-----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, OaBdQssRxjkNYGXdr1s6JxEu6EZKJyH+EJHCcqdB8/6svhUOdNAEl1exUPchd2N5 xUdM/NICzEliHP0ZkUt3fw== /in/edgar/work/0001104659-00-000654/0001104659-00-000654.txt : 20001110 0001104659-00-000654.hdr.sgml : 20001110 ACCESSION NUMBER: 0001104659-00-000654 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 20000930 FILED AS OF DATE: 20001109 FILER: COMPANY DATA: COMPANY CONFORMED NAME: CNA FINANCIAL CORP CENTRAL INDEX KEY: 0000021175 STANDARD INDUSTRIAL CLASSIFICATION: [6331 ] IRS NUMBER: 366169860 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-05823 FILM NUMBER: 757628 BUSINESS ADDRESS: STREET 1: CNA PLZ STREET 2: 235 CITY: CHICAGO STATE: IL ZIP: 60685 BUSINESS PHONE: 3128225000 MAIL ADDRESS: STREET 1: CNA PLAZA STREET 2: 235 CITY: CHICAGO STATE: IL ZIP: 60685 10-Q 1 0001.txt QUARTERLY REPORT ================================================================================ 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, 2000 COMMISSION FILE NUMBER 1-5823 -------------------------- CNA FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) DELAWARE 36-6169860 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) CNA PLAZA CHICAGO, ILLINOIS 60685 (Address of principal executive offices) (Zip Code) (312) 822-5000 (REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No... Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. CLASS OUTSTANDING AT NOVEMBER 6, 2000 ----------------------------- ------------------------------- Common Stock, Par value $2.50 183,261,373 ================================================================================ Page 1 CNA FINANCIAL CORPORATION INDEX PART I. FINANCIAL INFORMATION PAGE NO. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS: CONDENSED CONSOLIDATED BALANCE SHEETS SEPTEMBER 30, 2000 (Unaudited) AND DECEMBER 31, 1999............... 3 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999.... 4 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999.............. 5 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) SEPTEMBER 30, 2000.......................... 6 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......................................... 21 PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K............................ 45 SIGNATURES ............................................................ 45 EXHIBIT 10 EMPLOYMENT CONTRACT......................................... 46 EXHIBIT 27 FINANCIAL DATA SCHEDULE .................................... 57 Page 2 CNA FINANCIAL CORPORATION CONDENSED CONSOLIDATED BALANCE SHEETS
- ----------------------------------------------------------------------------------------------------------------------------------- (UNAUDITED) SEPTEMBER 30, DECEMBER 31, (In millions of dollars, except share data) 2000 1999 - ----------------------------------------------------------------------------------------------------------------------------------- ASSETS Investments: Fixed maturity securities available-for-sale (amortized cost: $26,978 and $27,948) $ 26,664 $ 27,248 Equity securities available-for-sale (cost: $1,224 and $1,150) 2,636 3,610 Mortgage loans and real estate (less accumulated depreciation: $1 and $1) 27 47 Policy loans 193 192 Other invested assets 1,376 1,108 Short-term investments 4,780 3,355 ------------- ------------ TOTAL INVESTMENTS 35,676 35,560 Cash 174 153 Receivables: Reinsurance 8,983 7,403 Insurance 5,087 5,115 Less allowance for doubtful accounts (314) (310) Deferred acquisition costs 2,578 2,436 Prepaid reinsurance premiums 1,496 1,456 Accrued investment income 402 387 Receivables for securities sold 892 284 Federal income taxes recoverable (includes: $0 and $241 due from Loews) - 269 Deferred income taxes 816 852 Property and equipment at cost (less accumulated depreciation: $821 and $701) 731 746 Intangibles 320 328 Other assets 2,168 1,937 Separate account business 4,513 4,603 - ----------------------------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $ 63,522 $ 61,219 =================================================================================================================================== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Insurance reserves: Claim and claim adjustment expense $ 27,112 $ 27,356 Unearned premiums 5,103 5,103 Future policy benefits 6,376 5,996 Policyholders' funds 656 710 Collateral on loaned securities 1,839 1,300 Payables for securities purchased 962 135 Participating policyholders' equity 139 121 Debt 2,774 2,881 Federal income taxes payable (includes: $171 and $0 due to Loews) 153 - Other liabilities 4,371 3,881 Separate account business 4,513 4,603 ------------- ------------ TOTAL LIABILITIES 53,998 52,086 ------------- ------------ Commitments and contingencies Minority Interest 217 195 Stockholders' equity: Common stock ($2.50 par value; Authorized - 500,000,000 shares; Issued - 185,525,907 shares; Outstanding as of September 30, 2000 - 183,419,823 shares, Outstanding as of December 31, 1999 - 184,406,931 shares) 464 464 Preferred stock - 150 Additional paid-in capital 126 126 Retained earnings 8,134 7,114 Accumulated other comprehensive income 720 1,188 Treasury stock, at cost (66) (41) ------------- ------------- 9,378 9,001 Notes receivable for the issue of stock (71) (63) ------------- ------------- TOTAL STOCKHOLDERS' EQUITY 9,307 8,938 - ----------------------------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 63,522 $ 61,219 ===================================================================================================================================
See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited). Page 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) 2000 1999 2000 1999 - ----------------------------------------------------------------------------------------------------------------------------------- Revenues: Net earned premiums $ 2,919 $ 3,351 $ 8,467 $ 10,296 Net investment income 529 531 1,537 1,562 Realized investment gains (losses), net of participating policyholders' and minority interest 706 (81) 1,168 308 Other 174 200 520 529 ---------- ------------ ---------- ------------ Total revenues 4,328 4,001 11,692 12,695 ---------- ------------ ---------- ------------ Claims, benefits and expenses: Insurance claims and policyholders' benefits 2,465 2,758 7,156 8,606 Amortization of deferred acquisition costs 456 483 1,381 1,591 Other operating expenses 542 656 1,489 1,802 Restructuring and other related charges - 16 - 70 Interest 54 55 154 163 ---------- ------------ ---------- ------------ Total claims, benefits and expenses 3,517 3,968 10,180 12,232 ---------- ------------ ---------- ------------ Income before income tax and cumulative effect of a change in accounting principle 811 33 1,512 463 Income tax (expense) benefit (251) 4 (468) (87) Minority interest (10) (8) (23) (21) ---------- ------------ ---------- ------------ Income before cumulative effect of a change in accounting principle 550 29 1,021 355 Cumulative effect of a change in accounting principle, net of tax of $95 - - - (177) - ----------------------------------------------------------------------------------------------------------------------------------- Net income $ 550 $ 29 $ 1,021 $ 178 =================================================================================================================================== BASIC AND DILUTED EARNINGS PER SHARE AVAILABLE TO COMMON STOCKHOLDERS Income before cumulative effect of a change in accounting principle $ 3.00 $ 0.15 $ 5.55 $ 1.87 Cumulative effect of a change in accounting principle, net of tax - - - (0.96) ----------- ------------ ---------- ------------ Net income $ 3.00 $ 0.15 $ 5.55 $ 0.91 =========== ============ ========== ============ Weighted average outstanding common shares and common stock equivalents (in millions of shares) Basic 183.4 184.3 183.7 184.2 Diluted 183.5 184.3 183.7 184.2 ===================================================================================================================================
See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited). Page 4 CNA FINANCIAL CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
- ------------------------------------------------------------------------------------------------------------- PERIOD ENDED SEPTEMBER 30 NINE MONTHS (In millions of dollars) 2000 1999 - ------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 1,021 $ 178 Adjustments to reconcile net income to net cash flows from operating activities: Minority interest 23 21 Deferred income tax provision 292 (50) Net realized investment gains (1,168) (308) Amortization of intangibles 16 18 Accretion of bond discount (232) (166) Depreciation 111 141 Changes in: Receivables, net (1,548) 71 Deferred acquisition costs (155) (217) Accrued investment income (20) (2) Federal income taxes recoverable / payable 422 101 Prepaid reinsurance premiums (40) (285) Insurance reserves 175 168 Other 230 331 ---------- ---------- Total adjustments (1,894) (177) ---------- ---------- NET CASH FLOWS FROM OPERATING ACTIVITIES (873) 1 ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of fixed maturity securities (29,061) (35,854) Proceeds from fixed maturity securities: Sales 27,003 35,015 Maturities, calls and redemptions 3,259 2,305 Purchases of equity securities (1,388) (735) Proceeds from sale of equity securities 2,298 892 Change in short-term investments (1,241) (3,382) Change in collateral on loaned securities 539 2,538 Change in other investments 5 81 Purchases of property and equipment, net (108) (149) Other, net (17) (92) ---------- ---------- NET CASH FLOWS FROM INVESTING ACTIVITIES 1,289 619 ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Dividends paid to preferred shareholders (1) (11) Purchase of treasury stock, net (28) - Receipts from investment contracts credited to policyholder account balances 4 5 Return of policyholder account balances on investment contracts (113) (56) Principal payments on debt (112) (447) Proceeds from issuance of debt 5 177 Redemption of preferred stock (150) (200) ---------- ---------- NET CASH FLOWS FROM FINANCING ACTIVITIES (395) (532) ---------- ---------- Net cash flows 21 88 Cash at beginning of period 153 217 - ------------------------------------------------------------------------------------------------------------- CASH AT END OF PERIOD $ 174 $ 305 ============================================================================================================= Supplemental disclosures of cash flow information: Cash received (paid): Interest expense $ (106) $ (128) Federal income taxes 240 142 Non-cash transactions: Notes receivable from the issuance of stock 4 17 Exchange of Canary Wharf limited partnership interest into common stock - 539 See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).
Page 5 CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE A - BASIS OF PRESENTATION The condensed consolidated financial statements (unaudited) include CNA Financial Corporation (CNAF) and its subsidiaries, which include property/casualty insurance companies (principally Continental Casualty Company and The Continental Insurance Company) and life insurance companies (principally Continental Assurance Company and Valley Forge Life Insurance Company), collectively CNA, or the Company. As of September 30, 2000, Loews Corporation (Loews) owned approximately 87% of the outstanding common stock of CNAF. The accompanying condensed consolidated financial statements are unaudited and have been prepared in conformity with accounting principles generally accepted in the United States (GAAP). Certain financial information that is normally included in annual financial statements, including financial statement footnotes, prepared in accordance with GAAP, but that is not required for interim reporting purposes, has been condensed or omitted. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in CNAF's Annual Report to Shareholders for the year ended December 31, 1999 (incorporated by reference in Form 10-K/A filed with the Securities and Exchange Commission for the year ended December 31, 1999). In the opinion of management, these statements include all adjustments (consisting of normal recurring accruals) that are necessary for the fair presentation of the consolidated financial position, results of operations and cash flows. The operating results for the interim periods are not necessarily indicative of the results to be expected for the full year. Certain amounts applicable to prior periods have been reclassified to conform to classifications followed in 2000. All material intercompany amounts have been eliminated. NOTE B - EARNINGS PER SHARE Earnings per share applicable to common stock is based on weighted average outstanding shares, retroactively adjusted for all stock splits. The computation of earnings per share follows.
- ------------------------------------------------------------------------------------------------------------------------ PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS (In millions of dollars, except per share data) 2000 1999 2000 1999 - ------------------------------------------------------------------------------------------------------------------------ Numerator: Net income $ 550 $ 29 $1,021 $ 178 Less: Preferred stock dividends - (2) (1) (10) ------------------------------------------------------------- Net income available to common stockholders $ 550 $ 27 $1,020 $ 168 ============================================================= Denominator: Weighted average outstanding common shares and common stock equivalents 183.4 184.3 183.7 184.2 Effect of dilutive securities: Employee Stock Options 0.1 - - - ------------------------------------------------------------- Adjusted weighted average shares outstanding and assuming conversions 183.5 184.3 183.7 184.2 ============================================================= Basic and diluted earnings per share available to common stockholders $3.00 $0.15 $5.55 $0.91 =============================================================
Page 6 CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (UNAUDITED) NOTE C - RESTRICTED INVESTMENTS The Company's largest equity holding in a single issuer is Global Crossing, Ltd. (Global Crossing) common stock. As of September 30, 2000, the Company owned 19.3 million shares valued at $600 million, representing approximately 2.2% of Global Crossing's outstanding common stock. Because the Company's holdings of Global Crossing were not acquired in a public offering, the shares may not be sold to the public unless the sale is registered or exempt from the registration requirements of the Securities Act of 1933 (the Act) including sales pursuant to Rule 144. In addition, the Company has the right to require Global Crossing to register under the Act all of the Company's current holdings. See Note G for discussion of the Company's hedge of this investment. NOTE D - LEGAL PROCEEDINGS AND CONTINGENT LIABILITIES TOBACCO LITIGATION Four insurance subsidiaries of the Company are defendants in a lawsuit arising out of policies allegedly issued to Liggett Group, Inc. ("Liggett"). The lawsuit was filed by Liggett and its current parent, Brooke Group Holding Inc., in the Delaware Superior Court, New Castle County on January 26, 2000. Although it did not issue policies to Liggett, CNAF also was named as a defendant. Subsequently, Liggett voluntarily dismissed CNAF. The lawsuit, which involves numerous insurers, concerns coverage issues relating to hundreds of tobacco-related claims asserted against Liggett over the past twenty years. However, Liggett only began submitting claims for coverage under the policies in January 2000. CNA believes its coverage defenses are strong. Based on facts and circumstances currently known, management believes that the ultimate outcome of the pending litigation should not materially affect the financial condition or operations of CNA. IGI CONTINGENCY In 1997, CNA Reinsurance Company Limited (CNA Re Ltd.) entered into an arrangement with IOA Global, Ltd. (IOA), an independent managing general agent based in Philadelphia, Pennsylvania, to develop and manage a book of accident and health coverages. Pursuant to this arrangement, IGI Underwriting Agencies, Ltd. (IGI), a personal accident reinsurance managing general underwriter, was appointed to underwrite and market the book under the supervision of IOA. Between April 1, 1997 and December 1, 1999, IGI underwrote a number of reinsurance arrangements with respect to personal accident insurance worldwide (the IGI Program). Under various arrangements, CNA Re Ltd. both assumed risks as a reinsurer and also ceded a substantial portion of those risks to other companies, including other CNA insurance subsidiaries and ultimately to a group of reinsurers participating in a reinsurance pool known as the Associated Accident and Health Reinsurance Underwriters (AAHRU) Facility. CNA's Group Operations business unit participated as a pool member in the AAHRU Facility in varying percentages over the past three years. CNA has undertaken a review of the IGI Program and, among other things, has determined that a small portion of the premium assumed under the IGI Program related to United States workers' compensation "carve-out" business. CNA is aware that a number of reinsurers with workers' compensation carve-out insurance exposure have disavowed their obligations under various legal theories. If one or more such companies are successful in avoiding or reducing their liabilities, then it is likely that CNA's liability will also be reduced. Moreover, based on information known at this time, CNA reasonably believes it has strong grounds for avoiding altogether a substantial portion of its United States workers' compensation carve-out exposure through legal action. Page 7 CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (UNAUDITED) As noted, CNA arranged substantial reinsurance protection to manage its exposures under the IGI Program. CNA believes it has valid and enforceable reinsurance contracts with the AAHRU Facility and other reinsurers with respect to the IGI Program, including the United States workers' compensation carve-out business. It is likely that certain reinsurers will dispute their liabilities to CNA; however, the Company is unable to predict the extent of such potential disputes at this time. Legal actions could result, and the resolution of any such actions could take years. Based on the Company's review of the entire IGI Program, CNA recorded a loss provision of $90 million in the fourth quarter of 1999. The loss provision was net of estimated recoveries from retrocessionaires. The Company is pursuing a number of loss mitigation strategies. Although the results of these various actions to date are consistent with the previous loss estimates, the estimate of ultimate losses is subject to considerable uncertainty. As a result of these uncertainties, the results of operations in future years may be adversely affected by potentially significant reserve additions. Management does not believe that any such future reserve additions will be material to the equity of the Company. OTHER LITIGATION CNAF and its subsidiaries are also parties to other litigation arising in the ordinary course of business. The outcome of such other litigation will not, in the opinion of management, materially affect the results of operations or equity of CNAF. ENVIRONMENTAL POLLUTION AND OTHER MASS TORT AND ASBESTOS CNA's property/casualty insurance companies have potential exposures related to environmental pollution and other mass tort and asbestos claims. Environmental pollution clean-up is the subject of both federal and state regulation. By some estimates, there are thousands of potential waste sites subject to clean-up. The insurance industry is involved in extensive litigation regarding coverage issues. Judicial interpretations in many cases have expanded the scope of coverage and liability beyond the original intent of the policies. The Comprehensive Environmental Response Compensation and Liability Act of 1980 (Superfund) and comparable state statutes (mini-Superfunds) govern the clean-up and restoration of abandoned toxic waste sites and formalize the concept of legal liability for clean-up and restoration by "Potentially Responsible Parties" (PRPs). Superfund and the mini-Superfunds establish mechanisms to pay for clean-up of waste sites if PRPs fail to do so, and to assign liability to PRPs. The extent of liability to be allocated to a PRP is dependent on a variety of factors. Further, the number of waste sites subject to clean-up is unknown. To date, approximately 1,300 clean-up sites have been identified by the Environmental Protection Agency (EPA) on its National Priorities List (NPL). The addition of new clean-up sites to the NPL has slowed in recent years. Many clean-up sites have been designated by state authorities as well. Many policyholders have made claims against various CNA insurance subsidiaries for defense costs and indemnification in connection with environmental pollution matters. These claims relate to accident years 1989 and prior, which coincides with CNA's adoption of the Simplified Commercial General Liability coverage form, which includes an absolute pollution exclusion. CNA and the insurance industry are disputing coverage for many such claims. Key coverage issues include whether clean-up costs are considered damages under the policies, trigger of coverage, allocation of liability among triggered policies, applicability of pollution exclusions and owned property exclusions, the potential for joint and several liability and the definition of an occurrence. To date, courts have been inconsistent in their rulings on these issues. Page 8 CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (UNAUDITED) A number of proposals to reform Superfund have been made by various parties. However, no reforms have been enacted by Congress in 1999 or thus far in 2000 and it is unclear as to what positions the Congress or the Administration will take and what legislation, if any, will result in the future. If there is legislation, and in some circumstances even if there is no legislation, the federal role in environmental clean-up may be significantly reduced in favor of state action. Substantial changes in the federal statute or the activity of the EPA may cause states to reconsider their environmental clean-up statutes and regulations. There can be no meaningful prediction of the pattern of regulation that would result. Due to the inherent uncertainties described above, including the inconsistency of court decisions, the number of waste sites subject to clean-up, and the standards for clean-up and liability, the ultimate liability of CNA for environmental pollution claims may vary substantially from the amount currently recorded. As of September 30, 2000 and December 31, 1999, CNA carried $366 million and $463 million of claim and claim expense reserves, net of reinsurance recoverables, for reported and unreported environmental pollution and other mass tort claims. CNA's property/casualty insurance subsidiaries have exposure to asbestos claims. 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, 2000 and December 31, 1999, CNA carried approximately $588 million and $684 million of claim and claim expense reserves, net of reinsurance recoverables, for reported and unreported asbestos-related claims, including those related to Fibreboard Corporation. Unfavorable asbestos claim reserve development totaled $12 million and $86 million for the three months ended September 30, 2000 and 1999 and $43 million and $215 million for the nine months ended September 30, 2000 and 1999. Unfavorable environmental pollution and other mass tort reserve development totaled $15 million and $36 million for the three and nine months ended September 30, 2000. Favorable environmental pollution and other mass tort reserve development totaled $33 million and $49 million for the three and nine months ended September 30, 1999. The results of operations in future years may continue to be adversely affected by environmental pollution and other mass tort and asbestos claims and claim expenses. Management will continue to monitor these liabilities and make further adjustments as warranted. The following table provides additional data related to CNA's environmental pollution, other mass tort and asbestos-related claim and claim adjustment expense reserves.
- -------------------------------------------------------------------------------------------------------------------- SEPTEMBER 30, 2000 DECEMBER 31, 1999 --------------------------------- --------------------------------- ENVIRONMENTAL ENVIRONMENTAL POLLUTION AND POLLUTION AND OTHER MASS OTHER MASS (In millions of dollars) TORT ASBESTOS TORT ASBESTOS - -------------------------------------------------------------------------------------------------------------------- Gross reserves $ 516 $ 849 $ 618 $ 946 Less ceded reserves (150) (261) (155) (262) ---------------------------------------------------------------------- Net reserves $ 366 $ 588 $ 463 $ 684 ======================================================================
Page 9 CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (UNAUDITED) NOTE E - REINSURANCE The effects of reinsurance on earned premiums are shown in the following table.
- -------------------------------------------------------------------------------------------------------------------- NINE MONTHS ENDED SEPTEMBER 30 EARNED PREMIUMS (In millions of dollars) DIRECT ASSUMED CEDED NET - -------------------------------------------------------------------------------------------------------------------- 2000 Property/casualty $ 6,261 $ 1,426 $ 2,601 $ 5,086 Accident and health 2,708 406 431 2,683 Life 896 173 371 698 -------------------------------------------------------- Total premiums $ 9,865 $ 2,005 $ 3,403 $ 8,467 ======================================================== 1999 Property/casualty $ 6,731 $ 1,237 $ 999 $ 6,969 Accident and health 2,813 140 276 2,677 Life 812 140 302 650 -------------------------------------------------------- Total premiums $ 10,356 $ 1,517 $ 1,577 $ 10,296 ========================================================
See Note J for discussion of the Personal Insurance business, which had the effect of increasing ceded earned premiums for the nine months ended September 30, 2000 by $1,431 million. NOTE F - DEBT
Debt is comprised of the following obligations. - -------------------------------------------------------------------------------------------------------------------- SEPTEMBER 30, DECEMBER 31, (In millions of dollars) 2000 1999 - -------------------------------------------------------------------------------------------------------------------- Variable rate debt: Commercial paper $ 675 $ 675 Credit facility--CNA - 77 Credit facility--CNA Surety 100 100 Senior notes: 7.25%, due March 1, 2003 138 143 6.25%, due November 15, 2003 249 249 6.50%, due April 15, 2005 490 497 6.75%, due November 15, 2006 249 248 6.45%, due January 15, 2008 149 149 6.60%, due December 15, 2008 199 199 8.375%, due August 15, 2012 68 81 6.95%, due January 15, 2018 148 148 7.25% debenture, due November 15, 2023 240 247 8.0% - 19.98% secured capital leases, due through December 31, 2011 41 42 Other debt, due through 2019 (rates of 1.0% to 8.50%) 28 26 -------------------------------------- Total debt $ 2,774 $ 2,881 ======================================
During the first nine months of 2000, the Company repaid bank loans drawn under the CNA credit facility and repurchased approximately $33 million of its notes. Page 10 CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (UNAUDITED) NOTE G - COMPREHENSIVE INCOME Comprehensive income is comprised of all changes to stockholders' equity, including net income, except for those changes resulting from investments by and distributions to owners. The components of comprehensive income are shown below.
- ----------------------------------------------------------------------------------------------------------------------- PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS (In millions of dollars) 2000 1999 2000 1999 - ----------------------------------------------------------------------------------------------------------------------- Net income $ 550 $ 29 $ 1,021 $ 178 Other comprehensive income (loss): Change in unrealized gains/losses on general account investments Holding gains (losses) arising during the period 441 (902) 250 (287) Less: Unrealized gains at beginning of period included in realized gains/losses during the period 503 34 958 287 ----------------------------------------------------------- Net change in unrealized gains/losses on general account investments (62) (936) (708) (574) Net change in unrealized gains/losses on separate accounts and other 31 (5) 28 15 Foreign currency translation adjustment (25) 8 (28) 13 Allocation to participating policyholders' and minority interest (10) (5) (15) 4 ----------------------------------------------------------- Other comprehensive (loss), before tax (66) (938) (723) (542) Deferred income tax benefit related to other comprehensive income 14 280 255 130 ----------------------------------------------------------- Other comprehensive (loss), net of tax (52) (658) (468) (412) ----------------------------------------------------------- Total comprehensive income (loss) $ 498 $ (629) $ 553 $ (234) ===========================================================
As of September 30, 2000, the Company held 19.3 million shares of Global Crossing common stock. During the first quarter of 2000, the Company entered into option agreements intended to hedge the market risk associated with approximately 19.3 million shares of Global Crossing common stock. These option agreements were structured as collars in which the Company purchased put options and sold call options on Global Crossing common stock. As of September 30, 2000, the average exercise prices were $51.70 and $64.93 on the put options and call options subject to adjustments on the call options under certain limited circumstances. The options expire in the first half of 2002 and are only exercisable on their expiration dates. The Company has designated the collars as hedges of its investment in Global Crossing. Accordingly, the fair value of the collars is presented in equity securities available-for-sale in the accompanying condensed consolidated balance sheets, consistent with the hedged item. The unrealized gain, including the fair market value of the collar, on the Company's position in Global Page 11 CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (UNAUDITED) Crossing was $920 million as of September 30, 2000. Changes in the Company's investment in Global Crossing were as follows, on a pretax basis.
- -------------------------------------------------------------------------------------------------------------------- PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS (In millions of dollars) 2000 1999 2000 1999 - -------------------------------------------------------------------------------------------------------------------- (Decrease) increase in unrealized gain on Global Crossing common stock $ (124) $ (588) $(1,203) $ 67 (Decrease) increase in unrealized gain on Collar (61) - 358 - ---------------------------------------------------------- Net (decrease) increase in unrealized gain on position in Global Crossing $ (185) $ (588) $ (845) $ 67 ========================================================== Realized gain on sales of Global Crossing common stock $ 229 - $ 485 $ 222 ==========================================================
NOTE H - BUSINESS SEGMENTS The Company's reportable segments are strategic businesses that offer different types of products and services. The Company has seven operating segments: Agency Market Operations, Specialty Operations, CNA Re, Global Operations, Risk Management, Group Operations and Life Operations. The Corporate segment results include interest expense on corporate borrowings of approximately $52 million and $54 million for the three months ended September 30, 2000 and 1999 and $149 million and $159 million for the nine months ended September 30, 2000 and 1999. All significant intercompany income and expenses, as well as intercompany dividends, have been eliminated. Risk Management intrasegment revenues and expenses, amounting to $39 million and $34 million for the three months ended September 30, 2000 and 1999 and $119 million and $127 million for the nine months ended September 30, 2000 and 1999 have been eliminated at the consolidated level. Page 12 CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------------ AGENCY RISK THREE MONTHS ENDED SEPTEMBER 30, 2000 MARKET SPECIALTY GLOBAL MANAGE- (In millions of dollars) OPERATIONS OPERATIONS CNA RE OPERATIONS MENT - ------------------------------------------------------------------------------------------------------------------------------------ Net earned premiums $ 807 $ 234 $ 289 $ 271 $ 142 Claims, benefits and expenses 939 244 312 283 177 ------------------------------------------------------------------------------ Underwriting loss (132) (10) (23) (12) (35) Net investment income 154 55 49 34 42 Other revenues 39 6 (8) 37 80 Other expenses 48 7 - 31 77 ------------------------------------------------------------------------------ Pretax operating income (loss) 13 44 18 28 10 Income tax benefit (expense) 4 (12) (2) (6) (2) Minority interest - - - (6) - ------------------------------------------------------------------------------ Net operating income (loss) (excluding realized investment gains) 17 32 16 16 8 Realized investment gains, net of tax, participating policyholders' interest and minority interest 191 69 42 54 48 ------------------------------------------------------------------------------ Net income (loss) $ 208 $ 101 $ 58 $ 70 $ 56 ==============================================================================
- ------------------------------------------------------------------------------------------------------------------------------------ THREE MONTHS ENDED SEPTEMBER 30, 2000 GROUP LIFE ELIMI- (In millions of dollars) OPERATIONS OPERATIONS CORPORATE NATIONS TOTAL - ------------------------------------------------------------------------------------------------------------------------------------ Net earned premiums $ 947 $ 236 $ 5 $ (12) $ 2,919 Claims, benefits and expenses 975 341 35 (12) 3,294 ------------------------------------------------------------------------------ Underwriting loss (28) (105) (30) - (375) Net investment income 38 152 5 - 529 Other revenues 12 49 1 (42) 174 Other expenses 9 27 66 (42) 223 ------------------------------------------------------------------------------ Pretax operating income (loss) 13 69 (90) - 105 Income tax benefit (expense) (3) (23) 39 - (5) Minority interest - - (4) - (10) ------------------------------------------------------------------------------ Net operating income (loss) (excluding realized investment gains) 10 46 (55) - 90 Realized investment gains, net of tax, participating policyholders' interest and minority interest 32 20 4 - 460 ------------------------------------------------------------------------------ Net income (loss) $ 42 $ 66 $ (51) $ - $ 550 ==============================================================================
Page 13 CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (UNAUDITED)
- ----------------------------------------------------------------------------------------------------------------------------- AGENCY RISK THREE MONTHS ENDED SEPTEMBER 30, 1999 MARKET SPECIALTY GLOBAL MANAGE- (In millions of dollars) OPERATIONS OPERATIONS CNA RE OPERATIONS MENT - ----------------------------------------------------------------------------------------------------------------------------- Net earned premiums $ 1,278 $ 229 $ 335 $ 258 $ 171 Claims, benefits and expenses 1,464 241 327 270 185 Restructuring and other related charges 11 - - - - --------------------------------------------------------------------- Underwriting (loss) gain (197) (12) 8 (12) (14) Net investment income 170 57 42 31 38 Other revenues 16 4 (2) 33 80 Other expenses 20 7 - 26 81 Non-insurance restructuring and other related charges - - - - 1 --------------------------------------------------------------------- Pretax operating (loss) income (31) 42 48 26 22 Income tax benefit (expense) 16 (13) (15) (7) (7) Minority interest - - - (6) - --------------------------------------------------------------------- Net operating (loss) income (excluding realized investment losses) (15) 29 33 13 15 Realized investment losses, net of tax, participating policyholders' interest and minority interest (22) (7) (3) (3) (4) --------------------------------------------------------------------- Net (loss) income $ (37) $ 22 $ 30 $ 10 $ 11 =====================================================================
- ------------------------------------------------------------------------------------------------------------------------ THREE MONTHS ENDED SEPTEMBER 30, 1999 GROUP LIFE ELIMI- (In millions of dollars) OPERATIONS OPERATIONS CORPORATE NATIONS TOTAL - ------------------------------------------------------------------------------------------------------------------------ Net earned premiums $871 $ 231 $ (2) $ (20) $ 3,351 Claims, benefits and expenses 864 339 44 (14) 3,720 Restructuring and other related charges - - - - 11 -------------------------------------------------------------------- Underwriting (loss) gain 7 (108) (46) (6) (380) Net investment income 30 136 27 - 531 Other revenues 11 48 58 (48) 200 Other expenses 12 21 119 (54) 232 Non-insurance restructuring and other related charges - - 4 - 5 -------------------------------------------------------------------- Pretax operating (loss) income 36 55 (84) - 114 Income tax benefit (expense) (12) (19) 33 - (24) Minority interest - - (2) - (8) -------------------------------------------------------------------- Net operating (loss) income (excluding realized investment losses) 24 36 (53) - 82 Realized investment losses, net of tax, participating policyholders' interest and minority interest (2) (12) - - (53) -------------------------------------------------------------------- Net (loss) income $ 22 $ 24 $ (53) $ - $ 29 ====================================================================
Page 14 CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (UNAUDITED)
- ----------------------------------------------------------------------------------------------------------------------------- AGENCY RISK NINE MONTHS ENDED SEPTEMBER 30, 2000 MARKET SPECIALTY GLOBAL MANAGE- (In millions of dollars) OPERATIONS OPERATIONS CNA RE OPERATIONS MENT - ----------------------------------------------------------------------------------------------------------------------------- Net earned premiums $ 2,477 $ 578 $ 802 $ 811 $ 448 Claims, benefits and expenses 2,818 595 868 854 554 ------------------------------------------------------------------ Underwriting loss (341) (17) (66) (43) (106) Net investment income 452 163 143 101 123 Other revenues 109 19 (5) 90 238 Other expenses 128 23 3 87 240 ------------------------------------------------------------------ Pretax operating income (loss) 92 142 69 61 15 Income tax (expense) benefit (12) (43) (18) (15) - Minority interest - - - (19) - ------------------------------------------------------------------ Net operating income (loss) (excluding realized investment gains) 80 99 51 27 15 Realized investment gains, net of tax, participating policyholders' interest and minority interest 341 124 72 71 85 ------------------------------------------------------------------ Net income (loss) $ 421 $ 223 $ 123 $ 98 $ 100 ==================================================================
- ---------------------------------------------------------------------------------------------------------------------------- NINE MONTHS ENDED SEPTEMBER 30, 2000 GROUP LIFE ELIMI- (In millions of dollars) OPERATIONS OPERATIONS CORPORATE NATIONS TOTAL - ---------------------------------------------------------------------------------------------------------------------------- Net earned premiums $ 2,708 $ 674 $ 1 $ (32) $ 8,467 Claims, benefits and expenses 2,772 990 89 (32) 9,508 -------------------------------------------------------------------- Underwriting loss (64) (316) (88) - (1,041) Net investment income 104 444 7 - 1,537 Other revenues 36 149 14 (130) 520 Other expenses 36 77 208 (130) 672 -------------------------------------------------------------------- Pretax operating income (loss) 40 200 (275) - 344 Income tax (expense) benefit (11) (68) 108 - (59) Minority interest - - (4) - (23) -------------------------------------------------------------------- Net operating income (loss) (excluding realized investment gains) 29 132 (171) - 262 Realized investment gains, net of tax, participating policyholders' interest and minority interest 52 13 1 - 759 -------------------------------------------------------------------- Net income (loss) $ 81 $ 145 $ (170) $ - $ 1,021 ====================================================================
Page 15 CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------------ AGENCY RISK NINE MONTHS ENDED SEPTEMBER 30, 1999 MARKET SPECIALTY GLOBAL MANAGE- (In millions of dollars) OPERATIONS OPERATIONS CNA RE OPERATIONS MENT - ------------------------------------------------------------------------------------------------------------------------------------ Net earned premiums $ 3,974 $ 773 $ 866 $ 767 $ 591 Claims, benefits and expenses 4,582 820 900 777 640 Restructuring and other related charges 48 - - - - --------------------------------------------------------------------- Underwriting loss (656) (47) (34) (10) (49) Net investment income 517 174 117 100 111 Other revenues 50 12 - 93 237 Other expenses 48 22 (5) 75 227 Non-insurance restructuring and other related charges - - - - 8 --------------------------------------------------------------------- Pretax operating (loss) income (137) 117 88 108 64 Income tax benefit (expense) 75 (32) (26) (31) (17) Minority interest - - - (20) - --------------------------------------------------------------------- Net operating (loss) income (excluding realized investment gains (losses)) (62) 85 62 57 47 Realized investment gains (losses), net of tax, participating policyholders' interest and minority interest 108 35 21 8 17 Cumulative effect of a change in accounting principle, net of tax (93) (3) - (3) (74) --------------------------------------------------------------------- Net (loss) income $ (47) $ 117 $ 83 $ 62 $ (10) =====================================================================
- ---------------------------------------------------------------------------------------------------------------------------- NINE MONTHS ENDED SEPTEMBER 30, 1999 GROUP LIFE ELIMI- (In millions of dollars) OPERATIONS OPERATIONS CORPORATE NATIONS TOTAL - ---------------------------------------------------------------------------------------------------------------------------- Net earned premiums $ 2,680 $ 648 $ 33 $ (36) $ 10,296 Claims, benefits and expenses 2,704 925 211 (36) 11,523 Restructuring and other related charges 5 - - - 53 ----------------------------------------------------------------- Underwriting loss (29) (277) (178) - (1,280) Net investment income 95 414 34 - 1,562 Other revenues 30 77 173 (143) 529 Other expenses 34 55 326 (143) 639 Non-insurance restructuring and other related charges - - 9 - 17 ----------------------------------------------------------------- Pretax operating (loss) income 62 159 (306) - 155 Income tax benefit (expense) (19) (55) 126 - 21 Minority interest - - (1) - (21) ----------------------------------------------------------------- Net operating (loss) income (excluding realized investment gains (losses)) 43 104 (181) - 155 Realized investment gains (losses), net of tax, participating policyholders' interest and minority interest 6 (31) 36 - 200 Cumulative effect of a change in accounting principle, net of tax (2) (2) - - (177) ----------------------------------------------------------------- Net (loss) income $ 47 $ 71 $ (145) $ - $ 178 =================================================================
Page 16 CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) NOTE I - RESTRUCTURING AND OTHER RELATED CHARGES As part of the Company's restructuring plan (the Plan) that was initiated in August 1998, restructuring-related charges of $70 million were recorded in the nine months ended September 30, 1999. Under GAAP, these charges did not qualify for the initial restructuring accrual at the end of the third quarter of 1998 and therefore, were expensed as incurred. The charges included the following: In the first nine months of 1999, restructuring-related charges for Agency Market Operations totaled approximately $48 million. The charges included employee severance and outplacement costs of $17 million related to the planned net reduction in the workforce. The Agency Market Operations charges also included consulting costs of $9 million and parallel processing charges of $10 million. Other charges, including relocation and facility charges, totaled approximately $12 million. In the first nine months of 1999, net restructuring-related charges for Risk Management totaled approximately $8 million. The charges included parallel processing costs of approximately $3 million and employee severance and outplacement costs of approximately $2 million. Other charges, including consulting and facility charges, totaled approximately $5 million. Additionally, Risk Management reduced its estimate for lease termination costs by $2 million during the nine months ended September 30, 1999. In the first nine months of 1999, restructuring-related charges for Group Operations totaled approximately $5 million related primarily to employee severance and other charges. For the other segments of the Company, restructuring-related charges totaled approximately $9 million for the first nine months of 1999 and related primarily to employee severance costs. No restructuring-related charges related to the Plan have been incurred in 2000; however, payments were made during 2000 related to amounts accrued under the Plan as of December 31, 1999. The following table sets forth the major categories of the restructuring accrual and changes therein during the first nine months of 2000.
- -------------------------------------------------------------------------------------------------------------------- EMPLOYEE TERMINATION AND RELATED LEASE BUSINESS BENEFIT TERMINATION EXIT (In millions of dollars) COSTS COSTS COSTS TOTAL - -------------------------------------------------------------------------------------------------------------------- Accrued costs at December 31, 1999 $ 4 $ 27 $ 15 $ 46 Payments charged against liability (4) (13) (10) (27) ---------------------------------------------------------------------- Accrued costs at September 30, 2000 $ - $ 14 $ 5 $ 19 ======================================================================
NOTE J - SIGNIFICANT TRANSACTIONS PERSONAL INSURANCE TRANSACTION On October 1, 1999, certain subsidiaries of CNA completed a transaction with The Allstate Corporation (Allstate), whereby CNA's personal lines insurance business (CNA Personal Insurance) and related employees were transferred to Allstate. Approximately $1.1 billion of cash and $1.1 billion of additional assets (primarily premium receivables and deferred policy acquisition costs) were transferred to Page 17 CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (UNAUDITED) Allstate, and Allstate assumed $2.2 billion of claim and claim adjustment expense reserves and unearned premium reserves. Additionally, CNA received $140 million in cash, which consisted of (i) $120 million in ceding commission for the reinsurance of the CNA Personal Insurance business by Allstate, and (ii) $20 million for an option exercisable during 2002 to purchase 100% of the common stock of five CNA insurance subsidiaries at a price equal to the GAAP carrying value as of the exercise date. Also, CNA invested $75 million in a ten year equity-linked note issued by Allstate. CNA will continue to write new and renewal CNA Personal Insurance policies and to reinsure this business with Allstate companies, until such time as Allstate exercises its option to buy the five CNA subsidiaries. Prior to 2002, the Company will concentrate the direct writing of CNA Personal Insurance business into the five optioned companies, such that most, if not all, business related to this transaction will be written by those companies by the date Allstate exercises its option. CNA continues to have primary liability on policies reinsured by Allstate. CNA will continue to have an ongoing interest in the profitability of the CNA Personal Insurance business and the related successor business through an agreement licensing the "CNA Personal Insurance" trademark and a portion of CNA's Agency Market Operations distribution system to Allstate for use in Allstate's personal insurance agency business for a period of five years. Under this agreement, CNA will receive a royalty fee based on the business volume of CNA Personal Insurance policies sold through the CNA agents for a period of six years. In addition, the $75 million equity-linked note will be redeemed on September 30, 2009 (subject to earlier redemption on stated contingencies) for an amount equal to the face amount plus or minus an amount not exceeding $10 million, depending on the underwriting profitability of the CNA Personal Insurance business. CNA also shares in any reserve development related to claim and claim adjustment expense reserves transferred to Allstate at the transaction date. Under the reserve development sharing agreement, 80% of any favorable or adverse reserve development up to $40 million and 90% of any favorable or adverse reserve development in excess of $40 million inures to CNA. CNA's obligation with respect to unallocated loss adjustment expense reserves was settled at the transaction date, and is therefore not subject to the reserve sharing arrangement. The retroactive portion of the reinsurance transaction, consisting primarily of the cession of claim and claim adjustment expense reserves approximating $1.0 billion, was not recognized as reinsurance because the criteria for risk transfer was not met for this portion of the transaction. The related consideration paid was recorded as a deposit and is included in reinsurance receivables in the consolidated balance sheets. The prospective portion of the transaction, which as of the transaction date consisted primarily of the cession of $1.1 billion of unearned premium reserves, has been recorded as reinsurance. The related consideration paid was recorded as prepaid reinsurance premiums. Premiums ceded after the transaction date will follow this same treatment. The $20 million received from Allstate for the option to purchase the five CNA subsidiaries was deferred and will not be recognized until Allstate exercises its option, at which time it will be recorded in realized gains and losses. The ceding commission related to the prospective portion of the transaction has been recognized in proportion to the recognition of the unearned premium reserve to which it relates. Approximately $8 million and $69 million of the ceding commission was earned for the three month and nine month periods ended September 30, 2000. The entire $120 million ceding commission has now been earned over the twelve months since the transfer to Allstate. Approximately $7 million and $21 million of royalty fees were earned for the three month and nine month periods ended September 30, 2000. Page 18 CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (UNAUDITED) The CNA Personal Insurance business (which was transferred to Allstate) contributed net earned premiums of $459 million and $1.4 billion, and net operating income of $17 million and $42 million, during the three month and nine month periods ended September 30, 1999. SALE OF AMS SERVICES, INC. On November 30, 1999, CNA sold the majority of its interest in AMS Services, Inc. (AMS), a software development company serving the insurance agency market. Prior to the sale, CNA owned 89% of AMS and consolidated AMS in its financial statements. As a result of the sale, CNA owns 9% of AMS and therefore AMS is no longer consolidated. CNA's share of AMS' operating results included $58 million and $178 million of operating revenue, and $3 million of net operating income and $7 million of net operating loss for the three and nine month periods ended September 30, 1999. NOTE K - RELATED PARTY TRANSACTIONS CNA reimburses Loews, or pays directly to Loews employees, approximately $13 million annually for management fees, travel and related expenses, and expenses of investment facilities and services provided to CNA. CNA and its eligible subsidiaries are included in the consolidated Federal income tax return of Loews and its eligible subsidiaries. During the first nine months of 2000, CNA received a tax refund of $282 million from Loews. For the first nine months of 1999, CNA received a tax refund of $154 million from Loews. CNA writes, at standard rates, a limited amount of insurance for Loews and its affiliates. Total premiums from Loews and its affiliates are less than $10 million on an annual basis. CNA assumes the risk for a limited amount of insurance from R.V.I. Guaranty Company, Inc., a 50% owned affiliate. Written premiums assumed are less than $10 million on an annual basis. CNA sponsors a stock ownership plan whereby the Company finances the purchase of Company stock by certain executive officers. NOTE L - ACCOUNTING PRONOUNCEMENTS In the first quarter of 2000, the Company adopted the American Institute of Certified Public Accountants' Statement of Position (SOP) 98-7, "Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." Adoption of the SOP did not have a material impact on the financial position or results of operations of the Company. In the first quarter of 1999, the Company adopted the American Institute of Certified Public Accountants' SOP 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." SOP 97-3 requires that insurance companies recognize liabilities for insurance-related assessments when an assessment is probable and will be imposed, when it can be reasonably estimated, and when the event obligating an entity to pay an imposed or probable assessment has occurred. Adoption of the SOP resulted in an after-tax charge of $177 million as a cumulative effect of a change in accounting principle. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements". This bulletin summarizes the SEC Staff's view in applying accounting principles generally accepted in the United States (GAAP) to revenue Page 19 CNA FINANCIAL CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--CONTINUED (UNAUDITED) recognition in financial statements. This bulletin, through its subsequent revised releases SAB No. 101A and No. 101B, is effective for registrants no later than the fourth fiscal quarter of fiscal years beginning after December 15, 1999. Adoption of this bulletin, which occurred on October 1, 2000, will not have a significant impact on the results of operations or equity of the Company. In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133 entitled "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133). SFAS No. 133 was subsequently amended by SFAS No. 137, which delayed the effective date by one year, and SFAS No. 138, which clarified four areas which were causing difficulties in implementation. SFAS No. 133 requires the recognition of all derivative financial instruments, including embedded derivative instruments, as either assets or liabilities in the statement of financial position and measurement of those instruments at fair value. The accounting for gains and losses associated with changes in the fair value of a derivative and the effect on the consolidated financial statements will depend on its hedge designation and whether the hedge is highly effective in achieving offsetting changes in the fair value or cash flows of the asset or liability hedged. If the derivative is designated in a fair value hedge, the changes in the fair value of the derivative and the hedged item will be recognized in earnings. If the derivative is designated as a cash flow hedge, changes in the fair value of the derivative will be recorded in other comprehensive income and will be recognized in the income statement when the hedged item affects earnings. A derivative that does not qualify as a hedge will be marked to fair value through earnings. Under the provisions of SFAS No. 133, the method that will be used for assessing the effectiveness of a hedging derivative as well as the measurement approach for determining the ineffective aspects of the hedge must be established at the inception of the hedge. On that initial application date, hedging relationships must be designated anew and documented pursuant to the provisions of SFAS No. 133. The Company is required to adopt SFAS No. 133 effective January 1, 2001. The transition adjustments resulting from adoption must be reported in net income or other comprehensive income, as appropriate, as the cumulative effect of a change in accounting principle. Based on current facts and circumstances, adoption of SFAS No. 133 will not have a material impact on total equity of the Company. It is estimated that the adoption will result in an after-tax decrease to earnings in the range of $20 million to $35 million. However, because the Company already carries the derivatives impacted by adoption at fair value via unrealized gains and losses, there is an equal and offsetting favorable adjustment to other comprehensive income. These estimates are based on the Company's current derivative holdings and hedging strategies. Changes therein, or changes in financial market conditions, during the fourth quarter could result in changes in the transition adjustment estimates. Effective January 1, 2001, the Company is required to adopt statutory-basis accounting changes related to the National Association of Insurance Commissioners codification of Statutory Accounting Practices. The Company is in the process of quantifying the impact these statutory-basis accounting changes will have on its operations and statutory capital and surplus. Page 20 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CONSOLIDATED OPERATIONS The following management discussion and analysis (MD&A) should be read in conjunction with the condensed consolidated financial statements and notes thereto found on pages 3 to 20, which contain additional information to evaluate operating results and financial condition. CNA is one of the largest insurance organizations in the United States and based on 1999 net written premiums, is the eighth largest property/casualty company and the thirty-sixth largest life insurance company. CNA conducts its operations through seven operating segments. In addition to the seven operating segments, certain other activities are reported in the corporate segment. These operating segments reflect the way in which CNA distributes its products to the marketplace and the way in which it manages operations and makes business decisions. OPERATING RESULTS The following chart summarizes key components of operating results for the three and nine months ended September 30, 2000 and 1999.
- ---------------------------------------------------------------------------------------------------------------------- PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS (In millions of dollars except per share data) 2000 1999 2000 1999 - ---------------------------------------------------------------------------------------------------------------------- Operating revenues (excluding realized investment gains (losses)): Net earned premiums $ 2,919 $ 3,351 $ 8,467 $ 10,296 Net investment income 529 531 1,537 1,562 Other 174 200 520 529 --------------------------------------------- Total operating revenues (excluding realized investment gains (losses)) 3,622 4,082 10,524 12,387 Claims, benefits and expenses 3,517 3,952 10,180 12,162 Restructuring and other related charges -- 16 -- 70 --------------------------------------------- Operating income before income tax 105 114 344 155 Income tax (expense) benefit (5) (24) (59) 21 Minority interest (10) (8) (23) (21) --------------------------------------------- Net operating income (excluding realized investment gains (losses)) 90 82 262 155 Realized investment gains (losses), net of tax, participating policyholders' and minority interest 460 (53) 759 200 --------------------------------------------- Income before cumulative effect of a change in accounting principle 550 29 1,021 355 Cumulative effect of a change in accounting principle, net of tax -- -- -- (177) --------------------------------------------- Net income $ 550 $ 29 $ 1,021 $ 178 ============================================ BASIC AND DILUTED EARNINGS PER SHARE Net operating income (excluding realized investments gains (losses)) $ 0.49 $ 0.43 $ 1.42 $ 0.78 Realized investment gains, net of tax, participating policyholders' and minority interest 2.51 (0.28) 4.13 1.09 Cumulative effect of a change in accounting principle, net of tax -- -- -- (0.96) --------------------------------------------- Net income $ 3.00 $ 0.15 $ 5.55 $ 0.91 ============================================
Page 21 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued The following table summarizes net operating income excluding realized investment gains/losses (net operating income) by segment for the three and nine months ended September 30, 2000 and 1999.
- ----------------------------------------------------------------- PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS (In millions of dollars) 2000 1999 2000 1999 - ----------------------------------------------------------------- Agency Market Operations $ 17 $ (15) $ 80 $ (62) Specialty Operations 32 29 99 85 CNA Re 16 33 51 62 Global Operations 16 13 27 57 Risk Management 8 15 15 47 Group Operations 10 24 29 43 Life Operations 46 36 132 104 Corporate and Eliminations (55) (53) (171) (181) -------------------------------- Net operating income $ 90 $ 82 $ 262 $ 155 ================================
Net operating income was $90 million, or $0.49 per share, for the third quarter of 2000, compared with net operating income of $82 million, or $0.43 per share, for the same period in 1999. Net operating income increased $8 million for the third quarter of 2000 as compared with the same period of 1999, primarily as a result of the absence of after-tax restructuring-related charges of $10 million. The quarter benefited from decreased net catastrophe losses of $43 million excluding losses related to CNA Personal Insurance, all of which were reinsured. Offsetting the favorable catastrophe experience was an increase in the current accident year loss ratio, primarily in CNA Re. Other factors in the quarter-over-quarter net operating income results were challenges faced in Group Operations and Risk Management as discussed in their individual MD&A sections, partially offset by improved earnings in Life Operations. Net operating income was $262 million, or $1.42 per share, for the first nine months of 2000, compared with net operating income of $155 million, or $0.78 per share, for the same period in 1999. Net operating income increased $107 million for the nine months ended September 30, 2000 as compared with the same period in 1999 primarily as a result of the improvement in property/casualty underwriting results, primarily in Agency Market Operations, and improved earnings in Life Operations. The primary drivers of the improvements are decreased net catastrophe losses of $49 million excluding losses related to CNA Personal Insurance, all of which were reinsured, increased use of reinsurance of $26 million and the absence of after-tax restructuring-related charges of $45 million. These improvements are partially offset by decreased investment income of $16 million and challenges faced in Group Operations and Risk Management as discussed in their individual MD&A sections. Net income for the third quarter of 2000 was $550 million, or $3.00 per share, compared with net income of $29 million, or $0.15 per share, for the third quarter of 1999. Net income for the first nine months of 2000 was $1,021 million, or $5.55 per share, as compared with net income of $178 million, or $0.91 per share, for the same period in 1999. Included in the net income for the nine months ended September 30, 1999 was a charge of $177 million, net of tax, or $0.96 per share, for the cumulative effect of a change in accounting principle for insurance-related assessments. Discussion of the results of operations from the Company's segments follow. Page 22 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued AGENCY MARKET OPERATIONS Agency Market Operations builds on the Company's long and successful relationship with the independent agency distribution system to market a broad range of property/casualty insurance products and services to small and middle market businesses. Business products include workers' compensation, commercial packages, general liability and commercial auto, as well as a variety of creative risk management services. Prior to October 1, 1999, these operations included personal auto and homeowners coverages and also offered personal umbrella, separate scheduled property, boat-owners and other recreational vehicle insurance. These personal lines (CNA Personal Insurance) were transferred to The Allstate Corporation (Allstate) effective October 1, 1999. See Note J of the Notes to the Condensed Consolidated Financial Statements (Notes) for further discussion of this transaction.
- ------------------------------------------------------------------------------------- PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS (In millions of dollars) 2000 1999 2000 1999 - ------------------------------------------------------------------------------------- Net written premiums $ 755 $ 1,234 $ 2,403 $ 4,000 Net earned premiums 807 1,278 2,477 3,974 Underwriting loss (132) (197) (341) (656) Net operating income (loss) 17 (15) 80 (62) Loss ratio 80.5% 81.7% 80.4% 83.3% Expense ratio 33.3 33.1 31.0 32.8 Dividend ratio 2.5 0.6 2.4 0.4 --------------------------------------------- Combined ratio 116.3% 115.4% 113.8% 116.5% =============================================
Agency Market Operations' net written and net earned premiums were impacted by the transfer of CNA Personal Insurance to Allstate. Net written premiums from CNA Personal Insurance for the three and nine months ended September 30, 1999 were $494 million and $1,500 million, and net earned premiums were $459 million and $1,354 million for the same periods. Apart from the impact of CNA Personal Insurance, Agency Market Operations' net written premiums increased $15 million, or 2%, to $755 million in the third quarter of 2000 as compared with the third quarter of 1999. Net written premiums for the Commercial Insurance business increased $36 million to $735 million caused primarily by a decrease in ceded premiums relating to a change in the structure of reinsurance which reduced ceded premiums and ceding commissions. Net earned premiums in Agency Market Operations decreased $12 million, or 2%, to $807 million in the same period. The decline in net earned premiums was due to continued efforts to re-underwrite business and obtain adequate rates for exposure. The combined ratio for the third quarter of 2000 increased 0.9 points to 116.3% as compared with the third quarter of 1999. The overall loss ratio improvement of 1.2 points is comprised of underwriting actions including the increased use of reinsurance, continued efforts to achieve adequate rates for exposure and the non-renewal of unprofitable business, and lower catastrophe losses than in 1999. These underwriting actions provided a benefit of 5.4 points on the loss ratio partially offset by the effects of CNA Personal Insurance which had a favorable impact on the aggregate 1999 loss ratio that is absent in 2000. The expense ratio increased 0.2 points due to a decrease in ceding commissions relating to reinsurance, partially offset by the absence of restructuring-related charges. The dividend ratio increase is attributable to favorable dividend development in 1999. Underwriting results for the third quarter of 2000 Page 23 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued improved $65 million from a loss of $197 million to a loss of $132 million, principally attributable to a lower loss ratio. Net operating income for the third quarter of 2000 increased to $17 million profit as compared with a loss of $15 million during the same period in 1999 based on improved underwriting results, partially offset by lower investment income. Aside from the effects of the CNA Personal Insurance transaction, net written premiums decreased $97 million, or 4%, to $2,403 million for the first nine months of 2000 as compared with the same period in 1999. The net written premiums of the Commercial Insurance business decreased slightly to $2,318 million for the same period. Net earned premiums declined by $143 million, or 5%, to $2,477 million for the first nine months of 2000 as compared with the same period in 1999. These declines were due principally to a continued focus on underwriting. The combined ratio for the nine months ended September 30, 2000 improved 2.7 points to 113.8% as compared with the same period of 1999. The overall loss ratio improvement of 2.9 points is comprised of underwriting actions including the continued efforts to achieve adequate rates for exposure, the non-renewal of unprofitable business, the increased benefit from reinsurance, and lower catastrophe losses than in 1999. These underwriting actions provided a benefit of 7.9 points on the loss ratio partially offset by the effects of CNA Personal Insurance which had a favorable impact on the aggregate 1999 loss ratio that is absent in 2000. The expense ratio declined 1.8 points due to a reduction in ongoing operating expenses and a 0.7 point decline from the absence of restructuring-related charges. The dividend ratio increase is attributable to favorable dividend development in 1999. Underwriting results for the nine months ended September 30, 2000 improved $315 million from a loss of $656 million to a loss of $341 million attributable principally to a lower loss ratio, of which $64 million is related to the increased use of reinsurance, and decreased operating expenses. Net operating income for the period ended September 30, 2000 increased to $80 million profit as compared with a loss of $62 million during the same period in 1999 based on improved underwriting results, partially offset by lower investment income. Commercial Insurance is currently achieving an average rate increase of approximately 15 percent. The current reported loss trend is the first year of loss ratio improvement for Commercial Insurance since 1993 and this improvement is expected to accelerate as rate increases and underwriting actions are earned. Commercial Insurance retention is in the low 70 percent range. Page 24 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued SPECIALTY OPERATIONS Specialty Operations provides a broad array of professional, financial and specialty property/casualty products and services distributed through a network of brokers, managing general agencies and independent agencies.
- ------------------------------------------------------------------------- PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS (In millions of dollars) 2000 1999 2000 1999 - ------------------------------------------------------------------------- Net written premiums $ 241 $ 225 $ 584 $ 733 Net earned premiums 234 229 578 773 Underwriting loss (10) (12) (17) (47) Net operating income 32 29 99 85 Loss ratio 79.2% 75.8% 76.1% 80.3% Expense ratio 25.0 29.8 26.8 25.7 Dividend ratio 0.1 (0.0) 0.1 0.1 ---------------------------------------- Combined ratio 104.3% 105.6% 103.0% 106.1% ========================================
Net written premiums for Specialty Operations for the third quarter of 2000 increased $16 million, or 7%, to $241 million as compared with the third quarter of 1999. In the third quarter of 2000, net earned premiums increased $5 million, or 2%, to $234 million as compared with the third quarter of 1999. These increases were primarily a result of $28 million of premium related to a contract assuming a large block of existing losses in medical professional liability, partially offset by a planned reduction in the lawyer's professional liability line of business and the lower premiums in the directors' and officers' business. The combined ratio improved 1.3 points to 104.3% for the third quarter of 2000 as compared with the third quarter of 1999. This improvement resulted primarily from the decrease in the expense ratio relating to increased net earned premiums coupled with decreased underwriting expenses. This improvement was partially offset by an increase in the loss ratio resulting from a relatively higher loss ratio on the medical professional liability transaction and an increase in the loss ratio for other medical malpractice business. Underwriting results improved by $2 million to a loss of $10 million in the third quarter of 2000 as compared with the same period in 1999 and net operating income improved $3 million for the third quarter of 2000 as compared with the third quarter of 1999 principally as a result of improvement in the expense ratio as discussed above. Net written premiums for the nine months ended September 30, 2000 decreased $149 million, or 20%, to $584 million as compared with the same period of 1999. Net earned premiums declined $195 million, or 25%, to $578 million for the nine months ended September 30, 2000 as compared with the same period in 1999. This premium decline related principally to 1) active decisions to renew only those accounts which meet current underwriting guidelines supporting the ongoing commitment to underwriting discipline, 2) a $27 million decline due to increased use of reinsurance for the medical professional liability lines, and 3) an increase in the retrospective return premium reserve relating to favorable loss development in the retrospectively rated Architects' and Engineers' business. The combined ratio improved 3.1 points to 103.0% for the first nine months of 2000 as compared with the same period in 1999 and underwriting results improved $30 million. These improvements are the Page 25 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued result of the ongoing commitment to underwriting discipline reflected by a 4.2 point decline in the loss ratio partially offset by the 1.1 point increase in the expense ratio. Acquisition and underwriting expenses have decreased year- over-year, but the expense ratio has increased because of the reduced net earned premium base. Net operating income increased $14 million for the first nine months of 2000 as compared with the same period of 1999, principally from the improvement in the underwriting results, partially offset by lower investment income. For the third quarter of 2000, Specialty Operations achieved an average rate increase of 25% in the CNA HealthPro business, including an average rate increase of 16% in the large institution and group practice business. Net written premiums are expected to decline from third quarter 2000 levels during the fourth quarter. CNA RE CNA Re operates globally as a reinsurer in the broker market, offering both treaty and facultative products through its principal offices in Chicago and London. While CNA Re's primary product is traditional treaty reinsurance, it also has positions in facultative and financial reinsurance.
- ----------------------------------------------------------------------------- PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS (In millions of dollars) 2000 1999 2000 1999 - ----------------------------------------------------------------------------- Net written premiums $ 214 $ 388 $ 769 $ 1,061 Net earned premiums 289 335 802 866 Underwriting (loss) gain (23) 8 (66) (34) Net operating income 16 33 51 62 Loss ratio 78.1% 68.7% 76.1% 73.3% Expense ratio 29.8 29.0 32.1 30.7 ------------------------------------------- Combined ratio 107.9% 97.7% 108.2% 104.0% ===========================================
For the third quarter, net written premiums decreased $174 million, or 45%, to $214 million as compared with the same period in 1999. This decrease reflects decisions not to renew contracts that CNA Re believes do not meet its underwriting profitability targets, partially offset by modest rate increases. Net earned premiums decreased $46 million, or 14%, to $289 million for the quarter consistent with the declines in net written premiums as discussed above. The third quarter combined ratio increased 10.2 points to 107.9% reflecting approximately $10 million of adverse loss development on 1999 catastrophe losses, including Typhoon Bart and the Danish storm, and adverse loss experience in 2000 in several lines of business including property excess of loss and directors' and officers' liability. Catastrophe losses were $34 million favorable from 1999. However, offsetting the favorable catastrophe experience was an increase in the current accident year loss ratio. Underwriting losses increased $31 million in the third quarter of 2000 as compared with the same period in 1999 principally as a result of the increase in the loss ratio. Net operating income decreased $17 million in the third quarter of 2000 as compared with 1999, reflecting the increase in underwriting losses, partially offset by increased investment income and a $3 million tax settlement recorded in the third quarter of 2000. For the nine months ended September 30, 2000, net written premiums decreased $292 million, or 28%, to $769 million as compared with the same period in 1999. Net earned premiums decreased $64 million, or 7%, to $802 million for Page 26 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued the nine month period ended September 30, 2000. These declines reflect continued decisions not to renew contracts that CNA Re believes do not meet its underwriting profitability targets, partially offset by modest rate increases. The nine month combined ratio increased 4.2 points to 108.2%. The combined ratio increase was driven by the third quarter 2000 increase in the loss ratio discussed above. The increase in the expense ratio was primarily due to the decrease in net earned premiums. The underwriting loss increased $32 million for the first nine months of 2000 as compared with the same period in 1999, primarily as a result of the third quarter 2000 underwriting results. Net operating income decreased $11 million for the first nine months of 2000 as compared with the same period in 1999. Increased investment income and the $3 million tax settlement recorded in the third quarter of 2000 partially offset the increased underwriting losses in 2000. In accordance with the Company's emphasis on disciplined underwriting, CNA Re is focusing its efforts on its core products. Certain non-core, low volume products not meeting underwriting profitability standards will no longer be written. These products currently represent less than 5% of CNA Re's earned premiums. Also, due to contraction of capacity in the reinsurance markets, CNA Re expects it will be able to achieve pricing improvements during upcoming renewal periods. GLOBAL OPERATIONS Global Operations provides products and services to U.S.-based customers, customers expanding overseas and foreign customers. The major product lines include marine, commercial and contract surety, warranty and specialty products, as well as commercial property and casualty coverages.
- ------------------------------------------------------------------------ PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS (In millions of dollars) 2000 1999 2000 1999 - ------------------------------------------------------------------------ Net written premiums $ 311 $ 311 $ 888 $ 837 Net earned premiums 271 258 811 767 Underwriting loss (12) (12) (43) (10) Net operating income 16 13 27 57 Loss ratio 61.7% 58.9% 62.2% 56.1% Expense ratio 43.0 45.4 43.0 44.9 Dividend ratio (0.3) 0.4 0.1 0.3 ---------------------------------------- Combined ratio 104.4% 104.7% 105.3% 101.3% ========================================
Net written premiums for Global Operations were consistent in the third quarter of 2000 as compared with the same period of 1999. For the third quarter of 2000, net earned premiums increased $13 million, or 5%, to $271 million over the same period in 1999. This increase was due to growth in the commercial property and warranty lines, partially offset by increased ceded premiums in the surety business. The combined ratio decreased 0.3 points to 104.4% for the three months ended September 30, 2000 as compared with the same period in 1999. The slight decrease in the combined ratio primarily related to a decreased expense ratio in the warranty business related to a change in the mix of business which caused a reduction in commissions, partially offset by 2.8 points in adverse loss experience in the marine insurance line of business. Underwriting results remain unchanged at $12 million loss for the third quarter of 2000 as compared with the Page 27 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued same period in 1999. Net operating income increased $3 million to $16 million for the third quarter of 2000 as compared with the third quarter of 1999. This increase was primarily a result of increased investment income. Net written premiums increased $51 million, or 6%, to $888 million for the first nine months of 2000 as compared with the same period in 1999. Net earned premiums for the nine months ended September 30, 2000 increased $44 million, or 6%, to $811 million over the same period in 1999. These increases were driven by growth in the commercial casualty and property lines in the European operations, as well as growth in the commercial warranty and surety lines. The combined ratio increased 4.0 points to 105.3% for the nine months ended September 30, 2000 as compared with the same period in 1999. The increase in the combined ratio primarily related to adverse loss experience of 3.1 points in the marine insurance line of business, and adverse loss experience and development in the vehicle warranty insurance line of business which is expected to continue into the fourth quarter of 2000. Underwriting and net operating income declined for the nine months ended September 30, 2000 as compared with the same period in 1999 principally driven by adverse loss experience as described above. RISK MANAGEMENT Risk Management serves the property/casualty needs of large domestic commercial businesses, offering customized strategies to address the management of business risks. Also, Risk Management, primarily through RSKCo, provides total risk management services relating to claims, loss control, cost management and information services to the commercial insurance marketplace.
- -------------------------------------------------------------------- PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS (In millions of dollars) 2000 1999 2000 1999 - -------------------------------------------------------------------- Net written premiums $ 129 $ 159 $ 506 $ 646 Net earned premiums 142 171 448 591 Underwriting loss (35) (14) (106) (49) Service revenues 75 78 226 229 Net operating income 8 15 15 47 Loss ratio 93.7% 75.1% 92.5% 79.0% Expense ratio 31.1 33.4 31.2 29.2 Dividend ratio 0.0 (0.1) 0.0 0.0 ------------------------------------- Combined ratio 124.8% 108.4% 123.7% 108.2% =====================================
Net written premiums for Risk Management declined $30 million, or 19%, to $129 million for the third quarter of 2000, as compared with the same period in 1999. This premium decline resulted from the Company's decision to cede a larger portion of its direct premiums, as well as a continued focus on re-underwriting the book of business. These operational efforts resulted in a $29 million, or 17%, decrease in net earned premiums to $142 million for the third quarter of 2000 as compared with the same period in 1999. The combined ratio increased 16.4 points to 124.8% for the three months ended September 30, 2000 as compared with the same period in 1999. The combined ratio increase resulted Page 28 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued principally from an increase in the loss ratio due to adverse current year property experience and casualty loss activity, partially offset by a decrease in the expense ratio due to lower acquisition expenses. Underwriting losses increased to $35 million for the third quarter of 2000 as compared with $14 million in the same period in 1999 due principally to the increased loss ratio. Net operating income decreased $7 million in the third quarter of 2000 because of higher underwriting losses, partially offset by increased investment income and a $5 million improvement in net operating income from RSKCo. Consistent with the third quarter, net written premiums for the first nine months of 2000 decreased $140 million, or 22%, to $506 million as compared with the same period in 1999. Likewise, net earned premiums for the first nine months of 2000 decreased $143 million, or 24%, to $448 million as compared with the same period in 1999. As expected, net written and net earned premiums were below 1999 due to improved underwriting focus, which led to an overall decrease in premiums written. The combined ratio increased 15.5 points to 123.7% for the nine months ended September 30, 2000 as compared with the same period in 1999. Increases in both the loss and expense ratios led to the unfavorable change in the combined ratio. The loss ratio increase is principally the result of adverse current year property and casualty experience. Acquisition and underwriting expenses have decreased year-over-year, but not at the same pace as the decline in net earned premiums. Underwriting losses deteriorated to $106 million for the first nine months of 2000 as compared with $49 million in the same period in 1999. Net operating income decreased $32 million in 2000 as compared with 1999, primarily due to poor underwriting results of the property business line, partially offset by increased investment income. Risk Management has been involved in numerous underwriting initiatives to improve results. In the third quarter of 2000, Risk Management achieved double-digit price increases on average across its book of business while maintaining premium-weighted retention in the mid-70 percent range, primarily driven by a decline in property lines of insurance. Risk Management's underwriting initiatives continue to: focus on risk selection, increase attachment points, strengthen underwriting terms and conditions through increasing deductibles and limiting the scope of coverage, and centralize all property underwriting into one location while maintaining regional management accountabilities. GROUP OPERATIONS Group Operations provides a broad array of group life and health insurance products and services to employers, affinity groups and other entities that purchase insurance as a group. Group Operations also provides health insurance to federal employees, retirees and their families (Federal Markets); managed care and self-funded medical excess insurance; medical provider network management and administration services; and reinsurance for life and health insurers.
- ------------------------------------------------------------------------------ PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS (In millions of dollars) 2000 1999 2000 1999 - ------------------------------------------------------------------------------ Net earned premiums $947 $871 $2,708 $2,680 Net operating income 10 24 29 43
Group Operations' net earned premiums for the third quarter increased $76 million, or 9%, to $947 million as compared with the same period in 1999. This increase is primarily attributable to a Page 29 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued $34 million increase in the Federal Markets business, a $21 million increase in Life Reinsurance and a $17 million increase in the group life and specialty lines of the Special Benefits business. Premiums from the Federal Markets business vary with the level of claims and the expense activity. Net operating income for the third quarter of 2000 decreased to $10 million from $24 million in the third quarter of 1999 due to favorable 1999 loss experience in the group life line within Special Benefits. Net earned premiums for the nine months ended September 30, 2000 increased $28 million, or 1%, to $2,708 million as compared with the same period of 1999. This increase was principally a result of a $52 million increase in Life Reinsurance and a $21 million increase in the Special Benefits business partially offset by a $45 million decline related to the Federal Markets business. Net operating income for the nine months ended September 30, 2000 decreased to $29 million from $43 million as compared with the same period in 1999. This decrease relates to lower profits of $20 million in the Special Benefits business, $7 million of costs incurred from the exit of the Management Services Organization (MSO) business and $12 million of adverse development on the medical stop loss business. These decreases were partially offset by a $22 million improvement in the Health Benefits business due to the 1999 exit of unprofitable medical lines. The MSO business was a suite of comprehensive administrative services designed to enable physician and hospital networks to assume financial risk for the health care services they provide. The decision to shut down the MSO business was based on lack of demand as providers are backing away from risk contracting. Subsequent to September 30, 2000, the Company reached an agreement to sell its Life Reinsurance business. The transaction is expected to result in a gain and should close by the end of 2000 or early 2001. For the nine months ended September 30, 2000, Life Reinsurance contributed $172 million of earned premiums and $15 million of net operating income to the overall results for Group Operations. LIFE OPERATIONS Life Operations provides financial protection to individuals through a full product line of term life insurance, universal life insurance, long term care insurance, annuities and other products. Life Operations also provides retirement services products to institutions in the form of various investment products and administration services.
- --------------------------------------------------------------------- PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS (In millions of dollars) 2000 1999 2000 1999 - --------------------------------------------------------------------- Sales volume * $698 $933 $2,382 $2,568 Net earned premiums 236 231 674 648 Net operating income 46 36 132 104
* Sales volume is a cash-based measure including premiums and annuity considerations, investment contract deposits, and other sales activity that are not reported as premiums under generally accepted accounting principles. For the third quarter of 2000, sales volume declined primarily as a result of a reduction in retirement products sold to institutions. These products tend to be "large case" institutional markets' sales, which can be sporadic, opportunistic and sensitive to independent agency ratings. Net earned premiums increased $5 million, or 2%, to $236 million for the third quarter of 2000 as compared with the third quarter of 1999. This increase is associated with a growing inforce block of individual life, long term care and annuity products. Page 30 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued These increases were partially offset by sales declines in structured settlements and single premium group annuities, due to a competitive pricing environment. For the third quarter, net operating income increased to $46 million in 2000 as compared with $36 million in 1999. The increase was primarily due to increased earnings in the Index 500 Plus guaranteed annuity contract, sold to large institutions, and favorable investment results in Individual Life, Long Term Care and the Retirement Services businesses. Sales volume decreased by $186 million in the first nine months of 2000 as compared with the same period in 1999. Most businesses in Life Operations had increased sales volume, particularly in variable annuity contracts sold to individuals and the Index 500 Plus guaranteed annuity contract, sold to large institutions, as well as an increasing base of direct premiums for life and long term care products. However, these increases in sales volume have been more than offset by a reduction in retirement products sold to institutions as discussed above. Net earned premiums for Life Operations increased $26 million, or 4%, to $674 million for the first nine months of 2000 as compared with the same period in 1999. Net operating income for the first nine months of 2000 was $28 million higher than net operating income for the same period in 1999. The increase was principally attributable to increased earnings in the Index 500 Plus guaranteed annuity contract, improved mortality experience in term life and favorable investment results for all products. CORPORATE The corporate segment results consist of interest expense on corporate borrowings, certain run-off insurance operations, asbestos claims related to Fibreboard Corporation (Fibreboard), financial guaranty insurance contracts, and certain non-insurance operations. Net operating loss increased to a loss of $55 million for the third quarter of 2000 as compared with a loss of $53 million for the same period during 1999. For the first nine months of 2000, net Page 31 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued operating loss declined to a loss of $171 million as compared with a loss of $181 million for the same period of 1999. RESTRUCTURING AND OTHER RELATED CHARGES The details of the restructuring and other related charges recognized in the three and nine months ended September 30, 1999 are discussed in Note I of the Notes. The table below presents the remaining accrued restructuring and other related charges as of September 30, 2000, and management's estimate of the timing of the ultimate payout thereof.
- ------------------------------------------------------------------------------------------------- LEASE BUSINESS TERMINATION EXIT (In millions of dollars) COSTS COSTS TOTAL - ------------------------------------------------------------------------------------------------- Accrued costs at September 30, 2000 $ 14 $ 5 $19 ================================================== Remainder of 2000 - 3 3 2001 5 2 7 2002 4 - 4 2003 2 - 2 2004 1 - 1 2005 and thereafter 2 - 2 -------------------------------------------------- Total future payments $ 14 $ 5 $ 19 ==================================================
Page 32 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued INVESTMENTS The components of net investment income for the three and nine month periods ended September 30, 2000 and 1999 are presented in the following table.
- ------------------------------------------------------------------- PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS (In millions of dollars) 2000 1999 2000 1999 - ------------------------------------------------------------------- Fixed maturity securities: Bonds: Taxable $ 391 $ 388 $ 1,141 $ 1,123 Tax-exempt 52 58 168 207 Short-term investments 61 54 152 147 Other 36 44 113 115 -------------------------------------- 540 544 1,574 1,592 Investment expenses (11) (13) (37) (30) -------------------------------------- Net investment income $ 529 $ 531 $ 1,537 $ 1,562 ======================================
Lower net investment income results for both the three month and nine month periods of 2000 as compared with the same periods in 1999 are due to a lower investment base attributable to asset transfers in the fourth quarter of 1999 in connection with the Personal Insurance transaction with Allstate and the $1.1 billion payment from escrow to the Fibreboard Corporation trust to settle certain asbestos related claims. The bond segment of the investment portfolio yielded 6.5% for the first nine months of 2000 as compared to 5.9% for the same period in 1999. The components of net realized investment gains for the three and nine month periods ended September 30, 2000 and 1999 are presented in the following table.
- -------------------------------------------------------------------------------------- PERIOD ENDED SEPTEMBER 30 THREE MONTHS NINE MONTHS (In millions of dollars) 2000 1999 2000 1999 - -------------------------------------------------------------------------------------- Realized investment gains (losses): Fixed maturity securities: U.S. Government bonds $ 24 $ (22) $ 21 $(104) Corporate and other taxable bonds (21) (43) (71) (54) Tax-exempt bonds 22 (36) (25) (23) Asset-backed securities (7) (15) (65) (13) ---------------------------------- Total fixed maturities 18 (116) (140) (194) Equity securities 612 6 987 316 Derivative securities (8) (11) 13 23 Other invested assets 87 38 308 156 ---------------------------------- Total realized investment gains (losses), net 709 (83) 1,168 301 Allocated to participating policyholders' interest (3) 2 -- 7 Income tax expense (246) 28 (409) (108) ---------------------------------- Net realized investment gains (losses) $ 460 $ (53) $ 759 $ 200 ==================================
Net realized investment gains increased both for the three months and nine months period ended September 30, 2000. These increases are principally related to realized gains for the sale of Global Crossing Ltd common stock (Global Crossing) and Canary Wharf Group plc common stock (Canary Wharf). The increase in net realized gains for the third quarter of 2000 as compared with 1999 was $193 million for Canary Wharf and $149 million for Global Crossing. The increase in net realized gains Page 33 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued for the nine months ended September 30, 2000 as compared with 1999 was $154 million for Canary Wharf and $171 million for Global Crossing. Additionally, decreased interest rates favorably impacted results from sales of bonds, especially in the third quarter. Substantially all invested assets are marketable securities classified as available-for-sale in the accompanying condensed financial statements. Accordingly, changes in fair value for these securities are reported in other comprehensive income. The following table presents the carrying values of the Company's investments as of September 30, 2000 and December 31, 1999, and the change in unrealized gains/losses of those securities included in other comprehensive income for the nine months ended September 30, 2000.
- ------------------------------------------------------------------------------------------------------------------ CARRYING VALUE CHANGE IN UNREALIZED -------------------------- GAINS/LOSSES SEPTEMBER 30, DECEMBER 31, NINE MONTHS ENDED (In millions of dollars) 2000 1999 SEPTEMBER 30, 2000 - ------------------------------------------------------------------------------------------------------------------ Fixed maturity securities: U. S. Treasury securities and obligations of Government agencies $ 5,783 $ 8,318 $ 209 Asset-backed securities 7,042 7,039 152 Tax-exempt securities 3,435 4,396 120 Taxable securities 10,351 7,365 (29) Redeemable preferred 53 130 (67) ------------------------------------------------------ Total fixed maturity securities 26,664 27,248 385 Equity securities: Common stock 2,387 3,344 (1,017) Non-redeemable preferred stock 249 266 (12) ------------------------------------------------------ Total equity securities 2,636 3,610 (1,029) Short-term investments 4,780 3,355 -- Other investments 1,596 1,347 (64) ------------------------------------------------------ Total investments $ 35,676 $35,560 (708) ======================== Separate account business and other 13 ----------------- Decrease in net unrealized gains reported in other comprehensive income $ (695) =================
The Company's general investment portfolio consists primarily of publicly traded government bonds, asset-backed securities, mortgage-backed securities, municipal bonds and corporate bonds. A primary objective in the management of the fixed maturity portfolio is to maximize total return relative to underlying liabilities and respective liquidity needs. In achieving this goal, assets may be sold to take advantage of market conditions, other investment opportunities or for credit and tax considerations. This activity will produce realized gains and losses depending on market conditions including interest rates. Page 34 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Total net unrealized gains for investments at September 30, 2000 were $1,104 million, down from $1,822 million at December 31, 1999. The unrealized position at September 30, 2000 was composed of an unrealized loss of $314 million for fixed maturity securities and an unrealized gain of $1,419 million for equity securities and other. The unrealized position at December 31, 1999 was composed of an unrealized loss of $700 million for fixed maturity securities and an unrealized gain of $2,522 million for equity securities and other. See Note G of the Notes for a discussion of the unrealized position on the Company's ownership in Global Crossing. The Company's investment policies for both the general and separate accounts emphasize high credit quality and diversification by industry, issuer and issue. Assets supporting interest rate sensitive liabilities are segmented within the general account to facilitate asset/liability duration management. The general account portfolio consists primarily of high quality (rated BBB or higher) bonds, approximately 93% and 94% of which are rated as investment grade at September 30, 2000 and December 31, 1999. The following table summarizes the ratings of CNA's general account bond portfolio at carrying value.
- --------------------------------------------------------------------------- SEPTEMBER 30, DECEMBER 31, (In millions of dollars) 2000 % 1999 % - --------------------------------------------------------------------------- U.S. government and affiliated securities $ 8,602 32% $ 8,781 32% Other AAA rated 7,395 28 9,692 36 AA and A rated 5,700 22 4,465 16 BBB rated 2,996 11 2,598 10 Below investment grade 1,918 7 1,582 6 ------------------------------- Total $26,611 100% $27,118 100% ===============================
In the above table, approximately 98% and 95% of the general account portfolio were U.S. Government Agency or were rated by Standard & Poor's or Moody Investors Service at September 30, 2000 and December 31, 1999. The remaining bonds were rated by other rating agencies, outside brokers or Company management. Below investment grade bonds, as presented in the table above, are high yield securities rated below BBB by bond rating agencies, as well as other unrated securities which, in the opinion of management, are below investment grade. High yield securities generally involve a greater degree of risk than investment grade securities. However, expected returns should compensate for the added risk. This risk is also considered in the interest rate assumptions in the underlying insurance products. CNA's concentration in high yield bonds was approximately 7% and 6% of total investments as of September 30, 2000 and December 31, 1999. Included in CNA's fixed maturity securities at September 30, 2000 are $7.0 billion of asset-backed securities, at fair value, consisting of approximately 42% in U.S. government agency issued pass-through certificates, 37% in collateralized mortgage obligations (CMOs), 15% in corporate asset-backed obligations and 6% in corporate mortgage-backed pass-through certificates. The majority of CMOs held are actively traded in liquid markets and are priced by broker-dealers. Page 35 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Short-term investments at September 30, 2000 and December 31, 1999 primarily consisted of commercial paper and money market funds. The components of the general account short-term investments portfolio are presented in the following table.
- ----------------------------------------------------------- SEPTEMBER 30, DECEMBER 31, (In millions of dollars) 2000 1999 - ----------------------------------------------------------- Commercial paper $ 3,753 $ 1,988 U.S. Treasury securities 23 41 Money market funds 422 904 Other 582 422 -------------------------- Total short-term investments $ 4,780 $ 3,355 ==========================
CNA invests in certain derivative financial instruments primarily to reduce its exposure to market risk (principally interest rate, equity price and foreign currency risk). CNA considers the derivatives in its general account to be held for purposes other than trading. Derivative securities, except for interest rate swaps associated with certain corporate borrowings, are recorded at fair value at the reporting date. The interest rate swaps on corporate borrowings are accounted for using accrual accounting with the related income or expense recorded as an adjustment to interest expense. Adjustments to fair value are not recognized. Certain derivatives in the separate accounts are held for trading purposes. The Company uses these derivatives to mitigate market risk by purchasing Standard & Poor's 500 (S&P 500) futures contracts in a notional amount equal to the contract liability relating to Life Operations' Index 500 Plus guaranteed annuity contract product. Changes in fair value of S&P 500 separate account derivatives held for trading purposes are reported as a component of net operating income. The Company's largest equity holding in a single issuer is Global Crossing common stock. See Note C and Note G for a discussion of the Company's ownership in Global Crossing. The Company's second largest equity holding is Canary Wharf. During the first nine months of 2000, the Company experienced a net decrease in unrealized gains of $211 million on its position in Canary Wharf common stock, which was valued at $414 million on September 30, 2000. The majority of this decline was due to the sale of 50.6 million shares, resulting in a pretax realized gain of $358 million. MARKET RISK Market risk is a broad term related to changes in the fair value of a financial instrument. Discussions herein regarding market risk focus on only one element of market risk - price risk. Price risk relates to changes in the level of prices due to changes in interest rates, equity prices, foreign exchange rates or other factors that relate to market volatility of the rate, index or price underlying the financial instrument. The Company's primary market risk exposures are due to changes in interest rates, although the Company has certain exposures to changes in equity prices and foreign currency exchange rates. The fair value of the financial instruments are adversely affected when interest rates rise, equity markets decline, and the dollar strengthens against foreign currency. Page 36 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued Active management of market risk is integral to the Company's operations. The Company may use the following tools to manage its exposure to market risk within defined tolerance ranges: (1) change the character of future investments purchased or sold, (2) use derivatives to offset the market behavior of existing assets and liabilities or assets expected to be purchased and liabilities to be incurred, or (3) rebalance its existing asset and liability portfolios. For purposes of this disclosure, market risk sensitive instruments are divided into two categories: (1) instruments entered into for trading purposes and (2) instruments entered into for purposes other than trading. The Company's general account market risk sensitive instruments presented in the tables on pages 38 to 41 are classified as held for purposes other than trading. SENSITIVITY ANALYSIS CNA monitors its sensitivity to interest rate risk by evaluating the change in the value of financial assets and liabilities due to fluctuations in interest rates. The evaluation is performed by applying an instantaneous change in interest rates of varying magnitudes on a static balance sheet to determine the effect such a change in rates would have on the Company's market value at risk and the resulting effect on stockholders' equity. The analysis presents the sensitivity of the market value of the Company's financial instruments to selected changes in market rates and prices. The range of change chosen reflects the Company's view of changes which are reasonably possible over a one-year period. The selection of the range of values chosen to represent changes in interest rates should not be construed as the Company's prediction of future market events, but rather an illustration of the impact of such events. The sensitivity analysis estimates the decline in the market value of the Company's interest sensitive assets and liabilities that were held on September 30, 2000 and December 31, 1999 due to instantaneous parallel increases in the period end yield curve of 100 and 150 basis points. The sensitivity analysis also assumes an instantaneous 10% and 20% decline in the foreign currency exchange rates versus the U.S. dollar from their levels at September 30, 2000 and December 31, 1999, with all other variables held constant. Equity price risk was measured assuming an instantaneous 10% and 25% decline in the S & P 500 Index (Index) from its level at September 30, 2000 and December 31, 1999, with all other variables held constant. The Company's equity holdings were assumed to be highly and positively correlated with the Index. At September 30, 2000, a 10% and 25% decrease in the Index would result in a $345 million and $863 million decrease compared to $505 million and $1,259 million decrease at December 31, 1999, in the market rate of the Company's equity investments. Of these amounts, under both scenarios, approximately 38% of the decrease indicated for the current period and approximately 25% of the decrease for the period ending December 31, 1999 would be offset by decreases in related separate account liabilities to customers. Similarly, increases in the market value of the Company's equity investments would also be offset by increases in the same related separate account liabilities by the same approximate percentages. Page 37 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued The following tables reflect the estimated effects on the market value of the Company's financial instruments at September 30, 2000 and December 31, 1999, due to an increase in interest rates of 100 basis points, a 10% decline in the Index, and a decline of 10% in foreign currency exchange rates.
- -------------------------------------------------------------------------------------- SENSITIVITY TO ----------------------------- SEPTEMBER 30, 2000 MARKET INTEREST CURRENCY EQUITY (In millions of dollars) VALUE RATE RISK RISK RISK - -------------------------------------------------------------------------------------- HELD FOR OTHER THAN TRADING PURPOSES General Account: Fixed maturity securities $ 26,664 $(1,393) $(185) $ (22) Equity securities 2,636 -- (70) (187) Short term investments 4,780 (3) (32) -- Interest rate caps 1 2 -- -- Other derivative securities 8 (8) 12 -- ----------------------------------------- TOTAL GENERAL ACCOUNT 34,089 (1,402) (275) (209) ----------------------------------------- Separate Account Business: Fixed maturity securities 2,446 (115) (6) -- Equity securities 230 -- (1) (23) Short term investments 170 -- -- -- Other derivative securities -- -- -- -- ----------------------------------------- TOTAL SEPARATE ACCOUNT BUSINESS 2,846 (115) (7) (23) ----------------------------------------- TOTAL ALL SECURITIES HELD FOR OTHER THAN TRADING PURPOSES 36,935 (1,517) (282) (232) ----------------------------------------- HELD FOR TRADING PURPOSES Separate Account Business: Fixed maturity securities 385 (15) (2) (1) Equity securities 19 -- -- (2) Short term investments 356 -- -- -- Equity index futures -- 2 -- (110) Other derivative securities 1 (4) -- -- ----------------------------------------- TOTAL ALL SECURITIES HELD FOR TRADING PURPOSES 761 (17) (2) (113) ----------------------------------------- TOTAL ALL SECURITIES $ 37,696 $(1,534) $(284) $(345) ========================================= DEBT (CARRYING VALUE) $ (2,774) $ 125 $ -- $ -- =========================================
Page 38 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued
- -------------------------------------------------------------------------------------- SENSITIVITY TO ----------------------------- DECEMBER 31, 1999 MARKET INTEREST CURRENCY EQUITY (In millions of dollars) VALUE RATE RISK RISK RISK - -------------------------------------------------------------------------------------- HELD FOR OTHER THAN TRADING PURPOSES General Account: Fixed maturity securities $ 27,248 $(1,268) $ (149) $ (14) Equity securities 3,610 -- (84) (361) Short term investments 3,355 (2) (26) -- Interest rate caps 4 5 -- -- Equity index futures -- 19 -- -- Other derivative securities 12 (8) 59 3 ----------------------------------------- TOTAL GENERAL ACCOUNT 34,229 (1,254) (200) (372) ----------------------------------------- Separate Account Business: Fixed maturity securities 2,927 (115) (16) (2) Equity securities 240 -- -- (24) Short term investments 59 -- -- -- Other derivative securities (1) (7) -- -- ----------------------------------------- TOTAL SEPARATE ACCOUNT BUSINESS 3,225 (122) (16) (26) ----------------------------------------- TOTAL ALL SECURITIES HELD FOR OTHER THAN TRADING PURPOSES 37,454 (1,376) (216) (398) ----------------------------------------- HELD FOR TRADING PURPOSES Separate Account Business: Fixed maturity securities 333 (12) (1) -- Equity securities 19 -- -- (2) Short term investments 430 -- (2) -- Equity index futures -- 2 -- (105) Other derivative securities -- (1) -- -- ----------------------------------------- TOTAL ALL SECURITIES HELD FOR TRADING PURPOSES 782 (11) (3) (107) ----------------------------------------- TOTAL ALL SECURITIES $ 38,236 $(1,387) $ (219) $ (505) ========================================= DEBT (CARRYING VALUE) $ (2,881) $ 132 $ -- $ -- =========================================
Page 39 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued The following tables reflect the estimated effects on the market value of the Company's financial instruments at September 30, 2000 and December 31, 1999, due to an increase in interest rates of 150 basis points, a 25% decline in the Index, and a decline of 20% in foreign currency exchange rates.
- ------------------------------------------------------------------------------------------- SENSITIVITY TO ----------------------------------- SEPTEMBER 30, 2000 MARKET INTEREST CURRENCY EQUITY (In millions of dollars) VALUE RATE RISK RISK RISK - ------------------------------------------------------------------------------------------- HELD FOR OTHER THAN TRADING PURPOSES General Account: Fixed maturity securities $ 26,664 $(2,086) $(371) $ (55) Equity securities 2,636 -- (139) (466) Short term investments 4,780 (4) (65) -- Interest rate caps 1 4 -- -- Other derivative securities 8 (14) 24 -- ---------------------------------------------- TOTAL GENERAL ACCOUNT 34,089 (2,100) (551) (521) ---------------------------------------------- Separate Account Business: Fixed maturity securities 2,446 (168) (12) -- Equity securities 230 -- (1) (57) Short term investments 170 -- -- -- Other derivative securities -- -- -- -- ---------------------------------------------- TOTAL SEPARATE ACCOUNT BUSINESS 2,846 (168) (13) (57) ---------------------------------------------- TOTAL ALL SECURITIES HELD FOR OTHER THAN TRADING PURPOSES 36,935 (2,268) (564) (578) ---------------------------------------------- HELD FOR TRADING PURPOSES Separate Account Business: Fixed maturity securities 385 (23) (3) (4) Equity securities 19 -- (1) (5) Short term investments 356 -- -- -- Equity index futures -- 3 -- (276) Other derivative securities 1 (6) -- -- ---------------------------------------------- TOTAL ALL SECURITIES HELD FOR TRADING PURPOSES 761 (26) (4) (285) ---------------------------------------------- TOTAL ALL SECURITIES $ 37,696 $(2,294) $(568) $(863) ============================================= DEBT (CARRYING VALUE) $ (2,774) $ 182 $ -- $ -- =============================================
Page 40 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued
- ------------------------------------------------------------------------------------------------- SENSITIVITY TO ------------------------------------ DECEMBER 31, 1999 MARKET INTEREST CURRENCY EQUITY (In millions of dollars) VALUE RATE RISK RISK RISK - ------------------------------------------------------------------------------------------------- HELD FOR OTHER THAN TRADING PURPOSES General Account: Fixed maturity securities $ 27,248 $(1,878) $(298) $ (35) Equity securities 3,610 -- (168) (902) Short term investments 3,355 (3) (51) -- Interest rate caps 4 11 -- -- Equity index futures -- 29 -- -- Other derivative securities 12 (13) 118 9 ---------------------------------------------------- TOTAL GENERAL ACCOUNT 34,229 (1,854) (399) (928) ---------------------------------------------------- Separate Account Business: Fixed maturity securities 2,927 (170) (32) (4) Equity securities 240 -- -- (60) Short term investments 59 -- (1) -- Other derivative securities (1) (11) -- -- ---------------------------------------------------- TOTAL SEPARATE ACCOUNT BUSINESS 3,225 (181) (33) (64) ---------------------------------------------------- TOTAL ALL SECURITIES HELD FOR OTHER THAN TRADING PURPOSES 37,454 (2,035) (432) (992) ---------------------------------------------------- HELD FOR TRADING PURPOSES Separate Account Business: Fixed maturity securities 333 (18) (1) (1) Equity securities 19 -- -- (5) Short term investments 430 -- (4) -- Equity index futures -- 3 -- (261) Other derivative securities -- (2) -- -- ---------------------------------------------------- TOTAL ALL SECURITIES HELD FOR TRADING PURPOSES 782 (17) (5) (267) ---------------------------------------------------- TOTAL ALL SECURITIES $ 38,236 $(2,052) $(437) $(1,259) ==================================================== DEBT (CARRYING VALUE) $ (2,881) $ 193 $ -- $ -- ====================================================
Page 41 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued LIQUIDITY AND CAPITAL RESOURCES The principal operating cash flow sources of CNA's property/casualty and life insurance subsidiaries are premiums and investment income. The primary operating cash flow uses are payments for claims, policy benefits and operating expenses. For the nine months ended September 30, 2000, net cash used for operating activities was $873 million as compared with a net cash inflow of $1 million for the same period in 1999. The transfer of CNA Personal Insurance to Allstate decreased cash from operations by approximately $250 million. Excluding the effects of CNA Personal Insurance, payments of claims and claim adjustment expenses increased approximately $1 billion, receipts of premiums and other revenues decreased approximately $130 million and expenditures for operating expenses decreased approximately $600 million and. In addition, inflows from Federal income tax refunds increased $98 million. For the nine months ended September 30, 2000, net cash inflows from investment activities were $1,289 million as compared with $619 million for the same period in 1999. Cash flows from investing activities were principally related to purchases and sales of invested assets. Cash inflows increased from the prior year as invested asset sales increased, primarily as a result of proceeds from the sales of Global Crossing and Canary Wharf common stock. For the nine months ended September 30, 2000, net cash used for financing activities was $395 million as compared with $532 million for the same period in 1999. Cash flows for financing activities include the repurchase of preferred and common equity instruments, the retirement or repurchase of senior debt securities and mortgages, the repayment of bank loans, and the payment of dividends and interest. On February 15, 2000, Standard & Poor's lowered the Company's senior debt rating from A- to BBB and lowered the Company's preferred stock rating from BBB to BB+. As a result of these actions, the facility fee payable on the aggregate amount of CNA's $795 million revolving credit facility (Facility) was increased to 12.5 basis points per annum from 9.0 basis points per annum and the interest rate was increased to London Interbank Offered Rate (LIBOR) plus 27.5 basis points from LIBOR plus 16.0 basis points. As a result of Standard & Poor's actions, the Company repurchased and retired all of its outstanding balance in its $150 million of money market preferred stock in the first nine months of 2000. During the first nine months of 2000, CNA purchased a portion of its debt notes when opportunities have arisen that made economic sense. CNA may purchase additional securities in the future if the purchase makes economic sense. These repurchases included approximately $19 million of The Continental Corporation (Continental) senior notes and approximately $14 million of CNA Financial Corporation (CNAF) senior notes. On August 3, 2000, CNA announced that the process of exploring the sale of its life insurance businesses was complete. The Company will retain the individual life, long term care and retirement services businesses. CNA will continue to explore the separate sale of the viatical settlements business. As described in Group Operations' MD&A, an agreement in principle has been reached to sell the life reinsurance business. Page 42 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued The table below reflects ratings issued by A.M. Best, Standard and Poor's, Moody's and Fitch (formerly Duff & Phelps) for the Continental Casualty Company (CCC) Pool, the Continental Insurance Company (CIC) Pool and the Continental Assurance Company (CAC) Pool. Also rated were CNAF's senior debt and commercial paper and Continental's senior debt.
- ------------------------------------------------------------------------------------------------------ INSURANCE RATINGS DEBT RATINGS -------------------------------- --------------------------------------------- CNAF Continental -------------------------- ---------------- Senior Commercial Senior CCC CAC CIC Debt Paper Debt --------------------------------------------------------------------------------- A.M. Best A A A- NR NR NR Fitch AA- AA NR A- NR NR Moody's A2 A2* A3 Baa1 P2 Baa2 Standard & Poor's A AA- A- BBB A2 BBB-
* - CAC AND VALLEY FORGE LIFE (VFL) ARE RATED SEPARATELY BY MOODY'S AND BOTH HAVE AN A2 RATING. NR - NOT RATED Moody's, Fitch, A.M. Best and Standard and Poor's removed the ratings from under review and affirmed the ratings for CAC and VFL following CNA's recent announcement that it would retain CAC's individual life and retirement services businesses. Moody's, Fitch and A.M. Best cited their outlook for CAC and VFL's rating as negative. The outlook from Standard and Poor's is stable. ACCOUNTING STANDARDS In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133 entitled "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133). SFAS No. 133 was subsequently amended by SFAS No. 137, which delayed the effective date by one year, and SFAS No. 138, which clarified four areas which were causing difficulties in implementation. SFAS No. 133 requires the recognition of all derivative financial instruments, including embedded derivative instruments, as either assets or liabilities in the statement of financial position and measurement of those instruments at fair value. The accounting for gains and losses associated with changes in the fair value of a derivative and the effect on the consolidated financial statements will depend on its hedge designation and whether the hedge is highly effective in achieving offsetting changes in the fair value or cash flows of the asset or liability hedged. If the derivative is designated in a fair value hedge, the changes in the fair value of the derivative and the hedged item will be recognized in earnings. If the derivative is designated as a cash flow hedge, changes in the fair value of the derivative will be recorded in other comprehensive income and will be recognized in the income statement when the hedged item affects earnings. A derivative that does not qualify as a hedge will be marked to fair value through earnings. Under the provisions of SFAS No. 133, the method that will be used for assessing the effectiveness of a hedging derivative as well as the measurement approach for determining the ineffective aspects of the hedge must be established at the inception of the hedge. On that initial application date, hedging relationships must be designated anew and documented pursuant to the provisions of SFAS No. 133. The Company is required to adopt SFAS No. 133 effective January 1, 2001. The transition adjustments resulting from adoption must be reported in net Page 43 CNA FINANCIAL CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued income or other comprehensive income, as appropriate, as the cumulative effect of a change in accounting principle. Based on current facts and circumstances, adoption of SFAS No. 133 will not have a material impact on total equity of the Company. It is estimated that the adoption will result in an after-tax decrease to earnings in the range of $20 million to $35 million. However, because the Company already carries the derivatives impacted by adoption at fair value via unrealized gains and losses, there is an equal and offsetting favorable adjustment to other comprehensive income. These estimates are based on the Company's current derivative holdings and hedging strategies. Changes therein, or changes in financial market conditions, during the fourth quarter could result in changes in the transition adjustment estimates. In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements". This bulletin summarizes certain of the SEC Staff's view in applying generally accepted accounting principles to revenue recognition in financial statements. This bulletin, through its subsequent revised releases SAB No. 101A and No. 101B, is effective for registrants no later than the fourth fiscal quarter of fiscal years beginning after December 15, 1999. CNA does not expect the implementation of this bulletin to have a significant impact on the results of operations or equity of the Company. FORWARD LOOKING STATEMENTS The statements contained in this Form 10-Q, which are not historical facts, are forward-looking statements. When included in this Form 10-Q, the words "believes," "expects," "intends," "anticipates," "estimates," and analogous expressions are intended to identify forward-looking statements. Such statements inherently are subject to a variety of risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties include, among others, the impact of competitive products, policies and pricing; product and policy demand and market responses; development of claims and the effect on loss reserves; the performance of reinsurance companies under reinsurance contracts with CNA; general economic and business conditions; changes in financial markets (interest rate, credit, currency, commodities and stocks); changes in foreign, political, social and economic conditions; regulatory initiatives and compliance with governmental regulations; judicial decisions and rulings; changes in rating agency policies and practices; the results of financing efforts; changes in CNA's composition of operating segments; the actual closing of contemplated transactions and agreements and various other matters and risks (many of which are beyond CNA's control) detailed in CNA's Securities and Exchange Commission filings. These forward-looking statements speak only as of the date of this Form 10-Q. CNA 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 CNA's expectations with regard thereto or any change in events, conditions or circumstances on which any statement is based. Page 44 CNA FINANCIAL CORPORATION PART II. OTHER INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS: Exhibit Page Description of Exhibit Number Number ---------------------- ------- ------ Employment Contract 10 46 Financial Data Schedule 27 57 (b) REPORTS ON FORM 8-K: On August 3, 2000, CNA Financial Corporation filed a report on Form 8-K related to its announcement that it will retain its individual life, long term care and retirement services businesses, but will continue to explore the separate sale of its viatical settlements and life reinsurance businesses. On October 6, 2000, CNA Financial Corporation filed a report on Form 8-K related to its announcement of the sale of its life reinsurance business to Munich American Reassurance Company, the U.S. life subsidiary of Munich Re. 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 9, 2000 By: /s/ ROBERT V. DEUTSCH ---------------- --------------------- Robert V. Deutsch Senior Vice President and Chief Financial Officer Page 45 EX-10 2 0002.txt EMPLOYMENT AGREEMENT EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT (the "Agreement") is made this 4th day of February, 2000, effective as of the Effective Date as hereinafter defined, by and between CNA Financial Corporation, a Delaware corporation (the "Company"), and Bernard L. Hengesbaugh ("Executive"). For purposes of Sections 8 through 16, the "Company" shall include its subsidiaries, affiliates and related entities. WITNESSETH: WHEREAS, Executive currently serves as the Chairman and Chief Executive Officer of all of the principal subsidiaries of the Company pursuant to the terms of that certain Employment Agreement with the Company, dated as of February 9, 1999 (the "Prior Employment Agreement"); and WHEREAS, the Company and the Executive now desire to terminate the Prior Employment Agreement and to enter into a new employment agreement in substitution for the Prior Employment Agreement; NOW, THEREFORE, in consideration of the mutual covenants and agreements set forth below, the Executive and the Company hereby agree to the following provisions, which shall supersede and be substituted for the provisions of the Prior Employment Agreement: 1. EMPLOYMENT TERM. The Company and Executive agree that the Company shall continue to employ Executive on the terms and conditions set forth herein beginning on the Effective Date and continuing through and until December 31, 2002 or such earlier date as of which Executive's employment is terminated in accordance with Section 6 hereof. The "Effective Date" of this Agreement shall be January 1, 2000. 2. DUTIES OF EXECUTIVE. (a) Executive shall serve as the Chief Executive Officer of Continental Casualty Company ("CCC"), the principal insurance subsidiaries of the Company, and such other subsidiaries of the Company as may be determined by the Board or the Chief Executive Officer of the Company (the "CNAF CEO"). All of the Company's subsidiaries including CCC and companies not engaged in the insurance business, are sometimes collectively referred to herein as the "CNA Companies". As Chief Executive Officer, Executive shall have responsibility for the day to day operations of the CNA Companies and for development and implementation of the CNA Companies' business plans and strategies. Executive shall report to the Board of Directors of the Company (the "Board"). Executive shall be elected and shall serve as a member and chairman of the board of directors of CCC, and of such of the other CNA Companies as may be determined by the Board or the CNAF CEO, and if so elected, Executive agrees to serve on such boards in such capacity without additional compensation. (b) Executive shall diligently and to the best of his abilities assume, perform, and discharge the duties and responsibilities of Chairman and Chief Executive Officer of the CNA Companies as determined by the Board, as well as such other specific duties and responsibilities as the Board shall assign or designate to Executive from time to time. Executive shall devote substantially all of his working time to the performance of his duties as set forth herein and shall not, without the prior written consent of the Board, accept other employment or render or perform other services, nor shall he have any direct or indirect ownership interest in any other business which is in competition with the business of the Company or its subsidiaries and its affiliates, other than in the form of publicly traded securities constituting fewer than five percent (5%) of the outstanding securities of a corporation (determined by vote or value) or limited partnership interests constituting fewer than five percent (5%) of the value of any such partnership. The foregoing shall not preclude Page 46 Executive from engaging in charitable, professional, and personal investment activities, provided that, in the reasonable judgment of the Board, such activities do not materially interfere with his performance of his duties and responsibilities hereunder. 3. COMPENSATION. (a) SALARY. The Company shall pay or cause to be paid to Executive, commencing on the Effective Date and continuing for the period he is employed by the Company hereunder, an annual base salary of NINE HUNDRED FIFTY THOUSAND AND NO ONE HUNDREDTHS DOLLARS ($950,000.00), payable not less frequently than monthly (the "Base Compensation"). Such salary shall be reviewed not less frequently than annually, commencing not later than one year after the Effective Date, by the Board with a view to making such positive adjustments as the Board deems equitable and appropriate based on Executive's performance and the overall profitability and revenue growth of the Company, and if the Board approves an increase, the increased amount shall thereafter be considered the Executive's Base Compensation for all purposes of this Agreement. In no event shall Executive's base salary rate be reduced to an amount that is less than his Base Compensation, without Executive's written consent. (b) INCENTIVE COMPENSATION AWARD. Executive shall be entitled to an Incentive Compensation Award, in accordance with the CNA Financial Corporation Incentive Compensation Plan for Certain Executive Officers (the "Incentive Compensation Plan") on terms no less favorable to the Executive than the performance criteria and amounts established by the Incentive Compensation Committee (the "Committee") in its August 4, 1999 meeting (the "Performance Criteria"). The establishment of the Performance Criteria by the Committee shall constitute the establishment of performance criteria under the Incentive Compensation Plan for each of the years included in the term of this Agreement, and payment of the Incentive Compensation Awards shall otherwise be in accordance with the provisions of the Incentive Compensation Plan, including the requirement of annual review and certification by the Committee of the awards; provided that satisfaction of the Performance Criteria shall be based on net income as defined in the Incentive Compensation Plan; and provided further that the Committee shall not exercise its negative discretion under the Incentive Compensation Plan to decrease the amount of the Incentive Compensation Award for any year by more than 10 percent. (c) LONG-TERM INCENTIVE AWARDS. During the term of this Agreement, Executive shall be entitled to annual grants of stock options (the "Stock Options"), to be granted under and in accordance with the terms of the CNA Financial Corporation 2000 Long Term Incentive Plan ("LTIP"), contingent on approval of the LTIP by the Company's shareholders at the Company's 2000 annual shareholders meeting. The target amount of Stock Options to be granted in each year shall be the amounts determined by the Committee in its August 4, 1999, meeting, but the actual amount of Stock Options to be granted for any year shall be determined by the Committee based on the performance of the Executive and the CNA Companies. For purposes of the LTIP, each calendar year during the term of this Agreement shall be considered a Performance Period. Any other awards under the LTIP shall be in the sole discretion of the Committee, in accordance with the terms of the LTIP. 4. OTHER BENEFITS. Commencing on the Effective Date, Executive shall be entitled to participate in the various benefit plans, programs or arrangements established and maintained by the Company from time to time applicable to senior executives of the Company and all fringe benefits made available to grade 96 executives of the Company and its subsidiaries. Executive's entitlement to participate in any such plan, program or arrangement shall, in each case, be subject to the terms and conditions thereof, subject to the following: Page 47 (a) In determining the amount of Executive's retirement benefit under the CNA Supplemental Executive Retirement Plan or any other supplemental retirement plan or program in which Executive may participate, Executive's compensation or pensionable earnings shall be deemed to include all Incentive Compensation Awards or other cash incentive compensation payable to Executive (with such amounts to be includible at the time they would otherwise be paid in the absence of any elective deferral by Executive), but shall not include any awards granted to Executive under the LTIP. (b) The Company currently maintains the CNA Supplemental Executive Savings Plan (the "Supplemental Plan"), which currently permits participants to make elective deferrals of certain compensation (the "Eligible Compensation"), not to exceed 16% of the Eligible Compensation. Further, the Supplemental Plan currently provides for an additional Company allocation equal to 70% of the amount electively deferred by the participant under the plan, not to exceed 6% of the participant's Eligible Compensation. For purposes of determining the maximum amount which may be deferred under the Supplemental Plan, and for purposes of determining the amount of the matching allocation, Executive's "Eligible Compensation" shall include all Incentive Compensation Awards or other cash incentive compensation payable to Executive (with such amounts to be includible at the time they would otherwise be paid to Executive in the absence of any elective deferral by Executive). Eligible Compensation shall not include any awards granted to Executive under the LTIP. 5. EXPENSE REIMBURSEMENT. Executive shall be entitled to reimbursement by the Company for all reasonable and customary travel and other business expenses incurred by Executive in carrying out his duties under this Agreement, in accordance with the general reimbursement policies adopted by the Company from time to time. 6. TERMINATION OF EMPLOYMENT. Executive's employment with the Company hereunder shall continue until the earlier of December 31, 2002 (or the date to which the term is extended pursuant to Section 6.6(a)), or the date on which his employment is terminated pursuant to this Section 6. Either party may terminate Executive's employment with the Company by written notice to the other party effective as of the date specified in such notice. Upon termination of Executive's employment under this Agreement, the rights of the parties under this Agreement shall be determined pursuant to this Section 6. 6.1. DEATH AND DISABILITY. In the event of the death of Executive or, at the Company's election, in the event of his Permanent Disability (as defined below) during the term of this Agreement and while Executive is in the employ of the Company, Executive's employment shall terminate. In such event: (a) Executive (or his personal representatives, heirs or beneficiaries as the case may be) shall be paid: (i) Any unpaid Base Compensation, including credited but unused vacation pay accrued up to the date of such termination. (ii) Any unpaid Incentive Compensation Award described in paragraph 3(b) with respect to the performance period prior to Executive's death or Permanent Disability. (iii) A pro-rata portion of the amount of the Incentive Compensation Award that the Executive would have earned for the performance period in which the termination occurs determined by multiplying the Incentive Compensation Award that would have been earned had the Executive remained employed through the end of such performance period (as determined by actual performance through the end of that period and without any exercise of negative discretion) by the number of days in the performance period prior to the date of termination and dividing such product by the number of days in the performance period. Page 48 (iv) In the event that the termination occurs during a Performance Period under the LTIP with respect to which the Committee has not yet made an award of Stock Options (or affirmatively determined not to make an award) pursuant to paragraph 3(c), an amount equal to the cash equivalent (determined under the methodology described in paragraph 6.3, as of the date of termination and without any present value discount) of the target amount referred to in paragraph 3(c) for such Performance Period multiplied by a fraction, the numerator of which is the number of days in such Performance Period through and including the date of termination and the denominator of which is the total number of days in such Performance Period. (v) Any unexercised Stock Option held by Executive upon termination of employment may be exercised by Executive (or his heirs or personal representative) following such termination to the extent of the sum of the number of shares with respect to which the Stock Option was vested but unexercised immediately prior to such termination, plus an additional number of shares determined by multiplying the unvested portion of the Stock Option by the fraction described in paragraph 6.1(a)(iv), and rounded to the next higher number of whole shares. Such portion of the Stock Options may be exercised through the one-year anniversary of such date of termination, but in no event later than the date on which such option would expire if Executive had remained employed by the Company. Other options held by Executive may be exercised during the same period, but only to the extent vested under the terms of such options. The provisions of this paragraph 6.1(a)(v) shall apply notwithstanding any contrary provision in any agreement governing any Stock Option or other option. (a) Except as otherwise provided in this Section 6, the rights of Executive or his personal representatives, heirs or beneficiaries under any benefit plan, program or arrangement in which he was participating at the time of his termination, including any benefits which shall have accrued and vested under the terms of the Incentive Compensation Plan or any plan, program or arrangement described in Section 4, and his right under any long-term incentive compensation plan, shall remain unaffected and shall be determined by the applicable terms of such plans, programs or arrangements. For purposes of this Agreement, the term "Permanent Disability" means a physical or mental condition of Executive which, as determined by the Board, in its sole discretion based on all available medical information, is expected to continue indefinitely and which renders Executive incapable of performing any substantial portion of the services contemplated hereunder. 6.1. TERMINATION FOR CAUSE BY THE COMPANY. In the event that Executive shall engage in any conduct that constitutes "Cause" as defined in the following sentence, the Company shall have the right to terminate Executive's employment with the Company by written notice to Executive effective as of the date of such notice. For purposes of this Agreement, "Cause" shall include any conduct by the Executive, which the Board, in good faith, shall determine to be fraudulent, a breach of fiduciary duty, unlawful or criminal conduct, a substantial breach of any material provision of this Agreement, willful malfeasance or gross negligence, or inconsistent with the dignity and character of a senior executive of the Company, but only if the Board also determines in good faith that such conduct has had a material adverse effect on the business or prospects of the Company. Following such termination, the Company shall pay any unpaid Base Compensation accrued through the date of termination, any unpaid Incentive Compensation Award described in paragraph 3(b) with respect to the performance period prior to the date of such termination, or which is otherwise earned but not yet paid as of the date of termination (including amounts voluntarily deferred) and unused vacation time accrued prior to the date of such termination. However, upon such termination, Executive's right to payments or otherwise with respect to any annual Incentive Award for the performance period during which the termination occurs, or any Long-Term Incentive Award or other amount that is unearned as of the date of termination, and any Stock Option or other option that is unexercised on the date of termination, shall be forfeited, and the Company shall have no further obligations under this Agreement. Page 49 6.2. TERMINATION FOR CONVENIENCE BY THE COMPANY. In the event that Executive's employment is terminated by the Company for any reason not described in subsections 6.1 or 6.2 above, the obligations of the parties hereto shall be deemed discharged, provided, however, that: (a) The Company shall pay to Executive (i) any unpaid Base Compensation, including credited but unused vacation pay accrued up to the date of such termination, (ii) any unpaid Incentive Compensation Award described in paragraph 3(b) with respect to the performance period prior to the date of such termination, and (iii) termination payments at the annual rate equal to three hundred percent (300%) of Executive's annual rate of Base Compensation as in effect immediately prior to his date of termination with such termination payment to be made in substantially equal installments, not less frequently than monthly, for a period of thirty-six (36) months following such termination. (b) The Company shall also pay to Executive a pro-rata portion of the amount of the Incentive Compensation Award that he would have earned for the performance period in which the termination occurs determined in the same manner as in paragraph 6.1(a)(iii). Executive shall not be entitled to any Incentive Compensation Award for the period following termination, it being the intent of the parties that the portion of the termination payments described in paragraph 6.3(a)(iii) that exceeds Base Compensation shall be in lieu of such Incentive Compensation. (c) The Executive shall receive a payment equal to the cash equivalent of all Stock Options which he would have received if his employment had continued until December 31, 2002, and if the target number of Stock Options described in paragraph 3(c) had been granted for each remaining Performance Period between the last Performance Period for which an award was made (or for which the Committee affirmatively determined to make no award) prior to the date of termination and December 31, 2002. The cash equivalent of a future Stock Option grant shall be equal to 48% of the fair market value of the number of shares of stock to be covered by the Stock Option, determined based on the on the fair market value of the stock on the date of termination, and then discounted from January 1 of the year for which the Stock Option would have been granted to the date of termination using an interest rate equal to the prime rate for the date of termination as reported in THE WALL STREET JOURNAL (Midwest Edition). Fair market value of the Stock shall be determined by taking the average of the highest and lowest sales prices of the Stock on the date of termination, as reported as the New York Stock Exchange-Composite Transactions for such day, or if the Stock was not traded on the New York Stock Exchange on such day then on the next preceding day on which the stock was traded, all as reported by THE WALL STREET JOURNAL (Midwest Edition) under the heading New York Stock Exchange-Composite Transactions, or, if the stock ceases to be listed on such exchange, as reported on the principal national securities exchange or national automated stock quotation system on which the stock is traded or quoted, but in no event shall the price be less than the par value of the stock. Payment pursuant to this paragraph (iv) shall be made as soon as practicable after Executive's date of termination. (d) Any unexercised Stock Option held by Executive upon termination of employment shall be fully vested on the date of termination and may be exercised by the Executive at any time up to the first anniversary of Executive's date of termination (but not later than the date on which such Stock Option would expire if Executive had remained employed by the Company). Any options other than Stock Options may be exercised during the same period, but only to the extent vested under the terms of such option. The provisions of this paragraph 6.3(d) shall apply notwithstanding any contrary provision in any agreement governing any Stock Option or other option. Page 50 (e) In the event that Executive dies before all payments pursuant to this Section 6 have been paid, all remaining payments shall be made to the beneficiary specifically designated by the Executive in writing prior to his death, or, if no such beneficiary was designated (or the Company is unable in good faith to determine the beneficiary designated), to his personal representative or estate. Except as otherwise provided in this Section 6, the rights of Executive or his personal representatives, heirs, or beneficiaries under any benefit plan, program or arrangement in which he participated at the time of such termination, including any benefits which shall have accrued and vested under the terms of any plan described in Section 4, and his rights under any long-term incentive compensation plan, shall remain unaffected and shall be determined by the applicable terms of such plans, programs or arrangements. 6.3. TERMINATION FOR GOOD REASON BY EXECUTIVE. (a) In the event that Executive's employment is terminated by Executive for "good reason," the Company's obligations shall be the same as they would have been, and Executive shall receive the same payments and other benefits that he would have received, had the Company terminated his employment pursuant to subsection 6.2. (b) For purposes of this Agreement, the term "good reason" means any of the following without Executive's written consent: (i) a reduction in the rate of Executive's Base Compensation; (ii) any change in the Incentive Compensation Plan, including an increase in the performance targets or a reduction in the maximum Incentive Compensation Award (as a percentage of Base Compensation), which has the effect of reducing the maximum Incentive Compensation Award that the Executive may earn below the amounts specified in paragraph 3(b), other than an exercise by the Committee of negative discretion to the extent permitted by paragraph 3(b), or a failure by the Committee in good faith to determine that the Performance Criteria have been satisfied; (iii) any change in the number of the target number of Stock Options under the LTIP or any material adverse change in the terms of any Stock Option after grant (other than a change permitted by the terms of the LTIP as of the date of this Agreement); or (iv) a material breach by the Company of any of the terms of this Agreement; provided, however, that in no event shall the Executive's employment be considered to have terminated for good reason unless the Executive shall give written notice to the Company of his intention to terminate his employment, which notice shall be given not later than 30 days following the date on which the Executive has knowledge (or, with the exercise of reasonable diligence), would have knowledge, of the Company's actions constituting good reason, and the Company shall have failed within a reasonable time after receipt of such notice to correct such conduct. 6.4. VOLUNTARY RESIGNATION BY EXECUTIVE. In the event that Executive's employment is terminated by Executive other than pursuant to subsection 6.4 or as a direct result of his death or Permanent Disability (as described in subsection 6.1), the Company shall pay any unpaid Base Compensation accrued through the date of termination, any unpaid Incentive Compensation Award described in paragraph 3(b) with respect to the performance period prior to the date of such termination, or which is otherwise earned but not yet paid as of the date of termination (including amounts voluntarily deferred) and unused vacation time accrued prior to the date of such termination. However, upon such termination, Executive's right to payments or otherwise with respect to any annual Incentive Award for the performance period during which the termination occurs, or any Long-Term Incentive Award or other amount that is unearned as of the date of termination, and any Stock Option or other option that is unexercised on the date of termination, shall be forfeited, and the Company shall have no further obligations under this Agreement. The rights of Executive under any benefit plan, program or arrangement in which he participated at the time of such termination, including any benefits which shall have accrued and vested under the terms of any plan described in Section 4 shall be determined by the applicable terms of such plans, programs or arrangements. Page 51 6.5. FAILURE TO EXTEND AGREEMENT. In the event that this Agreement has not been extended or renewed by mutual agreement at the end of its term on December 31, 2002 and the employment of Executive continues, then the following shall apply: (a) Such employment shall constitute an employment at will from month to month. During Executive's employment following December 31, 2002, (i) if the Company employs Executive under this section during the period from January 1, 2003 to March 31, 2003, he shall receive salary during such employment at the annual rate of 400% of his annual Base Compensation as of December 31, 2002; (ii) the terms of this Agreement that governed Executive's benefits and perquisites prior to January 1, 2003 will continue to apply, and will be in addition to Executive's salary specified in clause (i) above; (iii) Executive shall be entitled to payment with respect to the Incentive Compensation Award for calendar year 2002, and LTIP awards for the performance period ending December 31, 2002 to the extent provided by this Agreement, but Executive will not be entitled to an Incentive Compensation Award, or LTIP awards or any other incentive compensation award for performance periods beginning after December 31, 2002. (b) If the Company terminates Executive's employment following December 31, 2002, or if the Company and Executive shall not have mutually agreed to the terms of, and entered into, a new employment agreement prior to March 31, 2003, then Executive's employment shall terminate on April 1, 2003, and the Company's obligations shall be the same as they would have been, and Executive shall receive the same payments and other benefits that he would have received, had the Company terminated his employment pursuant to subsection 6.2 (but not including any additional payment with respect to Stock Options pursuant to paragraph 6.2(c)). 7. PARACHUTE PAYMENT GROSS-UP. In the event that any payments made to Executive under this Agreement shall be found to constitute an "excess parachute payment" within the meaning of section 280(G) of the Internal Revenue Code or other payment subject to a federal excise tax, the Company shall pay to Executive an amount equal to the amount of such excise tax, plus a tax gross-up payment in the amount of the aggregate additional federal, state, and local income, excise or other taxes payable by Executive with respect to the receipt of such excise tax payment. 8. CONFIDENTIAL INFORMATION AND PROPRIETARY DATA. (a) Executive agrees that, while he is employed by the Company, and at all times thereafter, he shall continue to hold in a fiduciary capacity for the benefit of the Company information, knowledge or data that is confidential or proprietary (as defined in paragraph 8(b)) and that relates to either (i) the Company, or (ii) any other business or entity in which the Company at any relevant time holds, directly or indirectly, a greater than a 10% equity (voting or non-voting) interest (in either case "Confidential Material"). Executive shall not, without the prior written consent of the CNAF CEO, communicate or divulge any Confidential Material to anyone other than the Company and those individuals or entities designated by the Company. Executive agrees that upon termination of his employment he shall return all copies and originals of Confidential Material. (b) The term "confidential or proprietary" means information, knowledge or data not known generally outside the Company (unless as a result of a breach of any of the obligations imposed by this Agreement) concerning the business and technical information of the Company or any entity described in paragraph 8(a), including without limitation information relating to data, finances, agents, trade secrets, processes, purchases, sales, customers, customer lists, price lists, pricing, margins, financial and marketing data, business plans, and key employees. Page 52 9. COMPETITION. Executive hereby agrees that, while he is employed by the Company, and for a period of 24 months following the date of his termination of employment with the Company for any reason, he will not, directly or indirectly, without the prior written approval of the CNAF CEO, enter into any business relationship (either as principal, agent, board member, officer, consultant, stockholder, employee or in any other capacity) with any business or other entity that at any relevant time competes in any respect with any of the principal businesses of the Company (a "Competitor"); PROVIDED, HOWEVER, that such prohibited activity shall not include the ownership of fewer than 5% of the voting securities of any publicly traded corporation (determined by vote or value) or limited partnership interests constituting fewer than five percent (5%) of the value of any such partnership regardless of the business of such corporation; and provided further, that this non-competition restriction shall not preclude Executive from working for a Competitor in a non-executive position, or a position which does not involve insurance operations or strategies. Upon the written request of Executive, the CNAF CEO will determine whether a business or other entity constitutes a "Competitor" for purposes of this Section 9; provided that the Chief Executive Officer of CNA Financial Corporation may require Executive to provide such information as the CNAF CEO reasonably determines to be necessary to make such determination; and further provided that the current and continuing effectiveness of such determination may be conditioned on the accuracy of such information, and on such other factors as the CNAF CEO may reasonably determine. 10. SOLICITATION. Executive agrees that while he is employed by the Company, and for a period of 36 months following his termination of employment with the Company for any reason, he will not employ, offer to employ, engage as a consultant, or form an association with any person who is then, or who during the preceding one year was, an employee of the Company, nor will he assist any other person in soliciting for employment or consultation any person who is then, or who during the preceding one year was, an employee of the Company, nor will he encourage any person who is then an employee or agent of the Company to terminate his or her employment or agency with the Company. 11. NON-INTERFERENCE. Executive agrees that while he is employed by the Company, and for a period of 36 months following his termination of employment with the Company for any reason, he will not disturb or attempt to disturb any business or employment relationship or agreement between the Company and any other person or entity. 12. ASSISTANCE WITH CLAIMS. Executive agrees that, while he is employed by the Company, and for a reasonable period (not fewer than 36 months) thereafter, he will be available, on a reasonable basis, to assist the Company in the prosecution or defense of any claims, suits, litigation, arbitrations, investigations, or other proceedings, whether pending or threatened ("Claims") that may be made or threatened by or against the Company. Executive agrees, unless precluded by law, to promptly inform the Company if he is requested (i) to testify or otherwise become involved in connection with any Claim against the Company or (ii) to assist or participate in any investigation (whether governmental or private) of the Company or any of their actions, whether or not a lawsuit has been filed against the Company relating thereto. 13. RETURN OF MATERIALS. Executive shall, at any time upon the request of the Company, and in any event upon the termination of his employment with the Company, for whatever reason, immediately return and surrender to the Company all originals and all copies, regardless of medium, of property belonging to the Company, created or obtained by Executive as a result of or in the course of or in connection with his employment with the Company regardless of whether such items constitute proprietary information, provided that Executive shall be under no obligation to return written materials acquired from third parties which are generally available to the public. Executive acknowledges that all such materials are, and will remain, the exclusive property of the Company. Page 53 14. EFFECT OF BREACH. Executive acknowledges that his violation of the covenants set forth in Sections 8, 9, 10, 11 and 13 could cause the Company irreparable harm and he agrees that the Company shall be entitled to injunctive relief from a court of competent jurisdiction restraining Executive from actual or threatened breach of the covenants and that if bond is required to be posted in order for the Company to secure such relief said bond need only be in a nominal amount. The right of the Company to seek injunctive relief shall be in addition to any other remedies available to the Company with respect to an alleged or threatened breach. 15. LIMITATION ON REMEDIES. The Company shall not be entitled to suspend payments otherwise due to Executive by reason of Executive's violation of Sections 8, 9, 10, 11 and 13, whether before or after a judgment is obtained by the Company against Executive. The Company shall not be entitled to set off against the amounts payable to Executive under this Agreement any amounts owed to the Company by Executive. Nothing in this Section 15 shall limit the Company's remedies in the case of Executive's violation of this Agreement, except as otherwise specifically provided in this Section 15. 16. EFFECT OF COVENANTS. Nothing in Sections 8 through 15 shall be construed to adversely affect the rights that the Company would possess in the absence of the provisions of such Sections and related entities. 17. REVISION. The parties hereto expressly agree that in the event that any of the provisions, covenants, warranties or agreements in this Agreement are held to be in any respect an unreasonable restriction upon Executive or are otherwise invalid, for whatsoever cause, then the court or arbitrator so holding is hereby authorized to (a) reduce the territory to which said covenant, warranty or agreement pertains, the period of time in which said covenant, warranty or agreement operates or the scope of activity to which said covenant, warranty or agreement pertains or (b) effect any other change to the extent necessary to render any of the restrictions contained in this Agreement enforceable. 18. SEVERABILITY. Each of the terms and provisions of this Agreement is to be deemed severable in whole or in part and, if any term or provision of the application thereof in any circumstances should be invalid, illegal or unenforceable, the remaining terms and provisions or the application thereof to circumstances other than those as to which it is held invalid, illegal or unenforceable, shall not be affected thereby and shall remain in full force and effect. 19. BINDING AGREEMENT; ASSIGNMENT. This Agreement shall be binding upon the parties hereto and their respective heirs, successors, personal representatives and assigns. The Company shall have the right to assign this Agreement to any successor in interest to the business, or any majority part thereof, of the Company or any joint venture or partnership to which the Company is a joint venturer or general partner which conducts substantially all of the Company's business. Executive shall not assign any of his obligations or duties hereunder and any such attempted assignment shall be null and void. 20. CONTROLLING LAW; JURISDICTION. This Agreement shall be governed by, interpreted and construed according to the laws of the State of Illinois (without regard to conflict of laws principles). 21. ARBITRATION OF ALL DISPUTES. Any controversy or claim arising out of or relating to this Agreement (or the breach thereof) shall be settled by final, binding and non-appealable arbitration in Chicago, Illinois by three arbitrators. Except as otherwise expressly provided in this Section 21, the arbitration shall be conducted in accordance with the rules of the American Arbitration Association (the "Association") then in effect. One of the arbitrators shall be appointed by the Company, one shall be appointed by Executive, and the third shall be appointed by the first two arbitrators. If the first two arbitrators cannot agree on the third arbitrator within 30 days of the appointment of the second arbitrator, then the third arbitrator shall be selected according to the rules of the Association. This Section 21 shall not be construed to limit the Company's right to obtain relief in court under Section 14 with respect to any matter or controversy subject to Section 14 and, prior to Page 54 a final determination by the arbitrator with respect to any such matter or controversy, the Company shall be entitled to obtain any such relief by direct application to state, federal or other applicable court, without being required to first arbitrate such matter or controversy. 22. ENTIRE AGREEMENT. Except as otherwise expressly set forth herein, this Agreement contains the entire agreement of the parties with regard to the subject matter hereof, supersedes all prior agreements and understandings, written or oral, and may only be amended by an agreement in writing signed by the parties thereto. 23. ADDITIONAL DOCUMENTS. Each party hereto shall, from time to time, upon request of the other party, execute any additional documents which shall reasonably be required to effectuate the purposes hereof. 24. INCORPORATION. The introductory recitals hereof are incorporated in this Agreement and are binding upon the parties hereto. 25. FAILURE TO ENFORCE. The failure to enforce any of the provisions of this Agreement shall not be construed as a waiver of such provisions. Further, any express waiver by any party with respect to any breach of any provision hereunder by any other party shall not constitute a waiver of such party's right to thereafter fully enforce each and every provision of this Agreement. 26. SURVIVAL. Except as otherwise set forth herein, the obligations contained in this Agreement shall survive the termination, for any reason whatsoever, of Executive's employment with the Company. 27. HEADINGS. All numbers and headings contained herein are for reference only and are not intended to qualify, limit or otherwise affect the meaning or interpretation of any provision contained herein. 28. NOTICES. Notices and all other communications provided for in this Agreement shall be in writing and shall be delivered personally or sent by registered or certified mail, return receipt requested, postage prepaid (provided that international mail shall be sent via overnight or two-day delivery), or sent by facsimile or prepaid overnight courier to the parties at the addresses or facsimile numbers set forth below (or such other addresses or facsimile numbers as shall be specified by the parties by like notice). Such notices, demands, claims and other communications shall be deemed given: (a) in the case of delivery by overnight service with guaranteed next day delivery, the next day or the day designated for delivery; (b) in the case of certified or registered U.S. mail, five days after deposit in the U.S. mail; or (c) in the case of facsimile, the date upon which the transmitting party received confirmation of receipt by facsimile, telephone or otherwise; provided, however, that in no event shall any such communications be deemed to be given later than the date they are actually received. Communications that are to be delivered by the U.S. mail or by overnight service or two-day delivery service are to be delivered to the addresses or facsimile numbers set forth below: Page 55 If to the Company: CNA Financial Corporation CNA Plaza Chicago, IL 60685 Attn: Corporate Secretary Facsimile Number: (312) 817-0511 If to Executive: Bernard L. Hengesbaugh 202 Thompson Drive Wheaton, IL 60187 Facsimile Number: (630) 260-5932 or to such other address as either party shall furnish to the other party in writing in accordance with the provisions of this Section 28. 29. GENDER. The masculine, feminine or neuter pronouns used herein shall be interpreted without regard to gender, and the use of the singular or plural shall be deemed to include the other whenever the context so requires. IN WITNESS WHEREOF, the parties hereto have executed this Agreement as of the date first above written. CNA FINANCIAL CORPORATION By: /s/JONATHAN D. KANTOR ------------------------------------- Title: Senior Vice President, General Counsel and Secretary BERNARD L. HENGESBAUGH /S/BERNARD L. HENGESBAUGH - --------------------------------------------- (executed on November 2, 2000) Page 56 EX-27 3 0003.txt FINANCIAL DATA SCHEDULE
7 0000021175 CNA FINANCIAL CORPORATION 1,000,000 9-MOS DEC-31-2000 JAN-1-2000 SEP-30-2000 26,664 0 0 2,636 22 5 35,676 174 8,983 2,578 63,522 33,488 5,103 139 656 2,774 0 0 464 8,843 63,522 8,467 1,537 1,168 520 7,156 1,381 1,489 1,512 468 1,021 0 0 0 1,021 5.55 5.55 0 0 0 0 0 0 0
-----END PRIVACY-ENHANCED MESSAGE-----