4. Fair Value

Fair value is the price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The following fair value hierarchy is used in selecting inputs, with the highest priority given to Level 1, as these are the most transparent or reliable:

—

Level 1 – Quoted prices for identical instruments in active markets.

—

Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs are observable in active markets.

—

Level 3 – Valuations derived from valuation techniques in which one or more significant inputs are not observable.

Prices may fall within Level 1, 2 or 3 depending upon the methodologies and inputs used to estimate fair value for each specific security. In general, the Company seeks to price securities using third party pricing services. Securities not priced by pricing services are submitted to independent brokers for valuation and, if those are not available, internally developed pricing models are used to value assets using methodologies and inputs the Company believes market participants would use to value the assets. Prices obtained from third-party pricing services or brokers are not adjusted by the Company.

The Company performs control procedures over information obtained from pricing services and brokers to ensure prices received represent a reasonable estimate of fair value and to confirm representations regarding whether inputs are observable or unobservable. Procedures include (i) the review of pricing service or broker pricing methodologies, (ii) back-testing, where past fair value estimates are compared to actual transactions executed in the market on similar dates, (iii) exception reporting, where changes in price, period-over-period, are reviewed and challenged with the pricing service or broker based on exception criteria, (iv) detailed analysis, where the Company performs an independent analysis of the inputs and assumptions used to price individual securities and (v) pricing validation, where prices received are compared to prices independently estimated by the Company.

The fair values of CNA’s life settlement contracts are included in Other assets on the Consolidated Condensed Balance Sheets. Equity options purchased are included in Equity securities, and all other derivative assets are included in Receivables. Derivative liabilities are included in Payable to brokers. Assets and liabilities measured at fair value on a recurring basis are summarized in the tables below:

September 30, 2014

Level 1

Level 2

Level 3

Total

(In millions)

Fixed maturity securities:

Corporate and other bonds

18,938

173

19,144

States, municipalities and political subdivisions

12,379

12,459

Asset-backed:

Residential mortgage-backed

4,986

160

5,146

Commercial mortgage-backed

2,061

2,158

Other asset-backed

588

642

1,230

Total asset-backed

7,635

899

8,534

U.S. Treasury and obligations of government- sponsored enterprises

Foreign government

424

471

Redeemable preferred stock

Fixed maturities available-for-sale

137

39,391

1,152

40,680

Fixed maturities, trading

124

Total fixed maturities

137

39,424

1,243

40,804

Equity securities available-for-sale

141

211

Equity securities, trading

540

543

Total equity securities

681

754

Short term investments

6,047

612

6,659

Other invested assets

102

146

Receivables

Life settlement contracts

Payable to brokers

(409)

(5)

(414)


December 31, 2013	Level 1			Level 2			Level 3			Total

(In millions)

Fixed maturity securities:
Corporate and other bonds	$	33		$	20,625		$	204		$	20,862
States, municipalities and political subdivisions					11,486			71			11,557
Asset-backed:
Residential mortgage-backed					4,640			331			4,971
Commercial mortgage-backed					1,912			151			2,063
Other asset-backed					509			446			955

Total asset-backed					7,061			928			7,989
U.S. Treasury and obligations of government- sponsored enterprises		116			28						144
Foreign government		81			462						543
Redeemable preferred stock		45			57						102

Fixed maturities available-for-sale		275			39,719			1,203			41,197
Fixed maturities, trading					43			80			123

Total fixed maturities	$	275		$	39,762		$	1,283		$	41,320


Equity securities available-for-sale	$	126		$	48		$	11		$	185
Equity securities, trading		678						8			686

Total equity securities	$	804		$	48		$	19		$	871


Short term investments	$	6,134		$	563					$	6,697
Other invested assets					54						54
Receivables					3						3
Life settlement contracts							$	88			88
Separate account business		9			171			1			181
Payable to brokers		(40	)		(1	)		(3	)		(44)
Assets of discontinued operations		28			2			2			32
Liabilities of discontinued operations					(6	)		(2	)		(8)

The tables below present reconciliations for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and nine months ended September 30, 2014 and 2013:


			Net Realized Gains (Losses) and Net Change in Unrealized Gains (Losses)										Transfers		Transfers				Unrealized Gains (Losses) Recognized in Net Income on Level 3 Assets and Liabilities
	Balance,		Included in		Included in								into		out of		Balance,		Held at
2014	July 1		Net Income		OCI		Purchases		Sales		Settlements		Level 3		Level 3		September 30		September 30
(In millions)

Fixed maturity securities:
Corporate and other bonds	$	194			$	(1)	$	4			$	(3)			$	(21)	$	173
States, municipalities and political subdivisions		79				1												80
Asset-backed:
Residential mortgage-backed		185	$	1								(17)	$	11		(20)		160
Commercial mortgage-backed		59		2		(2)		28				(21)		31				97
Other asset-backed		626		1		(4)		80				(25)				(36)		642

Total asset-backed		870		4		(6)		108	$	-		(63)		42		(56)		899	$	-

Fixed maturities available-for-sale		1,143		4		(6)		112				(66)		42		(77)		1,152
Fixed maturities, trading		91																91

Total fixed maturities	$	1,234	$	4	$	(6)	$	112	$	-	$	(66)	$	42	$	(77)	$	1,243	$	-


Equity securities available-for-sale	$	2			$	(1)	$	16									$	17
Equity securities trading		4						(1)										3

Total equity securities	$	6	$	-	$	(1)	$	15	$	-	$	-	$	-	$	-	$	20	$	-


Life settlement contracts	$	86	$	1							$	(1)					$	86	$	1
Derivative financial instruments, net		-																-		(1)


			Net Realized Gains (Losses) and Net Change in Unrealized Gains (Losses)										Transfers		Transfers				Unrealized Gains (Losses) Recognized in Net Income on Level 3 Assets and Liabilities
	Balance,		Included in		Included in								into		out of		Balance,		Held at
2013	July 1		Net Income		OCI		Purchases		Sales		Settlements		Level 3		Level 3		September 30		September 30
(In millions)

Fixed maturity securities:
Corporate and other bonds	$	202	$	1			$	6	$	(6)	$	(8)	$	17	$	(1)	$	211
States, municipalities and political subdivisions		140			$	(3)						(15)				(27)		95
Asset-backed:
Residential mortgage-backed		428				(20)		5				(21)				(22)		370	$	(1)
Commercial mortgage-backed		165		(1)		(2)		10				(1)				(14)		157
Other asset-backed		387				1		56				(6)				(5)		433		(1)

Total asset-backed		980		(1)		(21)		71		-		(28)		-		(41)		960		(2)
Redeemable preferred stock		25		(1)		1						(25)						-

Fixed maturities available-for-sale		1,347		(1)		(23)		77		(6)		(76)		17		(69)		1,266		(2)
Fixed maturities, trading		87		(8)						(1)								78		(8)

Total fixed maturities	$	1,434	$	(9)	$	(23)	$	77	$	(7)	$	(76)	$	17	$	(69)	$	1,344	$	(10)


Equity securities available-for-sale	$	13	$	(2)	$	2											$	13	$	(2)
Equity securities trading		2																2

Total equity securities	$	15	$	(2)	$	2	$	-	$	-	$	-	$	-	$	-	$	15	$	(2)


Life settlement contracts	$	91	$	3							$	(4)					$	90
Separate account business		2																2
Derivative financial instruments, net		5		2	$	(4)			$	(2)		(1)						-


			Net Realized Gains (Losses) and Net Change in Unrealized Gains (Losses)										Transfers		Transfers				Unrealized Gains (Losses) Recognized in Net Income on Level 3 Assets and Liabilities
	Balance,		Included in		Included in								into		out of		Balance,		Held at
2014	January 1		Net Income		OCI		Purchases		Sales		Settlements		Level 3		Level 3		September 30		September 30
(In millions)

Fixed maturity securities:
Corporate and other bonds	$	204	$	2			$	30	$	(10)	$	(13)	$	8	$	(48)	$	173
States, municipalities and political subdivisions		71		1	$	3		1		(10)				14				80
Asset-backed:
Residential mortgage-backed		331		(22)		62		47		(174)		(57)		32		(59)		160
Commercial mortgage-backed		151		4		(2)		28		(60)		(23)		43		(44)		97
Other asset-backed		446		2				457		(111)		(115)				(37)		642	$	(1)

Total asset-backed		928		(16)		60		532		(345)		(195)		75		(140)		899		(1)

Fixed maturities available-for-sale		1,203		(13)		63		563		(365)		(208)		97		(188)		1,152		(1)
Fixed maturities, trading		80		11														91		11

Total fixed maturities	$	1,283	$	(2)	$	63	$	563	$	(365)	$	(208)	$	97	$	(188)	$	1,243	$	10


Equity securities available-for-sale	$	11	$	3	$	(5)	$	16	$	(8)							$	17
Equity securities trading		8						1		(6)								3

Total equity securities	$	19	$	3	$	(5)	$	17	$	(14)	$	-	$	-	$	-	$	20	$	-


Life settlement contracts	$	88	$	23							$	(25)					$	86	$	3
Separate account business		1													$	(1)		-
Derivative financial instruments, net		(3)		1			$	(2)	$	2						2		-		1


			Net Realized Gains (Losses) and Net Change in Unrealized Gains (Losses)										Transfers		Transfers				Unrealized Gains (Losses) Recognized in Net Income on Level 3 Assets and Liabilities
	Balance,		Included in		Included in								into		out of		Balance,		Held at
2013	January 1		Net Income		OCI		Purchases		Sales		Settlements		Level 3		Level 3		September 30		September 30
(In millions)

Fixed maturity securities:
Corporate and other bonds	$	219	$	2	$	(1)	$	129	$	(96)	$	(34)	$	43	$	(51)	$	211	$	(2)
States, municipalities and political subdivisions		96		(3)		1		122		(79)		(20)		5		(27)		95
Asset-backed:
Residential mortgage-backed		413		2		(21)		116		(10)		(53)		4		(81)		370		(3)
Commercial mortgage-backed		129				7		88				(10)		21		(78)		157
Other asset-backed		368		3		(1)		230		(132)		(30)				(5)		433		(2)

Total asset-backed		910		5		(15)		434		(142)		(93)		25		(164)		960		(5)
Redeemable preferred stock		26		(1)								(25)						-

Fixed maturities available-for-sale		1,251		3		(15)		685		(317)		(172)		73		(242)		1,266		(7)
Fixed maturities, trading		89		(7)						(4)								78		(7)

Total fixed maturities	$	1,340	$	(4)	$	(15)	$	685	$	(321)	$	(172)	$	73	$	(242)	$	1,344	$	(14)


Equity securities available-for-sale	$	34	$	(22)	$	2									$	(1)	$	13	$	(22)
Equity securities trading		7		(5)														2		(5)

Total equity securities	$	41	$	(27)	$	2	$	-	$	-	$	-	$	-	$	(1)	$	15	$	(27)


Short term investments	$	6							$	(6)							$	-
Other invested assets		1								(1)								-
Life settlement contracts		100	$	14							$	(24)						90	$	(1)
Separate account business		2																2
Derivative financial instruments, net		5		7	$	(6)	$	1		(2)		(5)						-		1

Net realized and unrealized gains and losses are reported in Net income as follows:


Major Category of Assets and Liabilities		Consolidated Condensed Statements of Income Line Items

Fixed maturity securities available-for-sale		Investment gains (losses)
Fixed maturity securities, trading		Net investment income
Equity securities available-for-sale		Investment gains (losses)
Equity securities, trading		Net investment income
Other invested assets		Investment gains (losses) and Net investment income
Derivative financial instruments held in a trading portfolio		Net investment income
Derivative financial instruments, other		Investment gains (losses) and Other revenues
Derivative financial instruments included in Assets and Liabilities of discontinued operations		Discontinued operations, net
Life settlement contracts		Other revenues

Securities may be transferred in or out of levels within the fair value hierarchy based on the availability of observable market information and quoted prices used to determine the fair value of the security. The availability of observable market information and quoted prices varies based on market conditions and trading volume. During the three months ended September 30, 2014 there were no transfers between Level 1 and Level 2. During the nine months ended September 30, 2014 there were $24 million of transfers from Level 2 to Level 1 and $1 million from Level 1 to Level 2. There were no transfers between Level 1 and Level 2 during the three or nine months ended September 30, 2013. The Company’s policy is to recognize transfers between levels at the beginning of quarterly reporting periods.

Valuation Methodologies and Inputs

The following section describes the valuation methodologies and relevant inputs used to measure different financial instruments at fair value, including an indication of the level in the fair value hierarchy in which the instruments are generally classified.

Fixed Maturity Securities

Fixed maturity securities are valued using methodologies that model information generated by market transactions involving identical or comparable assets, as well as discounted cash flow methodologies. Common inputs include: prices from recently executed transactions of similar securities, broker/dealer quotes, benchmark yields, spreads off benchmark yields, interest rates and U.S. Treasury or swap curves. Specifically for asset-backed securities, key inputs include prepayment and default projections based on past performance of the underlying collateral and current market data.

Level 1 securities include exchange traded bonds, highly liquid U.S. and foreign government bonds, and redeemable preferred stock, valued using quoted market prices. Level 2 securities include most other fixed maturity securities as the significant inputs are observable in the marketplace. Securities are generally assigned to Level 3 in cases where broker/dealer quotes are significant inputs to the valuation and there is a lack of transparency as to whether these quotes are based on information that is observable in the marketplace. Level 3 securities also include private placement debt securities whose fair value is determined using internal models with inputs that are not market observable.

Equity Securities

Level 1 equity securities include publicly traded securities valued using quoted market prices. Level 2 securities are primarily non-redeemable preferred stocks and common stocks valued using pricing for similar securities, recently executed transactions, broker/dealer quotes and other pricing models utilizing market observable inputs. Level 3 securities are priced using internal models with inputs that are not market observable.

Derivative Financial Instruments

Exchange traded derivatives are valued using quoted market prices and are classified within Level 1 of the fair value hierarchy. Level 2 derivatives primarily include currency forwards valued using observable market forward rates. Over-the-counter derivatives, principally interest rate swaps, total return swaps, commodity swaps, credit default swaps, equity warrants and options, are valued using inputs including broker/dealer quotes and are classified within Level 2 or Level 3 of the valuation hierarchy, depending on the amount of transparency as to whether these quotes are based on information that is observable in the marketplace.

Short Term Investments

Securities that are actively traded and have quoted prices are classified as Level 1. These securities include money market funds and treasury bills. Level 2 primarily includes commercial paper, for which all inputs are market observable. Fixed maturity securities purchased within one year of maturity are classified consistent with fixed maturity securities discussed above. Short term investments as presented in the tables above differ from the amounts presented in the Consolidated Condensed Balance Sheets because certain short term investments, such as time deposits, are not measured at fair value.

Other Invested Assets

Level 1 securities include exchange traded open-end funds valued using quoted market prices. Level 2 securities include overseas deposits which can be redeemed at net asset value in 90 days or less.

Life Settlement Contracts

The fair values of life settlement contracts are determined as the present value of the anticipated death benefits less anticipated premium payments based on contract terms that are distinct for each insured, as well as CNA’s own assumptions for mortality, premium expense, and the rate of return that a buyer would require on the contracts, as no comparable market pricing data is available.

Separate Account Business

Separate account business includes fixed maturity securities, equities and short term investments. The valuation methodologies and inputs for these asset types have been described above.

Assets and Liabilities of Discontinued Operations

Assets and liabilities of discontinued operations relate to HighMount, as discussed in Notes 2 and 15. These balances represent short term investments and derivative assets and liabilities, which are valued using the methodologies and inputs for these asset and liability types described above.

Significant Unobservable Inputs

The tables below present quantitative information about the significant unobservable inputs utilized by the Company in the fair value measurements of Level 3 assets. Valuations for assets and liabilities not presented in the table below are primarily based on broker/dealer quotes for which there is a lack of transparency as to inputs used to develop the valuations. The quantitative detail of unobservable inputs from these broker quotes is neither provided nor reasonably available to the Company.

September 30, 2014

Fair Value

Valuation
Techniques

Unobservable

Inputs

Range

(Weighted

Average)

(In millions)

Assets

Fixed maturity securities

Discounted cash flow

Credit spread

2% – 12% (3%)

Equity securities

Market approach

Private offering price

$13 – $4,388 per share

($554 per share)

Life settlement contracts

Discounted cash flow

Discount rate risk premium

Mortality assumption

70% – 743% (193%)

December 31, 2013

Assets

Fixed maturity securities

142

Discounted cash flow

Credit spread

2% – 20% (4%)

Equity securities

Market approach

Private offering price

$360 – $4,268 per share

($1,148 per share)

Life settlement contracts

Discounted cash flow

Discount rate risk premium

Mortality assumption

70% – 743% (192%)

For fixed maturity securities, an increase in the credit spread assumptions would result in a lower fair value measurement. For equity securities, an increase in the private offering price, earnings projections and earnings multiple would result in a higher fair value measurement. For life settlement contracts, an increase in the discount rate risk premium or decrease in the mortality assumption would result in a lower fair value measurement.

Financial Assets and Liabilities Not Measured at Fair Value

The carrying amount, estimated fair value and the level of the fair value hierarchy of the Company’s financial instrument assets and liabilities which are not measured at fair value on the Consolidated Condensed Balance Sheets are listed in the tables below. The carrying amounts and estimated fair values of short term debt and long term debt exclude capital lease obligations. The carrying amounts reported on the Consolidated Condensed Balance Sheets for cash and short term investments not carried at fair value and certain other assets and liabilities approximate fair value due to the short term nature of these items.


	Carrying		Estimated Fair Value
September 30, 2014	Amount		Level 1	Level 2		Level 3		Total
(In millions)

Financial Assets:
Other invested assets	$	556				$	576	$	576

Financial Liabilities:
Short term debt		850		$	813		51		864
Long term debt		10,040			10,191		420		10,611

December 31, 2013

Financial Assets:
Other invested assets	$	508				$	515	$	515

Financial Liabilities:
Premium deposits and annuity contracts		57					58		58
Short term debt		818		$	832		20		852
Long term debt		9,515			9,907		182		10,089
Long term debt included in discontinued operations		500			500				500

The following methods and assumptions were used in estimating the fair value of these financial assets and liabilities.

The fair values of mortgage loans, included in Other invested assets, were based on the present value of the expected future cash flows discounted at the current interest rate for similar financial instruments, adjusted for specific loan risk.

Premium deposits and annuity contracts were valued based on cash surrender values or estimated fair values of policyholder liabilities, net of amounts ceded related to sold business.

Fair value of debt was based on observable market prices when available. When observable market prices were not available, the fair value for debt was based on observable market prices of comparable instruments adjusted for differences between the observed instruments and the instruments being valued or is estimated using discounted cash flow analyses, based on current incremental borrowing rates for similar types of borrowing arrangements.