GAINS/LOSSES): | |Revenues: | | Premiums $ 786 $ 847 $ 2,428 $ 2,544 | | Net investment income 111 102 335 306 | | Other 30 33 82 89 | | ------ ------ ------- ---------| | 927 982 2,845 2,939 | |Benefits and expenses 955 943 2,818 2,827 | | ------ ------ ------- ---------| | (Loss) income before income tax (28) 39 27 112 | |Income tax recovery (expense) 8 (15) (9) (41)| | ------ ------ ------- ---------| | NET OPERATING (LOSS) INCOME (EXCLUDING REALIZED | | INVESTMENT GAINS/LOSSES) $ (20) $ 24 $ 18 $ 71 | |=============================================================================================|
Life group revenues, excluding realized investment gains/losses, were approximately $2.85 billion, down 3.2% for the nine months ended September 30, 1998 compared to the same period a year ago. Revenues for the third quarter of 1998 were $927 million as compared to $982 million for the same period in 1997, representing a decrease of $55 million or 5.6%. Life group earned premium was $2.43 billion in the first nine months of 1998, down 4.6% as compared to $2.54 billion for the nine months ended September 30, 1997. For the three months ended September 30, 1998, earned premium decreased 7.2% to $786 million from $847 million for the same period in 1997. The decreases in earned premiums are primarily due to lower premiums for the Federal Employees Health Benefit Plan (FEHBP). The decrease in FEHBP premiums is due to improved claim experience upon which premiums are based and continues the trend from the first half of this year. Investment income for the nine months ended September 30, 1998 was $335 million as compared to $306 million for the same period a year ago. The fixed maturities segment of the life investment portfolio yielded 6.4% in the first nine months of 1998 and 6.3% for the first nine months of 1997. Pre-tax operating income for the life insurance subsidiaries, excluding net realized investment gains/losses, was $27 million for the nine months ended September 30, 1998, compared to $112 million for the same period in 1997. For the three months ended September 30, 1998, the life insurance subsidiaries recorded a pre-tax operating loss of $28 million as compared to pre-tax operating income of $39 million for the same period in 1997. The decrease in pre-tax operating income is primarily due to lower premium revenue and higher losses in the group medical business for the first nine months of 1998 as compared to the same period in 1997. Additionally, pre-tax operating income was reduced by restructuring and other related charges of approximately $38 million attributable to the Employer Health and Affinity Health lines of business that the Company decided to exit which include the employee termination benefit costs related to the net reduction in its current workforce of approximately 400 employees. Net realized investment gains for the nine and three months ended September 30, 1998 were $56 million and $1 million, compared to $73 million and $29 million for the same periods in 1997. (25) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued Investments - -----------
|-----------------------------------------------------------------------|------------------------------| |SUMMARY OF GENERAL ACCOUNT INVESTMENTS | NINE MONTHS ENDED | |AT CARRYING VALUE | SEPTEMBER 30, 1998 | | |------------------------------| | | CHANGE IN | | | SEPTEMBER 30, DECEMBER 31, | NET UNREALIZED | REALIZED | |(In millions of dollars) 1998 1997 | GAINS(LOSSES)|GAINS(LOSSES)| |-----------------------------------------------------------------------|----------------|-------------| |FIXED MATURITY SECURITIES: | | | |U.S. Treasury securities and | | | | obligations of government agencies $ 10,075 $ 12,980 | $ 236 | $ 165 | |Asset-backed securities 6,766 4,804 | 137 | 30 | |Tax exempt securities 6,144 4,724 | 98 | 58 | |Taxable securities 6,337 7,040 | (124)| 83 | | ---------- ----------- | ----------| --------| | Total fixed maturity securities 29,322 29,548 | 347 | 336 | |Stocks 1,362 814 | 272 | 12 | |Short-term investments 4,549 4,884 | - | (14)| |Other investments 1,064 945 | (107)| 113 | |Derivative security investments 8 12 | - | 28 | | ---------- ----------- | ----------| --------| | TOTAL INVESTMENTS $ 36,305 $ 36,203 | 512 | 475 | | ========== =========== | | | |Other, principally Separate Accounts | 9 | 37 | |Participating policyholders' interest | (6)| (9)| |Income tax expense | (180)| (185)| | | ----------| --------| | NET INVESTMENT GAINS | $ 335 | $ 318 | |=======================================================================|================|=============| |-----------------------------------------------------------------------| |SHORT-TERM INVESTMENTS: | |-----------------------------------------------------------------------| |Security repurchase collateral $ 58 $ 154 | |Escrow 1,049 1,065 | |U.S. Treasuries 525 558 | |Commercial paper 1,981 1,850 | |Money markets 312 624 | |Other 624 633 | |-----------------------------------------------------------------------| | TOTAL SHORT-TERM INVESTMENTS $ 4,549 $ 4,884 | |=======================================================================|
CNA's general account investment portfolio is managed to maximize after-tax investment return, while minimizing credit risks with investments concentrated in high quality securities to support its insurance underwriting operations. CNA has the capacity to hold its fixed maturity portfolio to maturity. However, securities may be sold as part of CNA's asset/liability strategies or to take advantage of investment opportunities generated by changing interest rates, prepayments, tax and credit considerations, or other similar factors. Accordingly, the fixed maturity securities are classified as available for sale. CNA 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 market 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. (26) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued The general account portfolio consists primarily of high quality marketable fixed maturity securities, approximately 93.7% of which are rated as investment grade. At September 30, 1998, tax-exempt securities and short-term investments, excluding collateral for securities sold under repurchase agreements, comprised approximately 16.9% and 12.4%, respectively, of the general account's total investment portfolio compared to 13.1% and 13.1%, respectively, at December 31, 1997. Historically, CNA has maintained short-term assets at a level that provided for liquidity to meet its short-term obligations, as well as reasonable contingencies and anticipated claim payout patterns. Short-term investments at both September 30, 1998 and December 31, 1997 are substantially higher than historical levels in anticipation of Fibreboard-related claim payments. At September 30, 1998, the major components of the short-term investment portfolio consist primarily of high-grade commercial paper and U.S. Treasury bills. As of September 30, 1998, the market value of CNA's general account investments in fixed maturities was $29.32 billion and was greater than amortized cost by approximately $876 million. This compares to a market value of $29.55 billion and approximately $528 million of net unrealized investment gains at December 31, 1997. The gross unrealized investment gains and losses for the fixed maturity securities portfolio at September 30, 1998 were $1,138 million and $262 million, respectively, compared to $644 million and $116 million, respectively, at December 31, 1997. Net unrealized investment gains on general account fixed maturities at September 30, 1998 include net unrealized losses on high yield securities of $137 million, compared to net unrealized losses of $2 million on such securities at December 31, 1997. High yield securities are bonds rated as below investment grade by bond rating agencies, plus private placements and other unrated securities which, in the opinion of management, are below investment grade. CNA's investment in high yield securities in the general account decreased $377 million to approximately $1.86 billion at September 30, 1998 when compared to December 31, 1997. At September 30, 1998, total Separate Account cash and investments amounted to $5.25 billion with taxable fixed maturity securities representing approximately 83.9% of the Separate Accounts' portfolios. Approximately 68.0% of Separate Account investments are used to fund guaranteed investments for which Continental Assurance Company guarantees principal and a specified return to the contractholders. The duration of fixed maturity securities included in the guaranteed investment portfolio is generally matched with the corresponding payout pattern of the liabilities of the guaranteed investment contracts. The fair value of all fixed maturity securities in the guaranteed investment portfolio was $3.44 billion at September 30, 1998 and $3.83 billion at December 31, 1997. At September 30, 1998, fair value exceeded amortized cost by approximately $101 million. This compares to an unrealized gain of approximately $71 million at December 31, 1997. The gross unrealized investment gains and losses for the guaranteed investment fixed maturity securities portfolio at September 30, 1998, were $118 million and $17 million, respectively, as compared to unrealized gains of $87 million and unrealized losses of $16 million at December 31, 1997. Carrying values of high yield securities in the guaranteed investment portfolio were $278 million at September 30, 1998 and $310 million at December 31, 1997. Net unrealized investment losses on high yield securities held in such Separate Accounts were $19 million at September 30, 1998, and $1 million at December 31, 1997. (27) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued High yield securities generally involve a greater degree of risk than that of investment grade securities. Expected returns should, however, compensate for the added risk. The risk is also considered in the interest rate assumptions in the underlying insurance products. As of September 30, 1998, CNA's concentration in high yield bonds, including Separate Accounts, was approximately 3.7% of total assets as compared to 3.2% at December 31, 1997. In addition, CNA's investments in mortgage loans and real estate are substantially below the industry average, representing less than one quarter of one percent of its total assets. Included in CNA's fixed maturity securities at September 30, 1998 (general and guaranteed investment portfolios) are $9.01 billion of asset-backed securities, consisting of approximately 54.5% in collateralized mortgage obligations ("CMOs"), 15.2% in corporate asset-backed obligations, 16.6% in corporate mortgage backed security pass thru obligations, and 13.7% in U.S. Government agency issued pass-through certificates. The majority of CMOs held are corporate mortgage-backed securities, which are actively traded in liquid markets and are priced by broker-dealers. At September 30, 1998, the fair value of asset-backed securities exceeded the amortized cost by approximately $299 million compared to net unrealized investment gains of $114 million at December 31, 1997. CNA limits the risks associated with interest rate fluctuations and prepayments by concentrating its CMO investments in early planned amortization classes with relatively short principal repayment windows. At September 30, 1998, 36.2% of the general account's fixed maturity securities portfolio was invested in U.S. Government securities, 36.4% in other AAA rated securities and 15.1% in AA and A rated securities. CNA's guaranteed investment fixed maturity securities portfolio is comprised of 5.7% U.S. Government securities, 61.9% in other AAA rated securities and 13.9% in AA and A rated securities. These ratings are primarily from Standard & Poor's. MARKET RISK: Market risk is a broad term related to economic losses due to adverse changes in the fair value of a financial instrument. Market risk is inherent to all financial instruments, and accordingly, the Company's risk management policies and procedures include all market risk sensitive financial instruments. A significant component of market risk is 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. The Company's market risk sensitive instruments presented in the table on page 31 are classified as held for purposes other than trading. The Company does not generally hold or issue derivatives for trading purposes. (28) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued 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. 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 that 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 rate risk arises from the possibility that changes in foreign currency exchange rates will impact the value of financial instruments. The Company has foreign exchange exposure when it buys or sells foreign currencies or financial instruments denominated in a foreign currency. The Company's foreign transactions are primarily denominated in Canadian Dollars, British Pounds, German Duetschmarks, and Japanese Yen. This exposure is mitigated by the Company's asset/liability matching strategy and through the use of forwards for those instruments, which are not matched. Sensitivity Analysis - -------------------- CNA monitors its sensitivity to interest rate risk by evaluating the change in its financial assets and liabilities relative to fluctuations in interest rates. The evaluation is made using an instantaneous parallel 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 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 net income or stockholders' equity. Further, the computations do not contemplate any actions CNA would undertake in response to changes in interest rates. (29) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued 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 September 30, 1998 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 $1.60 billion and $2.38 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 $1.67 billion and $2.53 billion, respectively. The Company's long-term debt, including interest rate swap agreements, as of September 30, 1998 is denominated in U.S. dollars. Approximately 93% of the Company's long-term debt has been issued at fixed rates or has been effectively converted into fixed rate debt by interest rate swap arrangements which mature in May 2000 through December 2000. As such, interest expense on this indebtedness would not be impacted by interest rate shifts. The impact of a 100 and 150 basis point increase in market interest rates would result in a decrease in the market value of the fixed rate debt by $138 million and $201 million, respectively. The impact of a 100 and 150 basis point decrease in market interest rates would result in an increase in the market value of the fixed rate debt by $154 million and $237 million, respectively. The impact of a 100 and 150 basis point increase in market interest rates on the variable rate debt would result in additional interest expense of $2.2 million and $3.2 million, respectively, per year. A 100 and 150 basis point decrease in interest rates would lower interest expense by $2.2 million and $3.2 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 September 30, 1998, 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 $240 million and $599 million decrease, respectively, in the net financial instrument position. Of these amounts, $82 million and $205 million, respectively, would be offset by decreases in liabilities to customers under variable annuity contracts. Similarly, increases in the index would result in like increases in the net financial instrument position. 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 September 30, 1998, with all other variables held constant. A 10% and 20% strengthening of the U.S. dollar versus other currencies would result in decreases of $196 million and $391 million 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. (30) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued The following table reflects an increase in interest rates of 100 basis points, a decline of 10% in foreign currency exchange rates and a 10% decline in the S&P 500 index. |------------------------------------------------------------------------------| | | |SEPTEMBER 30, 1998 MARKET INTEREST CURRENCY EQUITY | |(In millions of dollars) VALUE RATE RISK RISK RISK | |------------------------------------------------------------------------------| |Held for Other Than Trading Purposes | | General accounts | | Fixed maturity securities $ 29,322 $ (1,450) $(135) $ - | | Equity securities 1,362 - (1) (136)| | Short-term investments 4,549 (6) (36) - | | Interest rate swaps (15) 11 - - | |------------------------------------------------------------------------------| | Total general accounts 35,218 (1,445) (172) (136)| |------------------------------------------------------------------------------| | Separate Accounts | | Fixed maturity securities 4,405 (157) (22) (3)| | Equity securities 186 - - (19)| | Short-term investments 457 (1) (2) - | | Equity index futures - 2 - (82)| |------------------------------------------------------------------------------| | Total Separate Accounts 5,048 (156) (24) (104)| |------------------------------------------------------------------------------| | Total all securities $ 40,266 $ (1,601) $(196) $ (240)| |==============================================================================| |LONG TERM DEBT $ (3,133) $ 138 $ - $ - | |==============================================================================| The following table reflects an increase in interest rates of 150 basis points, a decline of 20% in foreign currency exchange rates, and a 25% decline in the S&P 500 index. |------------------------------------------------------------------------------| | | |SEPTEMBER 30, 1998 MARKET INTEREST CURRENCY EQUITY | |(In millions of dollars) VALUE RATE RISK RISK RISK | |------------------------------------------------------------------------------| |Held for Other Than Trading Purposes | | General accounts | | Fixed maturity securities $ 29,322 $ (2,151) $ (269) $ - | | Equity securities 1,362 - (2) (341)| | Short-term investments 4,549 (9) (73) - | | Interest rate swaps (15) 16 - - | |------------------------------------------------------------------------------| | Total general accounts 35,218 (2,144) (344) (341)| |------------------------------------------------------------------------------| | Separate Accounts | | Fixed maturity securities 4,405 (236) (44) (7)| | Equity securities 186 - - (46)| | Short-term investments 457 (1) (3) - | | Equity index futures - 3 - (205)| |------------------------------------------------------------------------------| | Total Separate Accounts 5,048 (234) (47) (258)| |------------------------------------------------------------------------------| | Total all securities $ 40,266 $ (2,378) $ (391) $ (599)| |==============================================================================| |LONG-TERM DEBT $ (3,133) $ 201 $ - $ - | |==============================================================================| (31) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued FINANCIAL CONDITION: |------------------------------------------------------------------------------| |FINANCIAL POSITION SEPTEMBER 30 DECEMBER 31| |(in millions of dollars, except per share data) 1998 1997 | |------------------------------------------------------------------------------| | | |Assets $ 62,566 $ 61,600 | |Stockholders' equity 8,973 8,309 | |Accumulated other comprehensive income 892 589 | |Book value per common share 47.63 44.01 | |==============================================================================| CNA's assets increased approximately $960 million from December 31, 1997 to $62.57 billion as of September 30, 1998. The major components of this increase were an increase of approximately $840 million in insurance receivables and approximately $545 million for receivables for securities sold offset by a decrease of approximately $170 million in deferred income taxes and a decrease of approximately $430 million in separate account business. During the first nine months of 1998, CNA's stockholders' equity increased by $664 million, or 8.0%, to $8.97 billion. The major components of this change were net income of $429 million and change in accumulated other comprehensive income of $303 million. The statutory surplus of the property/casualty subsidiaries was approximately $7.0 billion at both September 30, 1998 and December 31, 1997. Statutory surplus increased by net income of $291 million and a change in net unrealized investment gains of $25 million. These increases were more than offset by $367 million reductions in surplus, primarily dividends. The statutory surplus of the life insurance subsidiaries was approximately $1.2 billion at September 30, 1998 and December 31, 1997. LIQUIDITY AND CAPITAL RESOURCES: 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 nine months ended September 30, 1998, CNA's operating cash flows were a negative $730 million, compared to a negative $359 million for the nine months ended September 30, 1997. Negative cash flows for 1998 are primarily the result of reduced income from operations while negative cash flows for 1997 are substantially the result of the settlement of asbestos and environmental claims, including those attributable to the Fibreboard litigation. (32) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued In early 1998, CNAF was able to take advantage of favorable market conditions to refinance, on a fixed rate basis, $300 million of existing debt under the its revolving credit facility. During the second quarter of 1998 the Company issued $500 million principal amount of 6.50% senior notes, due April 15, 2005. The net proceeds were used to pay down existing debt, provide refinancing of certain senior notes and provide funds for acquisitions. The net effect of these transactions was an increase in cash flows from financing activities of approximately $61 million On August 5, 1998, CNAF's board of directors approved a plan to repurchase, in the open market or through privately negotiated transactions, its outstanding common stock from time to time as market conditions warrant. The timing of stock purchases are made at the discretion of management. As of September 30, 1998, CNAF has repurchased 1,690,700 shares at a cost of approximately $64 million. Total shares purchased by CNAF and classified on the September 30, 1998 balance sheet as treasury stock are approximately 1,821,821 at a cost of approximately $67 million. As of November 2, 1998 CNAF has repurchased 2,734,800 shares of its common stock at an aggregate cost, including commissions, of $102 million. In the past five years, several rating agencies have lowered the Company's ratings with regard to its debt and claims paying ability. Some of the factors causing these downgrades include Casualty's obligations under the Fibreboard settlement and the merger with The Continental Corporation in 1995. More recently, rating agencies in their evaluations of Casualty have expressed concern with regard to the intensely competitive environment in the U.S. commercial insurance markets, among other factors. The Company intends to take a number of steps to address the issue of lowered ratings and, among other things, intends to enhance its capital structure by approximately $500 million. It is anticipated that this will be accomplished in the fourth quarter of 1998 and the first quarter of 1999 through several transactions, including the issuance of preferred equity and debt securities by CNAF. Loews has advised CNAF that it would be willing to purchase approximately half of such securities. 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 beginning in 1999. Such malfunctions could lead to business delays and disruptions. The Company is in the process of renovating or replacing many of its legacy systems to accommodate business for the year 2000 and beyond. In addition, the Company is checking embedded systems in computer hardware and other infrastructure such as elevators, heating and ventilating systems, and security systems. To date, 89% of all planned hours have been expended, and a similar percentage of milestones have been completed. Approximately 81% of the Company's internal systems have been internally tested so far and expect to be running in a production environment by December 1, 1998. This deadline allows a full year for re-validation of already tested and implemented Year 2000 remediated systems, as well as for shake-out of any previously unidentified problems and for interacting with business partners and vendors that are still working on making their programs Year 2000 ready. (33) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued Based upon its current assessment, the Company estimates that the total cost to replace and upgrade its systems to accommodate Year 2000 processing will be approximately $60 to $70 million. As of September 30, 1998, approximately $48 million has been spent. However, prior to 1997, the Company did not specifically separate technology charges for Year 2000 from other information technology charges. In addition, while some hardware charges are included in the budget figures, the Company's hardware costs are typically included as part of ongoing technology updates and not specifically as part of the Year 2000 project. All funds spent and to be spent will be financed from current operating funds. The Company believes that it will be able to resolve the Year 2000 issue in a timely manner. 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. The Company has already sent Year 2000 information packages to more than 12,000 independent agents to encourage them to become Year 2000 ready on a timely basis. The Company has also sent Year 2000 information to almost 300,000 business policyholders to increase their awareness of the Year 2000 issue. Similar information packages have been sent to healthcare providers, lawyers and others with whom the Company has business relationships. Because of the interdependent nature of the issue, the Company cannot be sure that there will not be a disruption in its business. The Company has also developed business resumption plans to ensure that the Company is able to continue critical processes through other means in the event that it becomes necessary to do so. Formal strategies have been developed within each business unit and support organization to include appropriate recovery processes and use of alternative vendors. More than 200 strategies have been developed to address recovery plans for approximately 400 processes. These plans are being updated quarterly. In addition, property/casualty insurance companies may have an underwriting exposure related to Year 2000 issue. Although CNA has not received any claims for coverage from its policyholders based on losses resulting from Year 2000 issues, there can be no assurances that policyholders will not suffer losses of this type and seek compensation under insurance polices underwritten by CNA. If any claims are made, coverage, if any, will depend on the facts and circumstances of the claim and the provisions of the policy. The range of potential insurance exposure created by the Year 2000 problem is sufficiently broad that it is impossible to estimate with any degree of accuracy the extent to which various types of policies issued by the Company may afford coverage for loss or claims. At this time, in the absence of any claims experience, the Company is unable to forecast the nature and range of the losses, the availability of coverage for the losses, or the likelihood of significant claims. As a result, the Company is unable to determine whether the adverse impact, if any, in connection with the foregoing circumstances would be material to the Company. (34) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - concluded ACCOUNTING STANDARDS: In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) 131, "Disclosures about Segments of an Enterprise and Related Information," which establishes standards for the way that public business enterprises report information about operating segments in interim and annual financial statements. It requires that those enterprises report a measure of segment profit or loss, certain specific revenue and expense items, and segment assets, and that the enterprises reconcile the total of those amounts to the general-purpose financial statements. It also establishes standards for related disclosures about products and services, geographic areas and major customers. This Statement is effective for financial statements for periods beginning after December 15, 1997. This Statement need not be applied to interim financial statements in the initial year of its application. CNA intends to expand its business segment disclosure in connection with the adoption of this standard. 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 for 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 it is probable that an assessment will be imposed; the event obligating an entity to pay an imposed or probable assessment has occurred on or before the date of the financial statements; and the amount of the assessment can be reasonably estimated. This SOP is effective for financial statements for fiscal years beginning after December 15, 1998. CNA is currently evaluating the effects of this SOP on its accounting for insurance-related assessments. Certain insurance industry information required for compliance is not currently available and therefore the Company is studying alternatives for estimating the accrual. While it is possible that the cumulative effect of adoption could be material, the ongoing impact of this standard is not expected to be material to the results of operations, liquidity or financial position of the Company. 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. (35) CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - continued In March 1998, the American Institute of Certified Public Accountants' Accounting Standards Executive Committee issued SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," which provides guidance on accounting for costs of computer software developed or obtained for internal use and for determining whether computer software is for internal use. For purposes of this SOP, internal-use software is software acquired, internally developed or modified solely to meet the entity's internal needs for which no substantive plan exists or is being developed to market the software externally during the software's development or modification. Accounting treatment for costs associated with software developed or obtained for internal use, as defined by this SOP, is based upon a number of factors, including the point in time during the project that costs are incurred as well as the types of costs incurred. This SOP is effective for financial statements for fiscal years beginning after December 15, 1998. CNA is currently evaluating the effects of this SOP. In June 1998, the FASB issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes standards for the accounting and reporting for derivative instruments and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available-for-sale security, or a foreign-currency-denominated forecasted transaction. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. This Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. CNA is currently evaluating the effects of this Statement on its accounting and reporting for derivatives and hedges. FORWARD-LOOKING STATEMENTS: When included in management's discussion and analysis, the words "believe", "expects", "intends", "anticipates", "estimates", and analogous expressions are intended to identify forward-looking statements. Such statements inherently are subject to a variety of risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties include, among others, 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 statement contained herein to reflect any change in the Company's expectations with regard thereto or any change in events, conditions or circumstances on which any statement is based. (36) CNA FINANCIAL CORPORATION PART II OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS: Description of Exhibit Exhibit Page Number Number Computation of Net Income per Common Share 11 39 Computation of Ratio of Earnings to Fixed Charges 12.1 40 Computation of Ratio of Net Income, As Adjusted, to Fixed Charges 12.2 40 Financial Data Schedule 27 41 (b) REPORTS ON FORM 8-K: On August 6, 1998, CNA Financial Corporation filed a report on Form 8-K, which reported second quarter earnings, estimates of reorganization charges and an approval of a share repurchase program. (37) CNA FINANCIAL CORPORATION PART II OTHER INFORMATION - CONCLUDED SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CNA FINANCIAL CORPORATION Date: November 13, 1998 By: S/W. JAMES MACGINNITIE ----------------- --------------------- W. James MacGinnitie Senior Vice President and Chief Financial Officer (38) EXHIBIT 11 CNA FINANCIAL CORPORATION COMPUTATION OF NET INCOME PER COMMON SHARE
|----------------------------------------------------------------------------------| |PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS | |(In millions of dollars, except per share data) 1998 1997 1998 1997 | |----------------------------------------------------------------------------------| |Earnings per share: | | Net (loss) income $ (14) $ 274 $ 429 $ 687 | | Less preferred stock dividends 2 2 4 5 | | ------ ------ ------ ------| | Net (loss) income available to | | common stockholder's (16) $ 272 $ 425 $ 682 | | ====== ====== ====== ======| | Weighted average shares outstanding 185.2 185.4 185.2 185.4 | | ====== ====== ====== ======| | Net (loss) income per common share $(0.09) $ 1.47 $ 2.29 $ 3.68 | | ====== ====== ====== ======| | | |----------------------------------------------------------------------------------|
(39) EXHIBIT 12.1 CNA FINANCIAL CORPORATION COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES |------------------------------------------------------------------| |PERIOD ENDED SEPTEMBER 30 | |(In millions of dollars, except ratios) 1998 1997 | |------------------------------------------------------------------| |Income before income tax and cumulative effect | | of accounting changes $ 589 $ 963 | |Adjustments: | | Interest expense 168 153 | | Interest element of operating lease rental 37 25 | | ----- -------| | Income before income tax, as adjusted $ 794 $ 1,141 | | ===== =======| | | |Fixed charges: | | Interest expense $ 168 $ 153 | | Interest element of operating lease rental 37 25 | | ----- -------| |Fixed charges $ 205 $ 178 | | ===== =======| |Ratio of earnings to fixed charges (1) 3.9 6.4 | |------------------------------------------------------------------| (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 |----------------------------------------------------------------------------| |PERIOD ENDED SEPTEMBER 30 | |(In millions of dollars, except ratios) 1998 1997 | |----------------------------------------------------------------------------| |Net Income $ 429 $ 687 | |Adjustments: | | Interest expense, after tax 109 100 | | Interest element of operating lease rental, after tax 24 16 | | ----- ---- | |Net income, as adjusted $ 562 $ 803 | | ===== ==== | | | |Fixed charges: | | Interest expense, after tax $ 109 $ 100 | | Interest element of operating lease rental, after tax 24 16 | | ----- ---- | |Fixed charges $ 133 $ 116 | | ===== ==== | |Ratio of net income, as adjusted, to fixed charges (1) 4.2 6.9 | |--------------------------------------------------------------------------- | (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. (40) EX-27 2 ARTICLE 7 FDS FOR 10-Q
7 0000021175 CNA FINANCIAL CORPORATION 1,000,000 9-MOS DEC-31-1998 JAN-1-1998 SEP-30-1998 29,322 0 0 1,362 60 5 36,305 135 6,235 2,359 62,566 29,369 5,084 150 767 2,967 0 150 464 8,359 62,566 10,135 1,641 512 598 8,561 1,804 1,764 589 (160) 429 0 0 0 429 2.29 2.29 23,245 5,643 119 1,771 4,635 22,601 119
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