Note 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 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:


December 31, 2014	Level 1			Level 2			Level 3		Total

(In millions)

Fixed maturity securities:
Corporate and other bonds	$	32		$	18,692		$	162	$	18,886
States, municipalities and political subdivisions					12,646			94		12,740
Asset-backed:
Residential mortgage-backed					5,044			189		5,233
Commercial mortgage-backed					2,061			83		2,144
Other asset-backed					580			655		1,235

Total asset-backed					7,685			927		8,612
U.S. Treasury and obligations of government-sponsored enterprises		28			3					31
Foreign government		41			413					454
Redeemable preferred stock		30			12					42

Fixed maturities available-for-sale		131			39,451			1,183		40,765
Fixed maturities trading					30			90		120

Total fixed maturities	$	131		$	39,481		$	1,273	$	40,885


Equity securities available-for-sale	$	145		$	61		$	16	$	222
Equity securities trading		505						1		506

Total equity securities	$	650		$	61		$	17	$	728


Short term investments	$	4,989		$	963				$	5,952
Other invested assets		102			41					143
Receivables		2			7					9
Life settlement contracts							$	82		82
Payable to brokers		(546	)		(6	)				(552)


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 years ended December 31, 2014 and 2013:


																			Unrealized
																			Gains
																			(Losses)
																			Recognized in
			Net Realized Gains																Net Income
			(Losses) and Net Change																on Level
			in Unrealized Gains																3 Assets and
			(Losses)										Transfers		Transfers				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		December 31		December 31

(In millions)

Fixed maturity securities:
Corporate and other bonds	$	204	$	2	$	(1)	$	33	$	(23)	$	(16)	$	18	$	(55)	$	162
States, municipalities and political subdivisions		71		1		4		14		(10)				14				94
Asset-backed:
Residential mortgage-backed		331		(21)		61		94		(174)		(72)		32		(62)		189
Commercial mortgage-backed		151		7		(6)		28		(60)		(29)		43		(51)		83
Other asset-backed		446		2		(6)		488		(111)		(117)				(47)		655	$	(1)

Total asset-backed		928		(12)		49		610		(345)		(218)		75		(160)		927		(1)

Fixed maturities available-for-sale		1,203		(9)		52		657		(378)		(234)		107		(215)		1,183		(1)
Fixed maturities trading		80		11						(1)								90		11

Total fixed maturities	$	1,283	$	2	$	52	$	657	$	(379)	$	(234)	$	107	$	(215)	$	1,273	$	10


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

Total equity securities	$	19	$	2	$	(6)	$	16	$	(14)	$	-	$	-	$	-	$	17	$	1


Life settlement contracts	$	88	$	33							$	(39)					$	82	$	8
Separate account business		1													$	(1)		-
Derivative financial instruments, net		(3)		1					$	2								-		2


																			Unrealized
																			Gains
																			(Losses)
																			Recognized in
			Net Realized Gains																Net Income
			(Losses) and Net Change																on Level
			in Unrealized Gains																3 Assets and
			(Losses)										Transfers		Transfers				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		December 31		December 31

(In millions)

Fixed maturity securities:
Corporate and other bonds	$	219	$	3			$	123	$	(97)	$	(44)	$	51	$	(51)	$	204	$	(2)
States, municipalities and political subdivisions		96		(2)	$	4		122		(79)		(61)		18		(27)		71
Asset-backed:
Residential mortgage-backed		413		4		(14)		116		(10)		(75)		4		(107)		331		(3)
Commercial mortgage-backed		129				11		107		(3)		(11)		21		(103)		151
Other asset-backed		368		5		(4)		314		(197)		(35)				(5)		446		(2)

Total asset-backed		910		9		(7)		537		(210)		(121)		25		(215)		928		(5)
Redeemable preferred stock		26		(1)								(25)						-

Fixed maturities available-for-sale		1,251		9		(3)		782		(386)		(251)		94		(293)		1,203		(7)
Fixed maturities trading		89		(4)				19		(24)								80		(4)

Total fixed maturities	$	1,340	$	5	$	(3)	$	801	$	(410)	$	(251)	$	94	$	(293)	$	1,283	$	(11)


Equity securities available-for-sale	$	34	$	(27)	$	3	$	2							$	(1)	$	11	$	(27)
Equity securities trading		7		(5)				6										8		(5)

Total equity securities	$	41	$	(32)	$	3	$	8	$	-	$	-	$	-	$	(1)	$	19	$	(32)


Short term investments	$	6							$	(6)							$	-
Other invested assets		1								(1)								-
Life settlement contracts		100	$	13							$	(25)						88	$	(2)
Separate account business		2					$	1		(2)								1
Derivative financial instruments, net		5		8	$	(9)		(2)		1		(6)						(3)		1

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


Major Category of Assets and Liabilities		Consolidated 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. There were $24 million of transfers from Level 2 to Level 1 and $1 million of transfers from Level 1 to Level 2 during the year ended December 31, 2014. There were no transfers between Level 1 and Level 2 during the year ended December 31, 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, 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 or 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 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 included 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 20. 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.


December 31, 2014	Fair Value		Valuation Techniques	Unobservable Inputs	Range (Weighted Average)

	(In millions)

Assets

Fixed maturity securities	$	101	Discounted cash flow	Credit spread	2% – 13% (3%)

Equity securities		16	Market approach	Private offering price	$12 – $4,391 per share
					($600 per share)
Life settlement contracts		82	Discounted cash flow	Discount rate risk premium	9%
				Mortality assumption	55% – 1,676% (163%)

December 31, 2013


Assets

Fixed maturity securities	$	142	Discounted cash flow	Credit spread	2% – 20% (4%)

Equity securities		10	Market approach	Private offering price	$360 – $4,268 per share
					($1,148 per share)
Life settlement contracts		88	Discounted cash flow	Discount rate risk premium	9%
				Mortality assumption	70% – 743% (192%)

For fixed maturity securities, an increase to the credit spread assumptions would result in a lower fair value measurement. For equity securities, an increase in the private offering price 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 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 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
December 31, 2014	Amount		Level 1	Level 2		Level 3		Total

(In millions)

Financial Assets:
Other invested assets, primarily mortgage loans	$	588				$	608	$	608

Financial Liabilities:
Short term debt		334		$	255		84		339
Long term debt		10,320			10,299		420		10,719

December 31, 2013


Financial Assets:
Other invested assets, primarily mortgage loans	$	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 of 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.