CNA FINANCIAL CORP – 10-K – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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Index to this MD&A Management's discussion and analysis of financial condition and results of operations is comprised of the following sections:
Page No. OVERVIEW 17 CONSOLIDATED OPERATIONS 18 CRITICAL ACCOUNTING ESTIMATES 20 RESERVES - ESTIMATES AND UNCERTAINTIES 23 SEGMENT RESULTS 30 CNA Specialty 31 CNA Commercial 34 Life & Group Non-Core 37 Corporate & Other Non-Core 39 INVESTMENTS 41 Net Investment Income 41 Net Realized Investment Gains (Losses) 42 Portfolio Quality 42 Duration 44 Select Asset Class Discussion 44 LIQUIDITY AND CAPITAL RESOURCES 46 Cash Flows 46 2008 Senior Preferred and Surplus Note 47 Liquidity 47 Common Stock Dividends 47 Commitments, Contingencies and Guarantees 48 Ratings 49 ACCOUNTING STANDARDS UPDATES 49 FORWARD-LOOKING STATEMENTS 50 16
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OVERVIEW
The following discussion should be read in conjunction with Item 1A. Risk Factors, Item 6. Selected Financial Data and Item 8. Financial Statements and Supplementary Data of this Form 10-K. References to net operating income (loss), net realized investment gains (losses) and net income (loss) used in this MD&A reflect amounts attributable to CNA, unless otherwise noted. 17
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CONSOLIDATED OPERATIONS Results of Operations The following table includes the consolidated results of our operations. For more detailed components of our business operations and the net operating income financial measure, see the segment discussions within this MD&A. Years endedDecember 31 (In millions) 2011 2010 2009 Operating Revenues Net earned premiums $ 6,603 $ 6,515 $ 6,721 Net investment income 2,054 2,316 2,320 Other revenues 294 292 288 Total operating revenues 8,951 9,123 9,329 Claims, Benefits and Expenses Net incurred claims and benefits 5,476 4,955
5,267
Policyholders' dividends 13 30 23 Amortization of deferred acquisition costs 1,410 1,387
1,417
Other insurance related expenses 738 797
781
Other expenses 433 928
444
Total claims, benefits and expenses 8,070 8,097
7,932
Operating income from continuing operations before income tax 881 1,026
1,397
Income tax expense on operating income (251 ) (297 ) (353 ) Net operating (income) loss, after-tax, attributable to noncontrolling interests (16 ) (69 ) (62 ) Net operating income from continuing operations attributable to CNA 614 660
982
Net realized investment gains (losses), net of participating policyholders' interests (4 ) 86 (857 ) Income tax (expense) benefit on net realized investment gains (losses) 5 (36 ) 296 Net realized investment (gains) losses, after-tax, attributable to noncontrolling interests - 1 - Net realized investment gains (losses) attributable to CNA 1 51 (561 ) Income from continuing operations attributable to CNA 615 711
421
Loss from discontinued operations attributable to CNA (1 ) (21 ) (2 ) Net income attributable to CNA $ 614 $ 690
$ 419
Agreement to Cede A&EP Liabilities to NICO As further discussed in Note F to the Consolidated Financial Statements included under Item 8, on August, 31, 2010, we completed a transaction with NICO, a subsidiary of Berkshire Hathaway Inc., under which substantially all our legacy A&EP liabilities were ceded to NICO. We recognized an after-tax loss of$365 million in the third quarter of 2010, of which$344 million related to our continuing operations and$21 million related to our discontinued operations. 2011 Compared with 2010 Net income decreased$76 million in 2011 as compared with 2010. Excluding the loss associated with the Loss Portfolio Transfer in 2010, net income decreased$441 million in 2011 as compared with 2010 due to lower net operating income and decreased net realized investment gains. Net realized investment gains decreased$50 million in 2011 as compared with 2010. See the Investments section of this MD&A for further discussion of net investment income and net realized investment results. Net operating income decreased$46 million in 2011 as compared with 2010. Excluding the loss associated with the Loss Portfolio Transfer, net operating income decreased$390 million in 2011 as compared with 2010. Net operating income decreased$246 million for our core segments, CNA Specialty and CNA Commercial. This decrease was primarily due to lower net investment income, lower favorable net prior year development, and higher catastrophe losses. Catastrophe losses were$144 million after-tax in 2011 as compared to catastrophe losses of 18
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$79 million after-tax in 2010. These unfavorable impacts were partially offset by improved non-catastrophe current accident year underwriting results, including lower expenses. Expenses in 2010 were unfavorably impacted by costs associated with our Information Technology (IT) Transformation as discussed below. Net operating results decreased$144 million for our non-core segments, Life & Group Non-Core and Corporate & Other Non-Core. This decrease was primarily due to the 2011 results in our payout annuity business, which were negatively impacted by a$115 million after-tax increase in insurance reserves, due to unlocking actuarial reserve assumptions for anticipated adverse changes in mortality and discount rates, which reflect the current low interest rate environment and our view of expected investment yields. The initial reserving assumptions for these contracts were determined at issuance, including a margin for adverse deviation, and were locked in throughout the life of the contract unless a premium deficiency developed. In 2011, a premium deficiency emerged and the actuarial reserve assumptions were unlocked and revised to management's current best estimates. See the Life & Group Non-Core and Corporate & Other Non-Core sections of this MD&A for further discussion of our non-core results. As further discussed in Note O to the Consolidated Financial Statements included under Item 8, we commenced a program during 2010 to significantly transform our IT organization and delivery model. The total costs for this program were$37 million , of which$36 million were incurred in 2010. The savings resulting from this program are being reinvested in IT and other property and casualty underwriting areas necessary to support our business strategies. Favorable net prior year development of$431 million and$594 million was recorded in 2011 and 2010 related to our CNA Specialty, CNA Commercial and Corporate & Other Non-Core segments. Further information on net prior year development for 2011 and 2010 is included in Note F to the Consolidated Financial Statements included under Item 8. Net earned premiums increased$88 million in 2011 as compared with 2010 driven by a$117 million increase in CNA Specialty. See the Segment Results section of this MD&A for further discussion. Net loss from discontinued operations decreased$20 million in 2011 as compared to 2010 due to the loss associated with the Loss Portfolio Transfer in 2010. 2010 Compared with 2009 Net income improved$271 million in 2010 as compared with 2009. This improvement was driven by significantly improved net realized investment results, partially offset by a decrease in net operating income, primarily driven by the loss associated with the Loss Portfolio Transfer. Excluding the loss associated with the Loss Portfolio Transfer, net income improved$636 million in 2010 as compared with 2009. Net realized investment results improved$612 million in 2010 as compared with 2009. See the Investments section of this MD&A for further discussion of net investment income and net realized investment results. Net operating income decreased$322 million in 2010 as compared with 2009. Excluding the loss associated with the Loss Portfolio Transfer, net operating income increased$22 million in 2010 as compared with 2009. Net operating income increased$49 million for our core segments, CNA Specialty and CNA Commercial, primarily due to increased favorable net prior year development, partially offset by decreased current accident year underwriting results, including higher catastrophe losses, and decreased after-tax net investment income. Catastrophe losses were$79 million after-tax in 2010 as compared to$58 million after-tax in 2009. Net operating loss increased$27 million for our non-core segments, as further discussed in the Life & Group Non-Core and Corporate & Other Non-Core sections of this MD&A. Favorable net prior year development of$594 million and$208 million was recorded in 2010 and 2009 related to our CNA Specialty, CNA Commercial and Corporate & Other Non-Core segments. Further information on net prior year development for 2010 and 2009 is included in Note F to the Consolidated Financial Statements included under Item 8. Net earned premiums decreased$206 million in 2010 as compared with 2009 driven by a$176 million decrease in CNA Commercial and an$18 million decrease in CNA Specialty. See the Segment Results section of this MD&A for further discussion. Net loss from discontinued operations increased$19 million in 2010 as compared to 2009 due to the loss associated with the Loss Portfolio Transfer. 19
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CRITICAL ACCOUNTING ESTIMATES The preparation of the Consolidated Financial Statements in conformity with accounting principles generally accepted inthe United States of America (GAAP) requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the amounts of revenues and expenses reported during the period. Actual results may differ from those estimates. Our Consolidated Financial Statements and accompanying notes have been prepared in accordance with GAAP applied on a consistent basis. We continually evaluate the accounting policies and estimates used to prepare the Consolidated Financial Statements. In general, our estimates are based on historical experience, evaluation of current trends, information from third party professionals and various other assumptions that are believed to be reasonable under the known facts and circumstances. The accounting estimates discussed below are considered by us to be critical to an understanding of our Consolidated Financial Statements as their application places the most significant demands on our judgment. Note A to the Consolidated Financial Statements included under Item 8 should be read in conjunction with this section to assist with obtaining an understanding of the underlying accounting policies related to these estimates. Due to the inherent uncertainties involved with these types of judgments, actual results could differ significantly from estimates and may have a material adverse impact on our results of operations or equity. Insurance Reserves Insurance reserves are established for both short and long-duration insurance contracts. Short-duration contracts are primarily related to property and casualty insurance policies where the reserving process is based on actuarial estimates of the amount of loss, including amounts for known and unknown claims. Long-duration contracts include long term care products and payout annuity contracts and are estimated using actuarial estimates about mortality, morbidity and persistency as well as assumptions about expected investment returns. The reserve for unearned premiums on property and casualty and accident and health contracts represents the portion of premiums written related to the unexpired terms of coverage. The inherent risks associated with the reserving process are discussed in the Reserves - Estimates and Uncertainties section below. Reinsurance and Insurance Receivables An exposure exists with respect to the collectibility of property and casualty and life reinsurance ceded to the extent that any reinsurer is unable to meet its obligations or disputes the liabilities we have ceded under reinsurance agreements. An allowance for uncollectible reinsurance is recorded on the basis of periodic evaluations of balances due from reinsurers, reinsurer solvency, our past experience and current economic conditions. Further information on our reinsurance receivables is included in Note H to the Consolidated Financial Statements included under Item 8. Additionally, an exposure exists with respect to amounts due from policyholders related to insurance contracts, including amounts due from insureds under high deductible policies. An allowance for uncollectible insurance receivables is recorded on the basis of periodic evaluations of balances due from insureds currently or in the future, management's experience and current economic conditions. If actual experience differs from the estimates made by management in determining the allowances for uncollectible reinsurance and insurance receivables, net receivables as reflected on our Consolidated Balance Sheets may not be collected. Therefore, our results of operations or equity could be materially adversely impacted. 20
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Valuation of Investments and Impairment of Securities We classify our fixed maturity securities and equity securities as either available-for-sale or trading which are both carried at fair value on the balance sheet. Fair value represents the price that would be received to sell an asset in an orderly transaction between market participants on the measurement date, the determination of which requires us to make a significant number of assumptions and judgments. Securities with the greatest level of subjectivity around valuation are those that rely on inputs that are significant to the estimated fair value that are not observable in the market or cannot be derived principally from or corroborated by observable market data. These unobservable inputs represent the Company's own judgment and are based on assumptions consistent with what we believe other market participants would use to price such securities. Given the susceptibility of financial markets to severe events as well as the level of uncertainty related to management's assumptions and judgments, it is possible that changes in fair value estimates could have a material adverse impact on our results of operations or equity. Further information on our fair value measurements is included in Note D to the Consolidated Financial Statements included under Item 8. Our investment portfolio is subject to market declines below amortized cost that may be other-than-temporary and therefore result in the recognition of impairment losses in earnings. Factors considered in the determination of whether or not a decline is other-than-temporary include a current intention or need to sell the security or an indication that a credit loss exists. Significant judgment exists regarding the evaluation of the financial condition and expected near-term and long-term prospects of the issuer, the relevant industry conditions and trends, and whether we expect to receive cash flows sufficient to recover the entire amortized cost basis of the security. We have an Impairment Committee which reviews the investment portfolio on at least a quarterly basis, with ongoing analysis as new information becomes available. Further information on our process for evaluating impairments is included in Note B to the Consolidated Financial Statements included under Item 8. Long Term Care Products and Payout Annuity Contracts Future policy benefit reserves for our long term care products and payout annuity contracts and deferred acquisition costs for our long term care products are based on certain assumptions including morbidity, mortality, policy persistency, and discount rates, which are impacted by expected investment yields. The recoverability of deferred acquisition costs and the adequacy of the reserves are contingent on actual experience related to these key assumptions, which were generally established at time of issue. If actual experience differs from these assumptions, the deferred acquisition costs may not be fully realized and the reserves may not be adequate, requiring us to add to reserves. Therefore, our results of operations or equity could be adversely impacted. The inherent risks associated with the reserving process are discussed in the Reserves - Estimates and Uncertainties section below. Pension and Postretirement Benefit Obligations We make a significant number of assumptions in estimating the liabilities and costs related to our pension and postretirement benefit obligations to employees under our benefit plans. The assumptions that most impact these costs are the discount rate and the expected long term rate of return on plan assets. These assumptions are evaluated relative to current economic factors such as inflation, interest rates and fiscal and monetary policies. Changes in these assumptions can have a material impact on pension obligations and pension expense. To determine the discount rate assumption as of the year-end measurement date for ourCNA Retirement Plan and CNA Health and Group Benefits Program, we considered the estimated timing of plan benefit payments and available yields on high quality fixed income debt securities. For this purpose, high quality is considered a rating of Aa or better by Moody's or a rating of AA or better from S&P. We reviewed several yield curves constructed using the cash flow characteristics of the plans as well as bond indices as of the measurement date. The year-over-year change of those data points was also considered. In determining the expected long term rate of return on plan assets assumption for our CNA Retirement Plan, we considered the historical performance of the investment portfolio as well as the long term market return expectations based on the investment mix of the portfolio. Further information on our pension and postretirement benefit obligations is included in Note J to the Consolidated Financial Statements included under Item 8. 21
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Income Taxes We account for income taxes under the asset and liability method. Under this method, deferred income taxes are recognized for temporary differences between the financial statement and tax return basis of assets and liabilities. Any resulting future tax benefits are recognized to the extent that realization of such benefits is more likely than not, and a valuation allowance is established for any portion of a deferred tax asset that management believes will not be realized. The assessment of the need for a valuation allowance requires management to make estimates and assumptions about future earnings, reversal of existing temporary differences and available tax planning strategies. If actual experience differs from these estimates and assumptions, the recorded deferred tax asset may not be fully realized resulting in an increase to income tax expense in our results of operations. In addition, the ability to record deferred tax assets in the future could be limited, resulting in a higher effective tax rate in that future period. 22
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RESERVES - ESTIMATES AND UNCERTAINTIES Property and Casualty Claim and Claim Adjustment Expense Reserves We maintain loss reserves to cover our estimated ultimate unpaid liability for claim and claim adjustment expenses, including the estimated cost of the claims adjudication process, for claims that have been reported but not yet settled (case reserves) and claims that have been incurred but not reported (IBNR). Claim and claim adjustment expense reserves are reflected as liabilities and are included on the Consolidated Balance Sheets under the heading "Insurance Reserves." Adjustments to prior year reserve estimates, if necessary, are reflected in results of operations in the period that the need for such adjustments is determined. The carried case and IBNR reserves as of each balance sheet date are provided in the Segment Results section of this MD&A and in Note F to the Consolidated Financial Statements included under Item 8. The level of reserves we maintain represents our best estimate, as of a particular point in time, of what the ultimate settlement and administration of claims will cost based on our assessment of facts and circumstances known at that time. Reserves are not an exact calculation of liability but instead are complex estimates that we derive, generally utilizing a variety of actuarial reserve estimation techniques, from numerous assumptions and expectations about future events, both internal and external, many of which are highly uncertain. We are subject to the uncertain effects of emerging or potential claims and coverage issues that arise as industry practices and legal, judicial, social and other environmental conditions change. These issues have had, and may continue to have, a negative effect on our business by either extending coverage beyond the original underwriting intent or by increasing the number or size of claims. Examples of emerging or potential claims and coverage issues include: • the effects of worldwide economic conditions, which have resulted in an
increase in the number and size of certain claims, including both D&O and
E&O insurance claims related to corporate failures, as well as other
coverages;
• class action litigation relating to claims handling and other practices; and
• mass tort claims, including bodily injury claims related to welding rods,
benzene, lead, noise induced hearing loss, injuries from various medical
products including pharmaceuticals, and various other chemical and
radiation exposure claims.
The impact of these and other unforeseen emerging or potential claims and coverage issues is difficult to predict and could materially adversely affect the adequacy of our claim and claim adjustment expense reserves and could lead to future reserve additions. Our property and casualty insurance subsidiaries also have actual and potential exposures related to A&EP claims. Our experience has been that establishing reserves for casualty coverages relating to A&EP claims and the related claim adjustment expenses are subject to uncertainties that are greater than those presented by other claims. Additionally, traditional actuarial methods and techniques employed to estimate the ultimate cost of claims for more traditional property and casualty exposures are less precise in estimating claim and claim adjustment reserves for A&EP. As a result, estimating the ultimate cost of both reported and unreported A&EP claims are subject to a higher degree of variability. To mitigate the risks posed by our exposure to A&EP claims and claim adjustment expenses, as further discussed in Note F to the Consolidated Financial Statements included under Item 8, onAugust 31, 2010 we completed a transaction with NICO, a subsidiary of Berkshire Hathaway Inc., under which substantially all of our legacy A&EP liabilities were ceded to NICO effectiveJanuary 1, 2010 . 23
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Establishing Reserve Estimates In developing claim and claim adjustment expense ("loss" or "losses") reserve estimates, our actuaries perform detailed reserve analyses that are staggered throughout the year. The data is organized at a "product" level. A product can be a line of business covering a subset of insureds such as commercial automobile liability for small or middle market customers, it can encompass several lines of business provided to a specific set of customers such as dentists, or it can be a particular type of claim such as construction defect. Every product is analyzed at least once during the year, with the exception of certain run-off products which are analyzed on a periodic basis. The analyses generally review losses gross of ceded reinsurance and apply the ceded reinsurance terms to the gross estimates to establish estimates net of reinsurance. In addition to the detailed analyses, we review actual loss emergence for all products each quarter. The detailed analyses use a variety of generally accepted actuarial methods and techniques to produce a number of estimates of ultimate loss. Our actuaries determine a point estimate of ultimate loss by reviewing the various estimates and assigning weight to each estimate given the characteristics of the product being reviewed. The reserve estimate is the difference between the estimated ultimate loss and the losses paid to date. The difference between the estimated ultimate loss and the case incurred loss (paid loss plus case reserve) is IBNR. IBNR calculated as such includes a provision for development on known cases (supplemental development) as well as a provision for claims that have occurred but have not yet been reported (pure IBNR). Most of our business can be characterized as long-tail. For long-tail business, it will generally be several years between the time the business is written and the time when all claims are settled. Our long-tail exposures include commercial automobile liability, workers' compensation, general liability, medical professional liability, other professional liability coverages, assumed reinsurance run-off and products liability. Short-tail exposures include property, commercial automobile physical damage, marine and warranty. CNA Specialty and CNA Commercial contain both long-tail and short-tail exposures. Corporate & Other Non-Core contains long-tail exposures. Various methods are used to project ultimate loss for both long-tail and short-tail exposures including, but not limited to, the following: •paid development; •incurred development; •loss ratio; •Bornhuetter-Ferguson using paid loss; •Bornhuetter-Ferguson using incurred loss; •frequency times severity; and •stochastic modeling. The paid development method estimates ultimate losses by reviewing paid loss patterns and applying them to accident years with further expected changes in paid loss. Selection of the paid loss pattern requires consideration of several factors including the impact of inflation on claims costs, the rate at which claims professionals make claim payments and close claims, the impact of judicial decisions, the impact of underwriting changes, the impact of large claim payments and other factors. Claim cost inflation itself requires evaluation of changes in the cost of repairing or replacing property, changes in the cost of medical care, changes in the cost of wage replacement, judicial decisions, legislative changes and other factors. Because this method assumes that losses are paid at a consistent rate, changes in any of these factors can impact the results. Since the method does not rely on case reserves, it is not directly influenced by changes in the adequacy of case reserves. For many products, paid loss data for recent periods may be too immature or erratic for accurate predictions. This situation often exists for long-tail exposures. In addition, changes in the factors described above may result in inconsistent payment patterns. Finally, estimating the paid loss pattern subsequent to the most mature point available in the data analyzed often involves considerable uncertainty for long-tail products such as workers' compensation. 24
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The incurred development method is similar to the paid development method, but it uses case incurred losses instead of paid losses. Since the method uses more data (case reserves in addition to paid losses) than the paid development method, the incurred development patterns may be less variable than paid patterns. However, selection of the incurred loss pattern requires analysis of all of the factors above. In addition, the inclusion of case reserves can lead to distortions if changes in case reserving practices have taken place, and the use of case incurred losses may not eliminate the issues associated with estimating the incurred loss pattern subsequent to the most mature point available. The loss ratio method multiplies earned premiums by an expected loss ratio to produce ultimate loss estimates for each accident year. This method may be useful for immature accident periods or if loss development patterns are inconsistent, losses emerge very slowly, or there is relatively little loss history from which to estimate future losses. The selection of the expected loss ratio requires analysis of loss ratios from earlier accident years or pricing studies and analysis of inflationary trends, frequency trends, rate changes, underwriting changes, and other applicable factors. The Bornhuetter-Ferguson method using paid loss is a combination of the paid development method and the loss ratio method. This method normally determines expected loss ratios similar to the approach used to estimate the expected loss ratio for the loss ratio method and requires analysis of the same factors described above. This method assumes that only future losses will develop at the expected loss ratio level. The percent of paid loss to ultimate loss implied from the paid development method is used to determine what percentage of ultimate loss is yet to be paid. The use of the pattern from the paid development method requires consideration of all factors listed in the description of the paid development method. The estimate of losses yet to be paid is added to current paid losses to estimate the ultimate loss for each year. This method will react very slowly if actual ultimate loss ratios are different from expectations due to changes not accounted for by the expected loss ratio calculation. The Bornhuetter-Ferguson method using incurred loss is similar to the Bornhuetter-Ferguson method using paid loss except that it uses case incurred losses. The use of case incurred losses instead of paid losses can result in development patterns that are less variable than paid patterns. However, the inclusion of case reserves can lead to distortions if changes in case reserving have taken place, and the method requires analysis of all the factors that need to be reviewed for the loss ratio and incurred development methods. The frequency times severity method multiplies a projected number of ultimate claims by an estimated ultimate average loss for each accident year to produce ultimate loss estimates. Since projections of the ultimate number of claims are often less variable than projections of ultimate loss, this method can provide more reliable results for products where loss development patterns are inconsistent or too variable to be relied on exclusively. In addition, this method can more directly account for changes in coverage that impact the number and size of claims. However, this method can be difficult to apply to situations where very large claims or a substantial number of unusual claims result in volatile average claim sizes. Projecting the ultimate number of claims requires analysis of several factors including the rate at which policyholders report claims to us, the impact of judicial decisions, the impact of underwriting changes and other factors. Estimating the ultimate average loss requires analysis of the impact of large losses and claim cost trends based on changes in the cost of repairing or replacing property, changes in the cost of medical care, changes in the cost of wage replacement, judicial decisions, legislative changes and other factors. Stochastic modeling produces a range of possible outcomes based on varying assumptions related to the particular product being modeled. For some products, we use models which rely on historical development patterns at an aggregate level, while other products are modeled using individual claim variability assumptions supplied by the claims department. In either case, multiple simulations are run and the results are analyzed to produce a range of potential outcomes. The results will typically include a mean and percentiles of the possible reserve distribution which aid in the selection of a point estimate. For many exposures, especially those that can be considered long-tail, a particular accident year may not have a sufficient volume of paid losses to produce a statistically reliable estimate of ultimate losses. In such a case, our actuaries typically assign more weight to the incurred development method than to the paid development method. As claims continue to settle and the volume of paid loss increases, the actuaries may assign additional weight to the paid development method. For most of our products, even the incurred losses for accident years that are early in the claim settlement process will not be of sufficient volume to produce a reliable estimate of ultimate losses. 25
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In these cases, we will not assign any weight to the paid and incurred development methods. We will use the loss ratio, Bornhuetter-Ferguson and frequency times severity methods. For short-tail exposures, the paid and incurred development methods can often be relied on sooner, primarily because our history includes a sufficient number of years to cover the entire period over which paid and incurred losses are expected to change. However, we may also use the loss ratio, Bornhuetter-Ferguson and frequency times severity methods for short-tail exposures. For other more complex products where the above methods may not produce reliable indications, we use additional methods tailored to the characteristics of the specific situation. Periodic Reserve Reviews The reserve analyses performed by our actuaries result in point estimates. Each quarter, the results of the detailed reserve reviews are summarized and discussed with our senior management to determine the best estimate of reserves. This group considers many factors in making this decision. The factors include, but are not limited to, the historical pattern and volatility of the actuarial indications, the sensitivity of the actuarial indications to changes in paid and incurred loss patterns, the consistency of claims handling processes, the consistency of case reserving practices, changes in our pricing and underwriting, pricing and underwriting trends in the insurance market, and legal, judicial, social and economic trends. Our recorded reserves reflect our best estimate as of a particular point in time based upon known facts, consideration of the factors cited above, and our judgment. The carried reserve may differ from the actuarial point estimate as the result of our consideration of the factors noted above as well as the potential volatility of the projections associated with the specific product being analyzed and other factors impacting claims costs that may not be quantifiable through traditional actuarial analysis. This process results in management's best estimate which is then recorded as the loss reserve. Currently, our recorded reserves are modestly higher than the actuarial point estimate. For both CNA Commercial and CNA Specialty, the difference between our reserves and the actuarial point estimate is primarily driven by uncertainty with respect to immature accident years, claim cost inflation, changes in claims handling, tort reform roll-backs which may adversely impact claim costs, and the effects from the economy. For Corporate & Other Non-Core, the difference between our reserves and the actuarial point estimate is primarily driven by the potential tail volatility of run-off exposures. The key assumptions fundamental to the reserving process are often different for various products and accident years. Some of these assumptions are explicit assumptions that are required of a particular method, but most of the assumptions are implicit and cannot be precisely quantified. An example of an explicit assumption is the pattern employed in the paid development method. However, the assumed pattern is itself based on several implicit assumptions such as the impact of inflation on medical costs and the rate at which claim professionals close claims. As a result, the effect on reserve estimates of a particular change in assumptions usually cannot be specifically quantified, and changes in these assumptions cannot be tracked over time. Our recorded reserves are management's best estimate. In order to provide an indication of the variability associated with our net reserves, the following discussion provides a sensitivity analysis that shows the approximate estimated impact of variations in significant factors affecting our reserve estimates for particular types of business. These significant factors are the ones that we believe could most likely materially impact the reserves. This discussion covers the major types of business for which we believe a material deviation to our reserves is reasonably possible. There can be no assurance that actual experience will be consistent with the current assumptions or with the variation indicated by the discussion. In addition, there can be no assurance that other factors and assumptions will not have a material impact on our reserves. Within CNA Specialty, we believe a material deviation to our net reserves is reasonably possible for professional liability and related business. This business includes professional liability coverages provided to various professional firms, including architects, real estate agents, small and mid-sized accounting firms, law firms and technology firms. This business also includes D&O, employment practices, fiduciary and fidelity coverages as well as insurance products serving the healthcare delivery system. The most significant factor affecting reserve estimates for this business is claim severity. Claim severity is driven by the cost of medical care, the cost of wage replacement, legal fees, judicial decisions, legislative changes and other factors. Underwriting and claim handling decisions such as the classes of business written and individual claim settlement decisions can also impact claim 26
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severity. If the estimated claim severity increases by 9%, we estimate that the net reserves would increase by approximately$450 million . If the estimated claim severity decreases by 3%, we estimate that net reserves would decrease by approximately$150 million . Our net reserves for this business were approximately$4.9 billion atDecember 31, 2011 . Within CNA Commercial, the two types of business for which we believe a material deviation to our net reserves is reasonably possible are workers' compensation and general liability. For CNA Commercial workers' compensation, since many years will pass from the time the business is written until all claim payments have been made, claim cost inflation on claim payments is the most significant factor affecting workers' compensation reserve estimates. Workers' compensation claim cost inflation is driven by the cost of medical care, the cost of wage replacement, expected claimant lifetimes, judicial decisions, legislative changes and other factors. If estimated workers' compensation claim cost inflation increases by 100 basis points for the entire period over which claim payments will be made, we estimate that our net reserves would increase by approximately$450 million . If estimated workers' compensation claim cost inflation decreases by 100 basis points for the entire period over which claim payments will be made, we estimate that our net reserves would decrease by approximately$400 million . Our net reserves for CNA Commercial workers' compensation were approximately$5.0 billion atDecember 31, 2011 . For CNA Commercial general liability, the most significant factor affecting reserve estimates is claim severity. Claim severity is driven by changes in the cost of repairing or replacing property, the cost of medical care, the cost of wage replacement, judicial decisions, legislation and other factors. If the estimated claim severity for general liability increases by 6%, we estimate that our net reserves would increase by approximately$200 million . If the estimated claim severity for general liability decreases by 3%, we estimate that our net reserves would decrease by approximately$100 million . Our net reserves for CNA Commercial general liability were approximately$3.6 billion atDecember 31, 2011 . Given the factors described above, it is not possible to quantify precisely the ultimate exposure represented by claims and related litigation. As a result, we regularly review the adequacy of our reserves and reassess our reserve estimates as historical loss experience develops, additional claims are reported and settled and additional information becomes available in subsequent periods. In light of the many uncertainties associated with establishing the estimates and making the assumptions necessary to establish reserve levels, we review our reserve estimates on a regular basis and make adjustments in the period that the need for such adjustments is determined. These reviews have resulted in our identification of information and trends that have caused us to change our reserves in prior periods and could lead to the identification of a need for additional material increases or decreases in claim and claim adjustment expense reserves, which could materially affect our results of operations, equity, business and insurer financial strength and corporate debt ratings positively or negatively. See the Ratings section of this MD&A for further information regarding our financial strength and corporate debt ratings. Life & Group Non-Core Policyholder Reserves We calculate and maintain reserves for policyholder claims and benefits for our Life & Group Non-Core segment based on actuarial assumptions. The determination of these reserves is fundamental to our financial results and requires management to make assumptions about expected investment and policyholder experience over the life of the contract. Since many of these contracts may be in force for several decades, these assumptions are subject to significant estimation risk. The actuarial assumptions represent management's best estimate at the date the contract was issued plus a margin for adverse deviation. Actuarial assumptions include estimates of morbidity, mortality, policy persistency, discount rates and expenses over the life of the contracts. Under GAAP, these assumptions are locked in throughout the life of the contract unless a premium deficiency develops. The impact of differences between the actuarial assumptions and actual experience is reflected in results of operations each period. 27
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Annually, management assesses the adequacy of its GAAP reserves by product group by performing premium deficiency testing. In this test, reserves computed using best estimate assumptions as of the date of the test without provisions for adverse deviation are compared to the recorded reserves. If reserves determined based on management's current best estimate assumptions are greater than the existing net GAAP reserves (i.e. reserves net of any Deferred acquisition costs asset), the existing net GAAP reserves are adjusted to the greater amount. Payout Annuity Reserves Our payout annuity reserves consist primarily of single premium group and structured settlement annuities. The annuity payments are generally fixed and are either for a specified period or contingent on the survival of the payee. These reserves are discounted except for reserves for loss adjustment expenses on structured settlements not funded by annuities in our property and casualty insurance companies. We have recognized a premium deficiency on our payout annuity reserves, therefore the actuarial assumptions established at time of issue have been unlocked and updated to management's current best estimate. The actuarial assumptions that management believes are subject to the most variability are discount rates and mortality. The table below summarizes the estimated pretax impact on our results of operations from various hypothetical revisions to our assumptions. We have assumed that revisions to such assumptions would occur in each policy type, age and duration within each policy group. Although such hypothetical revisions are not currently required or anticipated, we believe they could occur based on past variances in experience and our expectations of the ranges of future experience that could reasonably occur. Sensitivity AnalysisDecember 31, 2011 Hypothetical revisions Estimated reduction to pretax income Discount rate: 50 basis point decline $ 139 million 100 basis point decline $ 294 million Mortality: 5% decline $ 24 million 10% decline $ 51 million Any actual adjustment would be dependent on the specific policies affected and, therefore, may differ from the estimates summarized above. Long Term Care Reserves Long term care policies provide benefits for nursing home, assisted living and home health care subject to various daily and lifetime caps. Policyholders must continue to make periodic premium payments to keep the policy in force. Generally we have the ability to increase policy premiums, subject to state regulatory approval. Our long term care reserves consist of an active life reserve, a liability for due and unpaid claims, claims in the course of settlement and incurred but not reported claims. The active life reserve represents the present value of expected future benefit payments and expenses less expected future premium. The actuarial assumptions that management believes are subject to the most variability are discount rates, morbidity, and persistency, which can be impacted by policy lapses and death. The table below summarizes the estimated pretax impact on our results of operations from various hypothetical revisions to our assumptions. We have assumed that revisions to such assumptions would occur in each policy type, age and duration within each policy group. Although such hypothetical revisions are not currently required or anticipated, we believe they could occur based on past variances in experience and our expectations of the ranges of future experience that could reasonably occur. 28
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It should be noted that our current GAAP long term care reserves contain a level of margin in excess of management's current best estimates. Any required increase in the net GAAP reserves resulting from the hypothetical revisions in the table below would first reduce the margin before they would impact results of operations. The estimated impact to results of operations in the table below are after consideration of the existing margin. Sensitivity AnalysisDecember 31, 2011 Estimated reduction to Hypothetical revisions pretax income Discount rate: 50 basis point decline $ 231 million 100 basis point decline $ 854 million Morbidity: 5% increase $ 154 million 10% increase $ 631 million Persistency:
5% decline in voluntary lapse and mortality $ - 10% decline in voluntary lapse and mortality
Any actual adjustment would be dependent on the specific policies affected and, therefore, may differ from the estimates summarized above.
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SEGMENT RESULTS The following discusses the results of continuing operations for our operating segments. Our core property and casualty commercial insurance operations are reported in two business segments: CNA Specialty and CNA Commercial. CNA Specialty provides a broad array of professional, financial and specialty property and casualty products and services, primarily through insurance brokers and managing general underwriters. CNA Commercial includes property and casualty coverages sold to small businesses and middle market entities and organizations primarily through an independent agency distribution system. CNA Commercial also includes commercial insurance and risk management products sold to large corporations primarily through insurance brokers. Our non-core operations are managed in two segments: Life & Group Non-Core and Corporate & Other Non-Core. Life & Group Non-Core primarily includes the results of the life and group lines of business that are in run-off. Corporate & Other Non-Core primarily includes certain corporate expenses, including interest on corporate debt, and the results of certain property and casualty business in run-off, including CNA Re and A&EP. Intersegment eliminations are also included in this segment. Our property and casualty field structure consists of 48 underwriting locations acrossthe United States . There are five centralized processing operations which handle policy processing, billing and collection activities, and also act as call centers to optimize service. The claims structure consists of two regional claim centers designed to efficiently handle the high volume of low severity claims including property damage, liability, and workers' compensation medical only claims, and 16 principal claim office locations handling the more complex claims. In addition, we have underwriting and claim capabilities inCanada andEurope . We utilize the net operating income financial measure to monitor our operations. Net operating income is calculated by excluding from net income (loss) attributable to CNA the after-tax effects of 1) net realized investment gains or losses, 2) income or loss from discontinued operations and 3) any cumulative effects of changes in accounting guidance. See further discussion regarding how we manage our business in Note N to the Consolidated Financial Statements included under Item 8. In evaluating the results of our CNA Specialty and CNA Commercial segments, we utilize the loss ratio, the expense ratio, the dividend ratio and the combined ratio. These ratios are calculated using GAAP financial results. The loss ratio is the percentage of net incurred claim and claim adjustment expenses to net earned premiums. The expense ratio is the percentage of insurance underwriting and acquisition expenses, including the amortization of deferred acquisition costs, to net earned premiums. The dividend ratio is the ratio of policyholders' dividends incurred to net earned premiums. The combined ratio is the sum of the loss, expense and dividend ratios. Changes in estimates of claim and allocated claim adjustment expense reserves and premium accruals, net of reinsurance, for prior years are defined as net prior year development within this MD&A. These changes can be favorable or unfavorable. Net prior year development does not include the impact of related acquisition expenses. Further information on our reserves is provided in Note F to the Consolidated Financial Statements included under Item 8. 30
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CNA Specialty Business Overview CNA Specialty provides professional and management liability and other coverages through property and casualty products and services, both domestically and abroad, through a network of brokers, independent agencies and managing general underwriters. CNA Specialty provides solutions for managing the risks of its clients, including architects, lawyers, accountants, health care professionals, financial intermediaries and public and private companies. Product offerings also include surety and fidelity bonds and warranty services. CNA Specialty includes the following business groups: Professional & Management Liability provides management and professional liability insurance and risk management services and other specialized property and casualty coverages inthe United States . This group provides professional liability coverages to various professional firms, including architects, real estate agents, small and mid-sized accounting firms, law firms and technology firms. Professional & Management Liability also provides D&O, employment practices, fiduciary and fidelity coverages. Specific areas of focus include small and mid-size firms as well as privately held firms and not-for-profit organizations, where tailored products for this client segment are offered. Products within Professional & Management Liability are distributed through brokers, independent agents and managing general underwriters. Professional & Management Liability, through CNA HealthPro, also offers insurance products to serve the healthcare industry. Products include professional liability and associated standard property and casualty coverages, and are distributed on a national basis through brokers, independent agents and managing general underwriters. Key customer segments include long term care facilities, allied health care providers, life sciences, dental professionals and mid-size and large health care facilities. International provides similar management and professional liability insurance and other specialized property and casualty coverages inCanada andEurope . Surety offers small, medium and large contract and commercial surety bonds. Surety provides surety and fidelity bonds in all 50 states through a network of independent agencies. Warranty and Alternative Risks provides extended service contracts and related products that provide protection from the financial burden associated with mechanical breakdown and other related losses, primarily for vehicles and portable electronic communication devices. These products are distributed through and administered by a wholly owned subsidiary,CNA National Warranty Corporation , or through third party administrators. 31
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The following table details the results of operations for CNA Specialty. Results of Operations Years endedDecember 31 (In millions, except ratios) 2011 2010 2009 Net written premiums $ 2,872 $ 2,691 $ 2,684 Net earned premiums 2,796 2,679 2,697 Net investment income 500 591 526 Net operating income 519 625 591
Net realized investment gains (losses), after-tax (3 ) 20
(123 ) Net income 516 645
468
Ratios
Loss and loss adjustment expense 59.3 % 54.0 % 56.9 % Expense 30.7 30.5 29.3 Dividend (0.1 ) 0.5 0.3 Combined 89.9 % 85.0 % 86.5 % 2011 Compared with 2010 Net written premiums for CNA Specialty increased$181 million in 2011 as compared with 2010, primarily driven by new business. Net earned premiums increased$117 million in 2011 as compared with 2010, consistent with increases in net written premiums in recent quarters and favorable premium development in 2011. CNA Specialty's average rate was flat for 2011, as compared to a decrease of 2% in 2010 for the policies that renewed in each period. Retention of 86% was achieved in each period. Net income decreased$129 million in 2011 as compared with 2010. This decrease was due to lower net operating income and decreased net realized investment results. Net operating income decreased$106 million in 2011 as compared with 2010, primarily due to lower favorable net prior year development and decreased net investment income. The combined ratio increased 4.9 points in 2011 as compared with 2010. The loss ratio increased 5.3 points, primarily due to lower favorable net prior year development as well as the impact of a higher current accident year loss ratio. The 2011 current accident year loss ratio was unfavorably affected by the anticipated loss cost trend that exceeded earned rate levels. Favorable net prior year development of$245 million and$344 million was recorded in 2011 and 2010. Further information on CNA Specialty's net prior year development for 2011 and 2010 is included in Note F to the Consolidated Financial Statements included under Item 8. The following table summarizes the gross and net carried reserves as ofDecember 31, 2011 and 2010 for CNA Specialty. Gross and Net Carried Claim and Claim Adjustment Expense ReservesDecember 31 (In millions) 2011 2010 Gross Case Reserves $ 2,441 $ 2,341 Gross IBNR Reserves 4,399 4,452 Total Gross Carried Claim and Claim Adjustment Expense Reserves $ 6,840 $ 6,793 Net Case Reserves $ 2,086 $ 1,992 Net IBNR Reserves 3,937 3,926
Total Net Carried Claim and Claim Adjustment Expense Reserves
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2010 Compared with 2009 Net written premiums for CNA Specialty increased$7 million in 2010 as compared with 2009. Net written premiums increased in our professional management and liability lines of business. This increase was partially offset by continued decreased insured exposures and lower rates in our architects & engineers and CNA HealthPro lines of business due to economic and competitive market conditions. Net earned premiums decreased$18 million as compared with the same period in 2009, due to the impact of decreased net written premiums in prior quarters. CNA Specialty's average rate decreased 2% for 2010 and 2009 for policies that renewed in each period. Retention of 86% and 84% was achieved in each period. Net income improved$177 million in 2010 as compared with 2009. This increase was due to improved net realized investment results and improved net operating income. Net operating income improved$34 million in 2010 as compared with 2009, primarily due to increased favorable net prior year development and improved net investment income, partially offset by decreased current accident year underwriting results. The combined ratio improved 1.5 points in 2010 as compared with 2009. The loss ratio improved 2.9 points, primarily due to increased favorable net prior year development, partially offset by the impact of a higher current accident year loss ratio. The expense ratio increased 1.2 points primarily related to higher underwriting expenses and higher commission rates. Underwriting expenses were unfavorably impacted by higher employee-related costs and IT Transformation costs. See the Consolidated Operations section of this MD&A for further discussion of IT Transformation costs. Favorable net prior year development of$344 million was recorded in 2010, compared to$224 million in 2009. Further information on CNA Specialty's net prior year development for 2010 and 2009 is included in Note F to the Consolidated Financial Statements included under Item 8. 33
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CNA Commercial Business Overview CNA Commercial works with an independent agency distribution system and a network of brokers to market a broad range of property and casualty insurance products and services to small, middle-market and large businesses and organizations domestically and abroad. Property products include standard and excess property coverages, as well as marine coverage, and boiler and machinery. Casualty products include standard casualty insurance products such as workers' compensation, general and product liability, commercial auto and umbrella coverages. Most insurance programs are provided on a guaranteed cost basis; however, we also offer specialized loss-sensitive insurance programs to those customers viewed as higher risk and less predictable in exposure. These property and casualty products are offered as part of our Small Business, Commercial and International insurance groups. Our Small Business insurance group serves our smaller commercial accounts and the Commercial insurance group serves our middle markets and larger risks. In addition, CNA Commercial provides total risk management services relating to claim and information services to the large commercial insurance marketplace, through a wholly-owned subsidiary,CNA ClaimPlus, Inc. , a third party administrator. The International insurance group primarily consists of the commercial product lines of our operations inEurope andCanada . Also included in CNA Commercial is CNA Select Risk (Select Risk), which includes our excess and surplus lines coverages. Select Risk provides specialized insurance for selected commercial risks on both an individual customer and program basis. Customers insured by Select Risk are generally viewed as higher risk and less predictable in exposure than those covered by standard insurance markets. Select Risk's products are distributed throughoutthe United States through specialist producers, program agents and brokers. The following table details the results of operations for CNA Commercial. Results of Operations Years endedDecember 31 (In millions, except ratios) 2011 2010 2009 Net written premiums $ 3,350 $ 3,208 $ 3,448 Net earned premiums 3,240 3,256 3,432 Net investment income 763 873 935 Net operating income 369 509 494
Net realized investment gains (losses), after-tax 12 (15 )
(236 ) Net income 381 494
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Ratios
Loss and loss adjustment expense 70.9 % 66.8 % 70.5 % Expense 34.5 35.7 35.2 Dividend 0.3 0.4 0.3 Combined 105.7 % 102.9 % 106.0 % 2011 Compared with 2010 Net written premiums for CNA Commercial increased$142 million in 2011 as compared with 2010. This increase was driven by continued positive rate achievement, improved economic conditions reflected in insured exposures, as well as lower reinsurance costs and higher new business levels in certain business lines. CNA Commercial's average rate increased 2% in 2011, as compared with an increase of 1% in 2010 for the policies that renewed in each period. Retention of 79% and 80% was achieved in each period. Net income decreased$113 million in 2011 as compared with 2010. This decrease was due to lower net operating income, partially offset by improved net realized investment results. 34
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Net operating income decreased$140 million in 2011 as compared with 2010. This decrease was primarily due to lower net investment income, higher catastrophe losses and lower favorable net prior year development. In addition, income tax expense of$22 million was recorded in the third quarter of 2011 due to an increase in the tax rate applicable to the undistributed earnings of a 50% owned subsidiary which was sold later in 2011. The sale resulted in a modest after-tax loss inclusive of this income tax expense. These unfavorable impacts were partially offset by improved non-catastrophe current accident year underwriting results, including lower expenses. In 2010, expenses were unfavorably impacted by IT transformation costs, as further discussed in Note O to the Consolidated Financial Statements included under Item 8. The combined ratio increased 2.8 points in 2011 as compared with 2010. The loss ratio increased 4.1 points, primarily due to lower favorable net prior year development and higher catastrophe losses, partially offset by an improved current accident year non-catastrophe loss ratio. Catastrophe losses were$208 million , or 6.4 points of the loss ratio, for 2011, as compared to$113 million , or 3.5 points of the loss ratio, for 2010. The expense ratio improved 1.2 points in 2011 as compared with 2010, primarily due to the favorable impact of recoveries in 2011 on insurance receivables written off in prior years and the impact of IT Transformation costs incurred in 2010, as discussed above. Favorable net prior year development of$183 million and$256 million was recorded in 2011 and 2010. Further information on CNA Commercial net prior year development for 2011 and 2010 is included in Note F to the Consolidated Financial Statements included under Item 8. The following table summarizes the gross and net carried reserves as ofDecember 31, 2011 and 2010 for CNA Commercial. Gross and Net Carried Claim and Claim Adjustment Expense ReservesDecember 31 (In millions) 2011 2010 Gross Case Reserves $ 6,266 $ 6,390 Gross IBNR Reserves 5,243 6,132 Total Gross Carried Claim and Claim Adjustment Expense Reserves $ 11,509 $ 12,522 Net Case Reserves $ 5,720 $ 5,349 Net IBNR Reserves 4,670 5,292
Total Net Carried Claim and Claim Adjustment Expense Reserves
2010 Compared with 2009 Net written premiums for CNA Commercial decreased$240 million in 2010 as compared with 2009. Premiums written were unfavorably impacted by decreased insured exposures and decreased new business as a result of competitive market conditions. Economic conditions led to decreased insured exposures, such as in the construction industry due to smaller payrolls and reduced project volume. Net earned premiums decreased$176 million in 2010 as compared with 2009, consistent with the trend of lower net written premiums. CNA Commercial's average rate increased 1% for 2010, as compared to flat rates for 2009 for the policies that renewed during those periods. Retention of 80% and 81% was achieved in each period. Net income improved$236 million in 2010 as compared with 2009. This improvement was primarily due to improved net realized investment results. Net operating income improved$15 million in 2010 as compared with 2009. This increase was primarily due to increased favorable net prior year development, partially offset by lower net investment income, and higher catastrophe losses. The combined ratio improved 3.1 points in 2010 as compared with 2009. The loss ratio improved 3.7 points, primarily due to increased favorable net prior year development, partially offset by the impact of higher catastrophe losses. Catastrophe losses were$113 million , or 3.5 points of the loss ratio, for 2010, as compared to$82 million , or 2.4 points of the loss ratio, for 2009. 35
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The expense ratio increased 0.5 points in 2010 as compared with 2009, primarily due to the unfavorable impact of the lower net earned premium base. Underwriting expenses include the unfavorable impact of the IT Transformation costs. See the Consolidated Operations section of this MD&A for further discussion of IT Transformation costs. Favorable net prior year development of$256 million was recorded in 2010, compared to favorable net prior year development of$143 million in 2009. Further information on CNA Commercial net prior year development for 2010 and 2009 is included in Note F to the Consolidated Financial Statements included under Item 8. 36
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Life & Group Non-Core Business Overview The Life & Group Non-Core segment primarily includes the results of the life and group lines of business that are in run-off. We continue to service our existing individual long term care commitments, our payout annuity business and our pension deposit business. We also retain a block of group reinsurance and life settlement contracts. These businesses are being managed as a run-off operation. Our group long term care business, while considered non-core, continues to accept new employees in existing groups. The following table summarizes the results of operations forLife & Group Non-Core. Results of Operations Years endedDecember 31 (In millions) 2011 2010 2009 Net earned premiums $ 569 $ 582 $ 595 Net investment income 759 715 664 Net operating loss (208 ) (87 ) (16 ) Net realized investment gains (losses), after-tax (5 ) 33 (153 ) Net loss (213 ) (54 ) (169 ) 2011 Compared with 2010 Net earned premiums for Life & Group Non-Core decreased$13 million in 2011 as compared with 2010. Net earned premiums relate primarily to the individual and group long term care businesses. Net loss increased$159 million in 2011 as compared with 2010 due to decreased results in our payout annuity, pension deposit and long term care businesses. In 2011, our payout annuity business was negatively impacted by a$115 million after-tax increase in insurance reserves, due to unlocking actuarial reserve assumptions for anticipated adverse changes in mortality and discount rates, which reflect the current low interest rate environment and our view of expected investment yields. The initial reserving assumptions for these contracts were determined at issuance, including a margin for adverse deviation, and were locked in throughout the life of the contract unless a premium deficiency developed. In 2011, a premium deficiency emerged and the actuarial reserve assumptions were unlocked and revised to management's current best estimates. In 2010, our payout annuity reserves were increased by$39 million pretax and after-tax, resulting from unlocking assumptions. Additionally, long term care claim reserves were increased by$33 million after-tax in 2011. A number of our separate account pension deposit contracts guarantee principal and an annual minimum rate of interest. If aggregate contract value in the separate account exceeds the fair value of the related assets, an additional Policyholders' funds liability is established. During 2011, we increased this pretax liability by$18 million . During 2010, we decreased this pretax liability by$24 million . Additionally, the increase in net loss was driven by decreased net realized investment results. The increase in net loss was further driven by favorable reserve development arising from a commutation of an assumed reinsurance agreement in 2010. These unfavorable impacts were partially offset by decreased expenses. In 2010, expenses were unfavorably impacted by the IT transformation costs, as further discussed in Note O to the Consolidated Financial Statements included under Item 8. 37
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Net Carried Life & Group Non-Core Policyholder ReservesDecember 31, 2011 Claim and claim adjustment Future policy Separate account (In millions) expenses benefits Policyholders' funds business Long term care $ 1,470 $ 6,374 $ - $ - Payout annuities 660 1,997 - - Institutional markets 1 15 129 417 Other 53 5 - - Total $ 2,184 $ 8,391 $ 129 $ 417 The reserve amounts above are net of$1,375 million of ceded reserves and exclude$95 million of claim and claim adjustment expenses and$627 million of future policy benefits relating to Shadow Adjustments, as further discussed in Note A to the Consolidated Financial Statements included under Item 8.December 31, 2010 Claim and claim adjustment Future policy Separate account (In millions) expenses benefits Policyholders' funds business Long term care $ 1,286 $ 5,829 $ - $ - Payout annuities 740 1,812 - - Institutional markets 1 15 106 450 Other 70 5 - - Total $ 2,097 $ 7,661 $ 106 $ 450 The reserve amounts above are net of$1,502 million of ceded reserves and exclude$235 million of future policy benefits relating to Shadow Adjustments. 2010 Compared with 2009 Net earned premiums for Life & Group Non-Core decreased$13 million in 2010 as compared with 2009. Net loss decreased$115 million in 2010 as compared with 2009. This improvement was primarily due to improved net realized investment results. In addition, 2009 results included the unfavorable impact of a$28 million after-tax legal accrual. The accrual was subsequently decreased in 2010 resulting in a favorable impact of$12 million after-tax. Favorable reserve development arising from a commutation of an assumed reinsurance agreement in 2010 also contributed to the improvement. These favorable impacts were partially offset by a$61 million after-tax gain recognized in 2009, net of reinsurance, arising from a settlement reached withWillis Limited that resolved litigation related to the placement of personal accident reinsurance. The favorable impacts were also partially offset by the increase to payout annuity benefit reserves resulting from unlocking assumptions due to loss recognition, unfavorable results in our long term care business and less favorable performance on our pension deposit business. During 2010 and 2009, we decreased the pretax liability in Policyholder funds related to our pension deposit business, as discussed above, by$24 million and$42 million , based on increases in the fair value of the investments supporting this business during those periods. 38
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Corporate & Other Non-Core Overview Corporate & Other Non-Core primarily includes certain corporate expenses, including interest on corporate debt, and the results of certain property and casualty business in run-off, including CNA Re and A&EP. In 2010, we ceded substantially all of our legacy A&EP liabilities under the Loss Portfolio Transfer, as further discussed in Note F to the Consolidated Financial Statements included under Item 8. The following table summarizes the results of operations for the Corporate & Other Non-Core segment, including A&EP and intersegment eliminations. Results of Operations Years endedDecember 31 (In millions) 2011 2010 2009 Net investment income $ 32 $ 137 $ 195 Net operating loss (66 ) (387 ) (87 ) Net realized investment gains (losses), after-tax (3 ) 13 (49 ) Net loss (69 ) (374 ) (136 ) 2011 Compared with 2010 Net loss decreased$305 million in 2011 as compared with 2010, primarily driven by the after-tax loss of$344 million as a result of the Loss Portfolio Transfer consummated in the third quarter of 2010. As a result of that transaction, the investment income allocated to the Corporate & Other Non-Core segment decreased substantially because of the lower net reserve base and associated risk capital. Claim adjustment expenses are lower because the counterparty to the Loss Portfolio Transfer is responsible for A&EP claim handling. The A&EP operations produced net operating income of$23 million for 2010. Additionally, the decrease in net loss was driven by the favorable impact of a$22 million prior year tax amount and a$15 million pretax release of a previously established allowance for uncollectible reinsurance receivables arising from a change in estimate. These favorable impacts were partially offset by decreased net realized investment results and higher interest expense. The increase in interest expense primarily relates to the use of debt to fund a portion of the 2010 redemption of our preferred stock. Favorable net prior year development of$3 million was recorded in 2011, compared to unfavorable net prior development of$6 million in 2010. The following table summarizes the gross and net carried reserves as ofDecember 31, 2011 and 2010 for Corporate & Other Non-Core. Gross and Net Carried Claim and Claim Adjustment Expense ReservesDecember 31 (In millions) 2011 2010 Gross Case Reserves $ 1,321 $ 1,430 Gross IBNR Reserves 1,808 2,012 Total Gross Carried Claim and Claim Adjustment Expense Reserves $ 3,129 $ 3,442 Net Case Reserves $ 347 $ 461 Net IBNR Reserves 244 257
Total Net Carried Claim and Claim Adjustment Expense Reserves
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2010 Compared with 2009 Net loss increased$238 million in 2010 as compared with 2009, driven by the after-tax net loss of$344 million as a result of the Loss Portfolio Transfer. Net results were also impacted by lower net investment income and higher interest expense. Partially offsetting these unfavorable items were decreased unfavorable net prior year development and improved net realized investment results. Unfavorable net prior year development of$6 million was recorded in 2010, and unfavorable net prior year development of$159 million was recorded in 2009 which included$79 million for asbestos exposures and$76 million for environmental pollution exposures. Further information on Corporate & Other Non-Core net prior year development for 2009 is included in Note F to the Consolidated Financial Statements included under Item 8. 40
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INVESTMENTS
Net Investment Income The significant components of pretax net investment income are presented in the following table. Net Investment Income Years endedDecember 31 (In millions) 2011 2010 2009 Fixed maturity securities $ 2,011 $ 2,051 $ 1,941 Short term investments 8 15 36 Limited partnership investments 48 249 315 Equity securities 20 32 49 Mortgage loans 9 2 - Trading portfolio 9 13 23 Other 7 8 6 Gross investment income 2,112 2,370 2,370 Investment expense (58 ) (54 ) (50 ) Net investment income $ 2,054 $ 2,316 $ 2,320 Net investment income decreased$262 million in 2011 as compared with 2010. The decrease was primarily driven by a significant decrease in limited partnership results as well as lower fixed maturity security income. Limited partnership results were adversely impacted by less favorable equity market returns, and overall capital market and credit spread volatility. The decrease in fixed maturity security income was primarily driven by reinvestment at lower market rates which led to a decline in the effective income yield of the portfolio. Net investment income decreased$4 million in 2010 as compared with 2009. This decrease was primarily driven by less favorable income from our limited partnership investments, substantially offset by an investment shift during 2010 from lower yielding short term and tax-exempt securities to higher yielding taxable fixed maturity securities. The unfavorable year-over-year comparison in income from our limited partnership investments was driven by significant returns from our limited partnership investments in 2009. The fixed maturity investment portfolio provided a pretax effective income yield of 5.5%, 5.6% and 5.7% for the years endedDecember 31, 2011 , 2010 and 2009. Tax-exempt municipal bonds generated$240 million ,$263 million and$381 million of net investment income for the years endedDecember 31, 2011 , 2010 and 2009. 41
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Net Realized Investment Gains (Losses) The components of net realized investment results are presented in the following table. Net Realized Investment Gains (Losses) Years endedDecember 31 (In millions) 2011 2010 2009 Fixed maturity securities: Corporate and other bonds $ 48 $ 164 $ (345 ) States, municipalities and political subdivisions 5 (128 ) (20 ) Asset-backed (82 ) 44 (778 ) U.S. Treasury and obligations of government-sponsored enterprises 1 3 (53 ) Foreign government 3 2 38 Redeemable preferred stock 3 7 (9 ) Total fixed maturity securities (22 ) 92 (1,167 ) Equity securities (1 ) (2 ) 243 Derivative securities - (1 ) 51 Short term investments and other 19 (3 ) 16 Net realized investment gains (losses), net of participating policyholders' interests (4 ) 86 (857 ) Income tax (expense) benefit on net realized investment gains (losses) 5 (36 )
296
Net realized investment (gains) losses, after-tax, attributable to noncontrolling interests - 1 - Net realized investment gains (losses) attributable to CNA $ 1 $ 51
$ (561 )
Net realized investment gains decreased$50 million for 2011 as compared with 2010. Net realized investment results improved$612 million for 2010 as compared with 2009, driven by significantly lower other-than-temporary impairment (OTTI) losses recognized in earnings. Net realized investment results include OTTI losses of$140 million ,$151 million , and$879 million for 2011, 2010, and 2009. Included in the 2009 pretax net realized gains for equity securities was$370 million related to the sale of our holdings of Verisk Analytics, Inc., which began trading onOctober 7, 2009 , after an initial public offering. Since our cost basis in this position was zero, the entire amount was recognized as a pretax realized investment gain. Further information on our realized gains and losses, including our OTTI losses and impairment decision process, is set forth in Note B to the Consolidated Financial Statements included under Item 8. During the second quarter of 2009, the Company adopted updated accounting guidance, which amended the OTTI loss model for fixed maturity securities. Portfolio Quality Our fixed maturity portfolio consists primarily of high quality bonds, 92% and 91% of which were rated as investment grade (rated BBB- or higher) atDecember 31, 2011 and 2010. The classification between investment grade and non-investment grade is based on a ratings methodology that takes into account ratings from two major providers, S&P and Moody's, in that order of preference. If a security is not rated by these providers, we formulate an internal rating. AtDecember 31, 2011 and 2010, approximately 98% of the fixed maturity portfolio was issued or guaranteed by theU.S. Government , Government agencies or Government-sponsored enterprises or was rated by S&P or Moody's. 42
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The following table summarizes the ratings of our fixed maturity portfolio at fair value. Fixed Maturity RatingsDecember 31 (In millions) 2011 % 2010 %U.S. Government , Government agencies and Government-sponsored enterprises $ 4,760 12 % $ 4,003 11 % AAA rated 3,421 8 3,950 10 AA and A rated 17,807 45 15,665 42 BBB rated 10,790 27 10,425 28 Non-investment grade 3,159 8 3,534 9 Total $ 39,937 100 % $ 37,577 100 % Non-investment grade fixed maturity securities, as presented in the table below, include high-yield securities rated below BBB- by bond rating agencies and other unrated securities that, according to our analysis, are below investment grade. Non-investment grade securities generally involve a greater degree of risk than investment grade securities. The amortized cost of our non-investment grade fixed maturity bond portfolio was$3,200 million and$3,490 million atDecember 31, 2011 and 2010. The following table summarizes the ratings of this portfolio at fair value. Non-investment Grade December 31 (In millions) 2011 % 2010 % BB $ 1,484 47 % $ 1,492 42 % B 867 27 1,163 33 CCC - C 689 22 801 23 D 119 4 78 2 Total $ 3,159 100 % $ 3,534 100 % The gross unrealized loss on available-for-sale fixed maturity securities was$536 million atDecember 31, 2011 . The following table provides the maturity profile for these available-for-sale fixed maturity securities. Securities not due at a single date are allocated based on weighted average life. Maturity Profile Percent of Percent of December 31, 2011 Fair Value Unrealized Loss Due in one year or less 8 % 3 % Due after one year through five years 34 24 Due after five years through ten years 30 31 Due after ten years 28 42 Total 100 % 100 % 43
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Duration
A primary objective in the management of the investment portfolio is to optimize return relative to corresponding liabilities and respective liquidity needs. Our views on the current interest rate environment, tax regulations, asset class valuations, specific security issuer and broader industry segment conditions, and the domestic and global economic conditions, are some of the factors that enter into an investment decision. We also continually monitor exposure to issuers of securities held and broader industry sector exposures and may from time to time adjust such exposures based on our views of a specific issuer or industry sector. A further consideration in the management of the investment portfolio is the characteristics of the corresponding liabilities and the ability to align the duration of the portfolio to those liabilities and to meet future liquidity needs, minimize interest rate risk and maintain a level of income sufficient to support the underlying insurance liabilities. For portfolios where future liability cash flows are determinable and typically long term in nature, we segregate investments for asset/liability management purposes. The segregated investments support the liabilities in the Life & Group Non-Core segment including annuities, structured settlements and long term care products. The effective durations of fixed maturity securities, short term investments, non-redeemable preferred stocks and interest rate derivatives are presented in the table below. Short term investments are net of payable and receivable amounts for securities purchased and sold, but not yet settled. Effective Durations December 31, 2011 December 31, 2010 Effective Effective Duration Duration (In millions) Fair Value (In years) Fair Value (In years) Investments supporting Life & Group Non-Core $ 13,820 11.5 $ 11,825 11.0 Other interest sensitive investments 28,071 3.9 28,096 4.5 Total $ 41,891 6.4 $ 39,921 6.4 The investment portfolio is periodically analyzed for changes in duration and related price risk. Additionally, we periodically review the sensitivity of the portfolio to the level of foreign exchange rates and other factors that contribute to market price changes. A summary of these risks and specific analysis on changes is included in Item 7A. Quantitative and Qualitative Disclosures About Market Risk included herein. Select Asset Class Discussion Asset-Backed Securities Our fixed maturity portfolio includes exposure to sub-prime residential mortgage securities (sub-prime) and Alternative A residential mortgage securities that have lower than normal standards of loan documentation (Alt-A), as measured by the original deal structure. As ofDecember 31, 2011 , the fair value of sub-prime securities was$330 million , 66% of which were rated investment grade, with associated net unrealized losses of$34 million . As ofDecember 31, 2011 , the fair value of Alt-A securities was$542 million , 68% of which were rated investment grade, with associated net unrealized losses of$18 million . Pretax OTTI losses on asset-backed securities recognized in earnings in 2011 were$111 million , and$44 million of this amount related to securities with sub-prime and Alt-A exposure. If additional deterioration in the underlying collateral occurs beyond our current expectations, additional OTTI losses may be recognized in earnings. See Note B to the Consolidated Financial Statements included under Item 8 for additional information related to unrealized losses on asset-backed securities. 44
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European Exposure Our fixed maturity portfolio also includes European exposure. The following table summarizes European exposure included within fixed maturity holdings. European Exposure December 31, 2011 Corporate Sovereign Total (In millions) Financial Sector Other Sectors AAA $ 178 $ 26 $ 165 $ 369 AA 192 136 1 329 A 806 682 11 1,499 BBB 264 986 - 1,250 Non-investment grade 2 142 - 144 Total fair value $ 1,442 $ 1,972 $ 177 $ 3,591 Total amortized cost $ 1,474 $ 1,790 $ 174 $ 3,438 European exposure is based on application of a country of risk methodology. Country of risk is derived from the issuing entity's management location, country of primary listing, revenue and reporting currency. As ofDecember 31, 2011 , securities with a fair value and amortized cost of$1,853 million and$1,768 million relate to Eurozone countries, which consist of member states of theEuropean Union that use the Euro as their national currency. Of this amount, securities with a fair value and amortized cost of$392 million and$399 million pertain toGreece ,Italy ,Ireland ,Portugal andSpain ("GIIPS"). Ratings presented in the table above do not reflect downgrades that occurred subsequent toDecember 31, 2011 which impact securities with a fair value of$117 million . Short Term Investments The carrying value of the components of the short term investment portfolio is presented in the following table. Short Term Investments December 31 (In millions) 2011 2010 Short term investments: Commercial paper $ 411 $ 686 U.S. Treasury securities 903 903 Money market funds 45 94 Other 282 532
Total short term investments
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LIQUIDITY AND CAPITAL RESOURCES Cash Flows Our principal operating cash flow sources are premiums and investment income from our insurance subsidiaries. Our primary operating cash flow uses are payments for claims, policy benefits and operating expenses. Additionally, cash may be paid or received for income taxes. For 2011, net cash provided by operating activities was$1,702 million as compared with net cash used by operating activities of$89 million for 2010. As further discussed in Note F to the Consolidated Financial Statements included under Item 8 and previously referenced in this MD&A, in 2010 we completed the Loss Portfolio Transfer transaction. As a result of this transaction, operating cash flows were reduced for the initial net cash settlement with NICO. Excluding the impact of this transaction, net cash provided by operating activities was approximately$1,800 million for 2010. Cash flows resulting from reinsurance contract commutations are reported as operating activities. During 2011, operating cash flows were increased by$547 million related to net cash inflows from commutations as compared to net cash inflows of$189 million during 2010. Additionally, payments made for income taxes were$61 million for 2011 as compared to a refund of$175 million in 2010. Further, because cash receipts and cash payments resulting from purchases and sales of trading securities are reported as cash flows related to operating activities, during 2010 operating cash flows were increased by$153 million as compared to an increase of$1 million during 2011 related to trading activity. Excluding the items above, net cash generated by our business operations was approximately$1,215 million for 2011 and$1,280 million for 2010. Net cash provided by operating activities was$1,258 million in 2009. Operating cash flows were decreased by$164 million in 2009 related to net cash outflows which increased the size of the trading portfolio held atDecember 31, 2009 . Cash flows from investing activities include the purchase and sale of available-for-sale financial instruments. Additionally, cash flows from investing activities may include the purchase and sale of businesses, land, buildings, equipment and other assets not generally held for resale. Net cash used by investing activities was$1,060 million for 2011, as compared with net cash provided of$767 million for 2010 and net cash used of$1,093 million for 2009. The cash flow from investing activities is impacted by various factors such as the anticipated payment of claims, financing activity, asset/liability management and individual security buy and sell decisions made in the normal course of portfolio management. Net cash provided by investing activities in 2010 primarily related to the sale of short term investments which was used to fund the$1.9 billion initial net cash settlement with NICO as discussed above. Cash flows from financing activities include proceeds from the issuance of debt and equity securities, outflows for stockholder dividends or repayment of debt and outlays to reacquire equity instruments. Net cash used by financing activities was$644 million ,$742 million , and$120 million for 2011, 2010 and 2009. During 2011, we purchased the noncontrolling interest ofCNA Surety and resumed payment of common stock dividends. Net cash used by financing activities in 2010 was primarily related to payments to redeem the outstanding 2008 Senior Preferred as discussed below. 46
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2008 Senior Preferred and Surplus Note In 2008, we issued, andLoews purchased, 12,500 shares of CNAF non-voting cumulative senior preferred stock for$1.25 billion . We used the majority of the proceeds to increase the statutory surplus of our principal insurance subsidiary, CCC, through the purchase of a$1.0 billion surplus note of CCC. As ofDecember 31, 2010 , we have fully redeemed all 12,500 shares originally issued, through a series of redemptions during 2009 and 2010. The redemptions were funded by the issuance of debt and the partial repayment of the surplus note. In 2011 and 2010, we repaid$250 million and$500 million of the$1.0 billion surplus note to CNAF, leaving an outstanding balance of$250 million as ofDecember 31, 2011 . Dividends of$76 million and$122 million on the 2008 Senior Preferred were declared and paid for the years endedDecember 31, 2010 and 2009. Liquidity We believe that our present cash flows from operations, investing activities and financing activities are sufficient to fund our current and expected working capital and debt obligation needs and we do not expect this to change in the near term. There are currently no amounts outstanding under our revolving credit facility, which provides for a total commitment of up to$250 million . This credit facility expiresAugust 2012 . We have an effective automatic shelf registration statement under which we may issue debt, equity or hybrid securities. Common Stock Dividends Dividends of$0.40 per share of our common stock were declared and paid in 2011. OnFebruary 3, 2012 , our Board of Directors declared a quarterly dividend of$0.15 per share, payableMarch 1, 2012 to stockholders of record onFebruary 16, 2012 . The declaration and payment of future dividends to holders of our common stock will be at the discretion of our Board of Directors and will depend on many factors, including our earnings, financial condition, business needs, and regulatory constraints. Our ability to pay dividends and other credit obligations is significantly dependent on receipt of dividends from our subsidiaries. The payment of dividends to us by our insurance subsidiaries without prior approval of the insurance department of each subsidiary's domiciliary jurisdiction is limited by formula. Dividends in excess of these amounts are subject to prior approval by the respective state insurance departments. Further information on our dividends from subsidiaries is provided in Note L to the Consolidated Financial Statements included under Item 8. 47
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Commitments, Contingencies, and Guarantees We have various commitments, contingencies and guarantees which arose in the ordinary course of business. The impact of these commitments, contingencies and guarantees should be considered when evaluating our liquidity and capital resources. A summary of our commitments as ofDecember 31, 2011 is presented in the following table. Contractual CommitmentsDecember 31, 2011 Less than 1 More than 5 (In millions) Total year 1-3 years 3-5 years years Debt (a) $ 3,835 $ 252 $ 875 $ 612 $ 2,096 Lease obligations 222 37 68 45 72 Claim and claim adjustment expense reserves (b) 25,858 5,738 7,531 3,923 8,666 Future policy benefits reserves (c) 32,188 111 365 616 31,096 Policyholder funds reserves (c) 151 22 29 (1 ) 101 Guaranteed payment contracts (d) 13 4 6 3 - Total (e) $ 62,267 $ 6,164 $ 8,874 $ 5,198 $ 42,031
(a) Includes estimated future interest payments.
(b) Claim and claim adjustment expense reserves are not discounted and represent
our estimate of the amount and timing of the ultimate settlement and
administration of gross claims based on our assessment of facts and
circumstances known as of
Uncertainties section of this MD&A for further information.
(c) Future policy benefits and policyholders' funds reserves are not discounted
and represent our estimate of the ultimate amount and timing of the
settlement of benefits based on our assessment of facts and circumstances
known as of
and policyholders' fund reserves of
been 100% ceded to unaffiliated parties in connection with the sale of our
individual life business in 2004 are not included. See the Reserves -
Estimates and Uncertainties section of this MD&A for further information.
(d) Primarily relating to outsourced services and software.
(e) Does not include expected estimated contribution of
pension and postretirement plans in 2012.
Further information on our commitments, contingencies and guarantees is provided in Notes A, B, C, F, G, I, J and K to the Consolidated Financial Statements included under Item 8.
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Ratings
Ratings are an important factor in establishing the competitive position of insurance companies. Our insurance company subsidiaries are rated by major rating agencies, and these ratings reflect the rating agency's opinion of the insurance company's financial strength, operating performance, strategic position and ability to meet our obligations to policyholders. Agency ratings are not a recommendation to buy, sell or hold any security, and may be revised or withdrawn at any time by the issuing organization. Each agency's rating should be evaluated independently of any other agency's rating. One or more of these agencies could take action in the future to change the ratings of our insurance subsidiaries. The table below reflects the various group ratings issued byA.M. Best , Moody's and S&P for the property and casualty and life companies. The table also includes the ratings for CNAF senior debt andThe Continental Corporation (Continental) senior debt. Insurance Financial Strength Ratings Corporate Debt
Ratings
Property & Casualty Life CNAF Continental CCC Group Western Surety Group CAC Senior Debt Senior Debt A.M. Best A A A- bbb Not rated Moody's A3 Not rated Not rated Baa3 Baa3 S&P A- A- Not rated BBB- BBB-A.M. Best and Moody's maintain a stable outlook on the Company. In 2011, S&P revised their outlook on our rating to positive from stable. If our property and casualty insurance financial strength ratings were downgraded below current levels, our business and results of operations could be materially adversely affected. The severity of the impact on our business is dependent on the level of downgrade and, for certain products, which rating agency takes the rating action. Among the adverse effects in the event of such downgrades would be the inability to obtain a material volume of business from certain major insurance brokers, the inability to sell a material volume of our insurance products to certain markets and the required collateralization of certain future payment obligations or reserves. Downgrades of our corporate debt ratings could result in adverse effects upon our liquidity position, including negatively impacting our ability to access capital markets, and increasing our financing costs. Further, additional collateralization may be required for certain settlement agreements and assumed reinsurance contracts, as well as derivative contracts, if our ratings or other specific criteria fall below certain thresholds. In addition, it is possible that a lowering of the corporate debt ratings ofLoews by certain of these agencies could result in an adverse impact on our ratings, independent of any change in our circumstances. None of the major rating agencies which ratesLoews currently maintains a negative outlook or hasLoews on negative Credit Watch. ACCOUNTING STANDARDS UPDATES For discussion of accounting standards updates that have been adopted or will be adopted in the future, see Note A to the Consolidated Financial Statements included under Item 8. 49
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FORWARD-LOOKING STATEMENTS This report contains a number of forward-looking statements which relate to anticipated future events rather than actual present conditions or historical events. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and generally include words such as "believes," "expects," "intends," "anticipates," "estimates," and similar expressions. Forward-looking statements in this report include any and all statements regarding expected developments in our insurance business, including losses and loss reserves for asbestos and environmental pollution and other mass tort claims which are more uncertain, and therefore more difficult to estimate than loss reserves respecting traditional property and casualty exposures; the impact of routine ongoing insurance reserve reviews we are conducting; our expectations concerning our revenues, earnings, expenses and investment activities; volatility in investment returns; expected cost savings and other results from our expense reduction activities; and our proposed actions in response to trends in our business. Forward-looking statements, by their nature, are subject to a variety of inherent risks and uncertainties that could cause actual results to differ materially from the results projected in the forward-looking statement. We cannot control many of these risks and uncertainties. These risks and uncertainties include, but are not limited to, the following: Company-Specific Factors • the risks and uncertainties associated with our loss reserves, as outlined in
the Critical Accounting Estimates and the Reserves - Estimates and
Uncertainties sections of this Report, including the sufficiency of the
reserves and the possibility for future increases, which would be reflected
in the results of operations in the period that the need for such adjustment
is determined;
• the risk that the other parties to the transaction in which, subject to
certain limitations, we ceded our legacy A&EP liabilities will not fully
perform their obligations to CNA, the uncertainty in estimating loss reserves
for A&EP liabilities and the possible continued exposure of CNA to liabilities for A&EP claims that are not covered under the terms of the transaction;
• the performance of reinsurance companies under reinsurance contracts with us;
and
• the consummation of contemplated transactions.
Industry and General Market Factors • the impact of competitive products, policies and pricing and the competitive
environment in which we operate, including changes in our book of business;
• product and policy availability and demand and market responses, including
the level of ability to obtain rate increases and decline or non-renew under
priced accounts, to achieve premium targets and profitability and to realize
growth and retention estimates;
• general economic and business conditions, including recessionary conditions
that may decrease the size and number of our insurance customers and create
additional losses to our lines of business, especially those that provide
management and professional liability insurance, as well as surety bonds, to
businesses engaged in real estate, financial services and professional
services, and inflationary pressures on medical care costs, construction
costs and other economic sectors that increase the severity of claims;
• conditions in the capital and credit markets, including continuing
uncertainty and instability in these markets, as well as the overall economy,
and their impact on the returns, types, liquidity and valuation of our
investments;
• conditions in the capital and credit markets that may limit our ability to
raise significant amounts of capital on favorable terms, as well as
restrictions on the ability or willingness of
capital support to us; and
• the possibility of changes in our ratings by ratings agencies, including the
inability to access certain markets or distribution channels and the required
collateralization of future payment obligations as a result of such changes,
and changes in rating agency policies and practices. 50
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Regulatory Factors • regulatory initiatives and compliance with governmental regulations, judicial
interpretations within the regulatory framework, including interpretation of
policy provisions, decisions regarding coverage and theories of liability,
rulings and changes in tax laws and regulations;
• regulatory limitations, impositions and restrictions upon us, including the
effects of assessments and other surcharges for guaranty funds and
second-injury funds, other mandatory pooling arrangements and future
assessments levied on insurance companies as well as the new federal
financial regulatory reform of the insurance industry established by the
Dodd-Frank Wall Street Reform and Consumer Protection Act;
• increased operating costs and underwriting losses arising from the Patient
Protection and Affordable Care Act and the related amendments in the Health
Care and Education Reconciliation Act, as well as health care reform
proposals at the state level; and
• regulatory limitations and restrictions, including limitations upon our
ability to receive dividends from our insurance subsidiaries, imposed by
regulatory authorities, including regulatory capital adequacy standards.
Impact of Catastrophic Events and Related Developments • weather and other natural physical events, including the severity and
frequency of storms, hail, snowfall and other winter conditions, natural
disasters such as hurricanes and earthquakes, as well as climate change,
including effects on weather patterns, greenhouse gases, sea, land and air
temperatures, sea levels, rain and snow;
• regulatory requirements imposed by coastal state regulators in the wake of
hurricanes or other natural disasters, including limitations on the ability
to exit markets or to non-renew, cancel or change terms and conditions in
policies, as well as mandatory assessments to fund any shortfalls arising
from the inability of quasi-governmental insurers to pay claims;
• man-made disasters, including the possible occurrence of terrorist attacks
and the effect of the absence or insufficiency of applicable terrorism
legislation on coverages;
• the unpredictability of the nature, targets, severity or frequency of
potential terrorist events, as well as the uncertainty as to our ability to
contain our terrorism exposure effectively; and
• the occurrence of epidemics.
Our forward-looking statements speak only as of the date on which they are made and we do not undertake any obligation to update or revise any forward-looking statement to reflect events or circumstances after the date of the statement, even if our expectations or any related events or circumstances change. 51
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