ITEM 1. BUSINESS
CNA Financial Corporation and its consolidated subsidiaries (CNA) constitute the twelfth largest insurance company in the United States as measured by 1993 statutory premium volume. CNA was incorporated in 1967 as the parent company of Continental Casualty Company ("CCC"), incorporated in 1897, and Continental Assurance Company ("CAC") incorporated in 1911. In 1975, CAC became a wholly-owned subsidiary of CCC. CNA's property and casualty insurance operations are conducted by CCC and its property and casualty insurance affiliates, and its life insurance operations are conducted by CAC and its life insurance affiliate. CNA's principal business conducted through its insurance subsidiaries is insurance. As multiple-line insurers, the insurance companies underwrite property, casualty, life, and accident and health coverages. Their principal market for insurance is the United States. Foreign operations are not significant.
In the fourth quarter of 1994, CNA reached an agreement to purchase the outstanding shares of common stock of The Continental Corporation (CIC) under which CNA will acquire CIC through a cash merger for approximately $1.1 billion, or $20 per CIC share. The acquisition will create the third-largest U.S. property/casualty insurance group and make CNA the seventh-largest U.S. insurance organization. The acquisition will be accounted for as a purchase and, accordingly, CIC's results of operations will be included in CNA's consolidated results of operations for periods subsequent to the date of closing, which is expected to be in the second quarter of 1995. CNA and CIC are jointly seeking prompt regulatory approvals. The transaction closing is subject to the approvals of the Continental shareholders and state insurance regulators. The transaction is also subject to review by the Federal Trade Commission and the Department of Justice (which review has been completed). Until the required approvals are received and the acquisition is complete, the companies will continue to operate independently.
Competition
All aspects of the insurance business are highly competitive. CNA's insurance operations compete with a large number of stock and mutual insurance companies and other entities for both producers and customers and must continuously allocate resources to refine and improve insurance products and services.
There are approximately 3,900 companies that sell property/casualty insurance in the United States, about 900 of which operate in all or most states. CCC and its consolidated subsidiaries are ranked as the sixth largest property/casualty insurance organization based on statutory net premiums written in 1993.
There are approximately 1,800 companies selling life insurance (including health insurance and pension products) in the United States. CAC is ranked as the twenty-third largest life insurance organization based on consolidated statutory premium revenue in 1993.
Dividends by Insurance Subsidiaries
The payment of dividends to CNA by its insurance affiliates without prior approval of the Illinois Insurance Department ("IID") is limited to formula amounts determined in accordance with the accounting practices prescribed or permitted by the IID. The current formula limits dividends, without approval of the insurance commissioner, to the greater of 10% of prior year statutory surplus or prior year statutory net income, less the aggregate of all dividends paid during the twelve months prior to date of payment. For 1995, approximately $336 million in dividends could be paid to CNA by its insurance affiliates without prior approval. The National Association of Insurance Commissioners ("NAIC") Financial Regulation Standards and Accreditation Committee approved the Illinois dividend formula as complying with the NAIC Model Dividend Law. All dividends must be reported to the insurance department within five business days of declaration and ten days prior to payment.
Regulation
The insurance industry is subject to comprehensive and detailed regulation and supervision throughout the United States. Each state has established supervisory agencies with broad administrative power relative to licensing insurers and agents, approving policy forms, establishing reserve requirements, maintaining guarantee funds, fixing minimum interest rates for accumulation of surrender values and maximum interest rates of policy loans, prescribing the form and content of statutory financial reports and regulating solvency and the type and amount of investments permitted. Regulatory powers also extend to premium rate regulations which require that rates not be excessive, inadequate or unfairly discriminatory. In addition to regulation of dividends by insurance subsidiaries discussed above, intercompany transfers of assets may be subject to prior notice or approval, depending on the size of such transfers and payments in relation to the financial position of the insurance affiliates making the transfer.
The trend for legislation and voter initiatives continues, particularly for personal lines products, directly impacting insurance rate development, rate application and the ability of insurers to cancel or renew insurance policies. Restrictions on the consideration of certain expenses, limits on services provided by advisory organizations and politically suppressed workers' compensation rates in certain states continue to be of concern.
Insurers are also required by the states to provide coverage to risks which would not otherwise be considered eligible by the insurers. Each state dictates the types of insurance and the level of coverage which must be provided to such involuntary risks. CNA's insurance subsidiaries' share of these involuntary risks is generally a function of their respective share of the voluntary market by line of insurance in each state.
In recent years, insolvencies of a few large insurers previously believed to be on solid financial ground by many rating agencies and state regulators led to increased scrutiny of state regulated insurer solvency requirements by certain members of the U.S. Congress. Had Congress formally adopted initiatives in the 103rd Congress, insurers would have been subject to federal solvency regulation. In response to this challenge the National Association of Insurance Commissioners (NAIC) developed industry minimum Risk-Based Capital (RBC) requirements, established a formal state accreditation process designed to minimize the diversity of approved statutory accounting and actuarial practices, and has increased the annual statutory statement disclosure requirements.
RBC requirements were first effective for life insurers in 1993 and for property and casualty insurers in 1994. The RBC formulas were designed to identify an insurer's minimum capital requirements based upon the inherent risks (e.g., asset default, credit and insurance) of its operations. In addition to the minimum capital requirements, the RBC formula and related regulations identify various levels of capital adequacy and corresponding action that the state insurance departments should initiate. The level of capital adequacy below which insurance departments would take action is defined as the Company Action Level. As of December 31, 1994, all of CNA's life insurance affiliates and property/casualty domestic affiliates have adjusted capital amounts in excess of NAIC Company Action Levels.
The NAIC established minimum capital requirements and also maintains the Insurance Regulatory Information System ("IRIS"), which assists the state insurance departments in overseeing the financial condition of both life and property/casualty insurers. These tests are in the form of ratios and have a range of results characterized as "usual" by the NAIC. The NAIC IRIS user guide regarding these ratios specifically states that "Falling outside the usual range is not considered a failing result..." and "...in some years it may not be unusual for financially sound companies to have several ratios with results outside the usual range." It is important, therefore, that IRIS ratio test results be reviewed carefully in conjunction with all other financial information.
CCC had one IRIS ratio with an unusual value in 1994, three in 1993 and four in 1992. The ratio with an unusual value in 1994 is the two year overall operating ratio. The three IRIS ratios with unusual values in 1993 were the two year overall operating, investment yield, and the two year reserve development ratios. The four IRIS ratios with unusual values in 1992 were the two year overall operating, the change in surplus, and both the one and two year reserve development ratios. Catastrophe losses and reserve increases associated with Fibreboard Corporation litigation (see Note J to the Consolidated Financial Statements) recognized in 1992 and 1993 triggered the unusual values for the operating ratios generated in 1993 and 1994 and development ratios generated in 1993. Additionally, lower interest
Regulation--(continued)
rates in the capital markets in 1993, coupled with a proportionately large short-term investment portfolio, triggered the unusual value for the investment yield ratio.
CAC had no IRIS ratios with unusual values in 1994. CAC had two unusual values for IRIS ratios in 1993, net gain to total income and change in net written premium, and one unusual value for IRIS ratios in 1992, net gain to total income. CAC's reported statutory net income was adversely affected in both 1993 and 1992 by the transfer of significant realized capital gains to the Interest Maintenance Reserve and depressed investment earnings. The unusual value for the change in premium ratio primarily relates to decreases in the Separate Account annuity products fund deposits.
Federal measures, which if reintroduced in the 104th Congress and enacted, would significantly affect the insurance business include proposals for directly regulating insurance company solvency as well as repeal of the McCarran-Ferguson Act, which exempts certain aspects of insurance from Federal regulation to the extent regulated by the states. The potential for Federal health care reform had been widely publicized and debated over the past year. Although legislative reforms failed in 1994, some health care reform could emerge in 1995. Such possible reforms include legislation affecting tort reform, medical malpractice, insurance market reforms and tax laws affecting health care and long term care benefits.
Although the courts and legislatures are often asked to expand liability, there is a growing trend among business and professional organizations to wage campaigns, which in several instances have been successful, aimed at limiting their liability risks. Several states have adopted and some are considering "tort reform" measures which, among other things, limit non-economic and punitive damages and otherwise limit damage awards in product liability and malpractice cases. The U.S. House of Representatives has passed three bills providing for significant tort reform. The passage of these bills, in their present form, by the Senate is uncertain.
Reinsurance
CNA assumes and cedes insurance with other insurers and reinsurers and members of various reinsurance pools and associations. CNA utilizes reinsurance arrangements to limit its maximum loss, to provide greater diversification of risk and to minimize exposures on larger risks. The reinsurance coverages are tailored to the specific risk characteristics of each product line with CNA's retained amount varying by type of coverage. Generally, reinsurance coverage for property risks is on an excess of loss, per risk basis. Liability coverages are generally reinsured on a quota share basis in excess of CNA's retained risk.
The ceding of insurance does not discharge the primary liability of the original insurer. CNA places reinsurance with other carriers only after careful review of the nature of the contract and a thorough assessment of the reinsurers' credit quality and claim settlement performance. Further, for carriers that are not authorized reinsurers in Illinois, CNA receives collateral primarily in the form of bank letters of credit, securing a large portion of the recoverables. Such collateral totaled approximately $165 and $155 million at December 31, 1994 and 1993, respectively. CNA's largest recoverable, including prepaid reinsurance premiums was approximately $348 and $484 million with Lloyd's of London at December 31, 1994 and 1993, respectively.
Employee Relations
CNA has approximately 15,600 employees and has experienced satisfactory labor relations. CNA has never had work stoppages due to labor disputes.
CNA has comprehensive benefit plans for substantially all of its employees, including a retirement plan, a savings plan, a disability program, a group life program, and a group health care program.
Business Segments
Information as to CNA's business segments is set forth in Note L to the Consolidated Financial Statements, incorporated by reference in Item 8, herein.
Life Business
CNA's life insurance operations market individual and group insurance products through licensed agents, most of whom are independent contractors, who sell life insurance for CNA and for other companies on a commission basis. Individual insurance products include life, accident and health and annuity products, and are sold to individuals and small businesses.
The individual life products currently being marketed consist primarily of term, universal life and participating policies. Included in the universal life category is a salary allotment product marketed through employers as a supplement to employers' benefit plans. Premiums are collected from employees through payroll deduction. The individual accident and health policies currently being marketed are long-term disability products. Individual annuity products are primarily periodic payment plans.
Group insurance products include life, accident and health and pension products, and are sold to employers, employer associations and trusts ranging in size from small local employers to large multinational corporations. The group accident and health plans are primarily major medical and hospitalization. Most of the major medical and hospitalization plans are written under experience-rated contracts or contracts to provide claim administrative services only.
CNA's products are designed and priced using assumptions management believes to be reasonably conservative for mortality, morbidity, persistency, expense levels and investment results. Underwriting practices that management believes are prudent are followed in selecting the risks that will be insured. Further, actual experience related to pricing assumptions is monitored closely so that prospective adjustments to these assumptions may be implemented as necessary. CNA mitigates the risk related to persistency by including contractual surrender charge provisions in its ordinary life and annuity policies in the first five to ten years, thus providing for the recovery of acquisition expenses. The investment portfolios supporting interest sensitive products, including universal life and individual annuities, are managed as a separate portfolio to minimize liquidity and interest rate risk.
Profitability in the health insurance business continues to be impacted by intense competition and rising medical costs. CNA has aggressively pursued expense reduction through increases in automation and other productivity improvements. Further, increasing costs of health care have resulted in a continued market shift away from traditional forms of health coverage toward managed care products and experience-rated plans. CNA's ability to compete in this market will be increasingly dependent on its ability to control costs through managed care techniques, innovation, and quality customer-focused service in order to properly position CNA in the evolving health care environment.
Although the Federal Government's proposed comprehensive health care reform failed to be enacted in 1994, some health care initiatives could emerge in 1995. Such possible reforms include legislation affecting tort reform, medical malpractice, insurance market reforms and tax laws affecting health care and long term care benefits. CNA has urged a meaningful role for the private sector in any proposed plan. The present health care system is clearly in need of reform, and CNA has emphasized that the competitive strengths of the insurance industry must be an integral part of a workable solution.
Life Business--(continued)
The following table sets forth supplemental data for the life insurance business:
(a) Group accident and health premiums include contracts involving U.S. government employees and their dependents amounting to approximately $1.8, $1.7, $1.6, $1.5, and $1.3 billion in 1994, 1993, 1992, 1991 and 1990, respectively.
(b) Lapse ratios as measured by surrenders and withdrawals as a percentage of average ordinary life insurance in force were 9.7%, 9.7%, 8.6%, 10.4%, and 11.4%, in 1994, 1993, 1992, 1991, and 1990, respectively.
(c) Other Data is determined on the basis of statutory accounting principles and reflects capital contributions from Continental Casualty Company of $100 million in 1990. Life insurance subsidiaries have received, or will receive, reimbursement from CNA for general management and administrative expenses and investment expenses in the amounts of $24.7, $25.6, $24.5, $25.7, and $25.0 million in 1994, 1993, 1992, 1991 and 1990, respectively. Statutory capital and surplus as a percent of total liabilities is determined after excluding Separate Account liabilities and reclassifying the Asset Valuation and Interest Maintenance Reserves (statutorily defined and created reserves) as surplus.
Annuities and Guaranteed Investment Contracts ---------------------------------------------
CAC writes the majority of its annuities and guaranteed investment contracts ("GIC's") in a fixed Separate Account, which is permitted by Illinois insurance statutes. CAC guarantees principal and a specified return to GIC contractholders. This guarantee affords the contractholders additional security, in the form of CAC's general account surplus, which supports any principal and/or guaranteed interest payment shortfalls of the Separate Account.
CNA manages the liquidity and interest rate risks on the GIC portfolio by matching the GIC assets and liabilities on the basis of duration and maintaining market value surrender adjustments on the majority of the contracts.
Life Business--(continued)
The table below shows a comparison of the duration of assets and liabilities, the investment yield, the weighted average interest crediting rates and withdrawal characteristics of the GIC portfolio.
As shown above, the investment yield at December 31, 1994 was more than the average crediting rate. The investment yields at December 31, 1993 and 1992 were less than the average crediting rates. This resulted from the reinvestment of proceeds from security sales, that generated substantial gains, at rates that were lower than those of the securities sold. However, because the security sales created a larger asset base to reinvest, the aggregate future cash flows from interest and principal were substantially unchanged and sufficient to meet the product obligations.
Property/Casualty Business
CNA's property/casualty operations market commercial and personal lines of property/casualty insurance through independent agents and brokers.
CCC and its property/casualty insurance subsidiaries write primarily commercial lines coverages. Customers include large national corporations, small and medium-sized businesses, groups and associations, and professionals. Coverages are written primarily through traditional insurance contracts under which risk is transferred to the insurer. Many commercial account policies are written under retrospectively-rated contracts which are experience-rated. Premiums for such contracts may be adjusted, subject to limitations set by contract, based on loss experience of the insureds. Other experience-rated policies include provisions for adjustments to dividends based on loss experience. Experience-rated contracts reduce but do not eliminate risk to the insurer. Approximately 38% of CNA's property/casualty insurance is written on an experience-rated basis.
CNA also provides loss control, policy administration and claim administration services under service contracts for fees. Such services are provided primarily in the workers' compensation market where retention of more risk by the employer through self-insurance or high-deductible programs has become increasingly prevalent.
Commercial business includes such lines as workers' compensation, general liability, professional and specialty, multiple peril, and accident and health coverages. Professional and specialty coverages include liability coverage for architects and engineers, lawyers, accountants, medical and dental professionals; directors and officers liability; and other specialized coverages. CNA also assumes commercial risks from other insurers. The major components of CNA's commercial business are workers' compensation, general liability and professional and specialty coverages, which accounted for 26%, 18% and 15%, respectively, of 1994 premiums earned including premiums for involuntary risks on these lines of business. Premiums for involuntary risks result from mandatory participation in residual markets. CNA is required by the various states in which it does business to provide coverage for risks that would not otherwise be considered under CNA's underwriting standards. CNA's share of involuntary risks is generally a function of its share of the voluntary market by line of insurance in each state.
CNA also markets personal lines of insurance, primarily automobile and homeowners coverages sold to individuals under monoline and package policies.
Property/Casualty Business--(continued)
The following table sets forth supplemental data for the property/casualty business:
(*)In 1991, CNA changed its statutory method of accounting for property/casualty written premium on indeterminate premium products (policies subject to exposure audits). This new method defers the recognition of written premium and acquisition expenses generally until billed. The effect of this change in 1991 was a one-time reduction in written premium and related acquisition expenses of $864 million and $78 million, respectively. In order to provide comparability, the Other Data and Trade Ratios for 1991 shown above do not reflect the one-time impact of this statutory accounting change.
(a) Property/casualty involuntary risks include mandatory participation in residual markets, statutory assessments for insolvencies of other insurers and other involuntary charges.
(b) Trade ratios reflect the results of Continental Casualty Company and its property/casualty insurance subsidiaries. Trade ratios are industry measures of property/casualty underwriting results. The loss ratio is the percentage of incurred claim and claim adjustment expenses to premiums earned. Under generally accepted accounting principles, the expense ratio is the percentage of underwriting expenses, including the change in deferred acquisition costs, to premiums earned. Under statutory accounting principles, the expense ratio is the percentage of underwriting expenses (with no deferral of acquisition costs) to premiums written. The combined ratio is the sum of the loss and expense ratios. The policyholder dividend ratio is the ratio of dividends incurred to premiums earned.
Property/Casualty Business--(continued)
(c) Other Data is determined on the basis of statutory accounting principles and reflects capital contributions from CNA of $475 million in 1993 and $120 million in 1990. In addition, dividends of $175 million, $150 million, $100 million and $130 million were paid to CNA by Continental Casualty Company in 1994, 1993, 1992 and 1991, respectively. Property/casualty insurance subsidiaries have received, or will receive, reimbursement from CNA for general management and administrative expenses, unallocated loss adjustment expenses and investment expenses in the amounts of $169.6, $167.5, $141.1, $133.8, and $128.1 million in 1994, 1993, 1992, 1991 and 1990, respectively.
The following table displays the distribution of domestic written premium by state:
The growth and profitability of CNA's property/casualty insurance business is dependent on many factors, including competitive and regulatory influences, the efficiency and costs of operations, underwriting quality, the level of natural disasters, and investment results.
In recent years, CNA's growth and earnings have been impacted by a prolonged cycle of inadequate commercial lines pricing. CNA has intensified efforts in the political sphere to achieve a more predictable and equitable insurance marketing climate. Among CNA's marketing strategies are to emphasize responsible pricing over premium growth and to aggressively adapt to changes in certain markets such as those in which self-insurance has become important. CNA has also initiated wide-scale cost management measures. CNA has continued actions to reduce or stabilize the costs of doing business, including costs of health care, fraud and tort liability. Programs include managed health care programs and intensified efforts of fighting fraud.
The workers' compensation line has improved steadily since 1992. Legislative reforms have cut costs in some states, residual market losses have dropped, and the insurance regulators have sharpened their focus on workers' compensation fraud.
Property/Casualty Claim and Claim Expenses
Property/casualty claim and claim expense reserves, except reserves for structured settlements, workers' compensation lifetime claims and accident and health disability claims are based on (a) case basis estimates for losses reported on direct business, adjusted in the aggregate for ultimate loss expectations, (b) estimates of unreported losses based upon past experience, (c) estimates of assumed insurance, (d) estimates of future expenses to be incurred in settlement of claims and (e) estimates of claim recoveries. In establishing these estimates, consideration is given to current conditions and trends as well as past Company and industry experience. The schedule on page 9 provides information on mix of business.
Structured settlements have been negotiated for claims on certain property/casualty insurance policies. Structured settlements are agreements to provide periodic payments to claimants, which are fixed and determinable as to the amount and time of payment. Certain structured settlements are funded by annuities purchased from Continental Assurance Company. Related annuity obligations are carried in future policy benefits reserves. Obligations for structured settlements not funded by annuities are carried at discounted values which approximate the alternative cost of annuity purchases. Such reserves, discounted at interest rates ranging from 6.25% to 7.5%, totaled $839.0 million and $748.9 million at December 31, 1994 and 1993, respectively. Ultimate payouts under all structured settlements,
Property/Casualty Claim and Claim Expenses--(continued)
funded or unfunded, at December 31, 1994 and, 1993 will approximate $2.4 billion and $2.2 billion, respectively.
In 1992, CNA changed its accounting for claim reserves related to workers' compensation lifetime claims and accident and health disability claims. Reserving practices under both statutory and generally accepted accounting principles allow discounting of reserves for fixed and determinable claim obligations. Reserve discounting for these types of claims is common industry practice. These claim reserves are discounted at interest rates ranging from 3.5% to 6.0% with mortality and morbidity assumptions reflecting current industry experience. At December 31, 1994 and 1993, such discounted reserves totaled $1,115 million and $970 million, respectively. Ultimate payouts for these claims are estimated to be $1.5 billion and $1.4 billion at December 31, 1994 and 1993, respectively.
Claim and claim expense reserves are based on estimates, and the ultimate liability may vary significantly from such estimates. CNA regularly reviews its reserves, and any adjustments that are made to the reserves are reflected in operating income in the period such adjustments become apparent.
The retention limits of CNA as a result of reinsurance of its property/casualty business vary by type of coverage and are based on individual risks underwritten. In general, retention limits have been increased. See additional discussion of reinsurance in Notes G and K to the Consolidated Financial Statements.
Asbestos-related and Environmental Pollution Claims ---------------------------------------------------
Reserves include estimated amounts for exposures to asbestos-related and environmental pollution claims. Reserving for such claims involves significant uncertainties for both CNA and the industry, characterized by complex and costly litigation and further compounded by the tendency of the courts to broadly interpret contracts beyond their original intent.
A summary of asbestos-related and environmental pollution claim and claim expense activity follows:
A major portion of CNA's asbestos-related claim exposure involves litigation with Fibreboard Corporation, as discussed in Note J to the Consolidated Financial Statements. Adverse reserve development for asbestos-related claims totaled $37 million, $601 million, and $1.689 billion in 1994, 1993 and 1992, respectively, which include approximately $500 million and $1.5 billion related to Fibreboard for 1993 and 1992, respectively.
Potential exposures also exist for claims involving environmental pollution including toxic waste clean-up. Environmental pollution clean-up is the subject of both Federal and state regulation. By some estimates there are thousands of potential waste sites subject to clean-up. The insurance industry is involved in extensive litigation regarding coverage issues. Judicial interpretations in many cases have expanded the scope of coverage and liability beyond the original intent of the policies. CNA has not attributed any reinsurance to reserves for unreported environmental pollution claims. The reserves in the table above are net of reinsurance recoverables of $3 million and $5 million at December 31, 1994 and 1993, respectively. Estimating loss reserves is a difficult process as there are many factors that can ultimately affect the final settlement of a claim and, therefore, the reserve that is needed. Changes in the law, results of litigation, medical costs, the cost of repair materials and labor rates can all impact ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be.
Property/Casualty Claim and Claim Expenses--(continued)
Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail claims, such as general liability and professional liability claims.
Reserve Development -------------------
The table below provides a reconciliation between beginning and ending claim and claim expense reserve balances for 1994, 1993 and 1992. Not included in the table below is premium development related to certain insurance policies subject to retroactive premium adjustments which are based on various factors including loss experience. As a result, CNA also recorded premium and dividend related development to prior years (increasing (decreasing) premium) of $(29), $(127) and $50 million in 1994, 1993 and 1992, respectively.
Property/Casualty Claim and Claim Expenses--(continued)
The loss reserve development table below illustrates the change over time of reserves established for property/casualty claims and claims expense at the end of various calendar years. The first section shows the reserves as originally reported at the end of the stated year. The second section, reading down, shows the cumulative amounts paid as of the end of successive years with respect to that reserve liability. The third section, reading down, shows retroactive reestimates of the original recorded reserve as of the end of each successive year which is the result of CNA's expanded awareness of additional facts and circumstances that pertain to the unsettled claims. The last section compares the latest reestimated reserve to the reserve originally established, and indicates whether of not the original reserve was adequate or inadequate to cover the estimated costs of unsettled claims.
The loss reserve development table is cumulative and, therefore, ending balances should not be added since the amount at the end of each calendar year includes activity for both the current and prior years.
Most of CNA's unfavorable reserve development has been due to asbestos-related and environmental pollution claims. A discussion of CNA's litigation with Fibreboard Corporation regarding asbestos-related bodily injury claims can be found in Note J to the Consolidated Financial Statements in the Annual Report to Shareholders.
Investments
CNA's general account investment portfolio is managed to maximize after-tax investment return, while minimizing credit risks with investments concentrated in high quality securities to support its insurance underwriting operations. At December 31, 1994, approximately 14% of CNA's general account portfolio is invested in long-term state and municipal bonds in order to maximize after-tax yield and provide for a more stable yield on the portfolio with a higher quality of investment than may otherwise be available.
CNA has the capacity to hold its fixed income portfolio to maturity. However, securities may be sold as part of CNA's asset/liability strategies or to take advantage of investment opportunities generated by changing interest rates, prepayments, tax and credit considerations, or other similar factors. Accordingly, the fixed income securities are classified as available-for-sale. CNA's portfolio is managed based on the following investment strategies: i) diversification is used to limit exposures to any one issue or issuer, and ii) in general, the public market is used in order to provide liquidity.
Historically, CNA has maintained short-term assets at a level that provided for liquidity to meet its short-term obligations, principally anticipated claim payments. At December 31, 1994, short-term investments primarily consisted of U.S. treasury bills and high-grade commercial paper. The major components of the short-term investment portfolio were $2.5 billion of collateral for securities sold under agreements to repurchase, $1.0 billion in an escrow account (see Note A to the Consolidated Financial Statements) and approximately $1.5 billion of other short-term investments.
The following summarizes CNA's distrbution of general account investments:
CNA's general account fixed income portfolio has consistently been of high quality as illustrated in the following table using the Standard & Poor's ratings convention (see Note on page 15).
CNA's Separate Account investment portfolio is managed to specifically support the underlying insurance products (see the discussion of annuities and GIC's in "Life Insurance" above). Approximately 88% or $5.2 billion of Separate Account investments are used to fund GIC's; the remaining investments are used to fund variable products.
Investments--(continued)
Approximately 88% of the GIC investment portfolio is comprised of taxable fixed income securities. The quality of the GIC fixed income portfolio is as follows (see Note below):
Note: The bond ratings shown in the two tables above are primarily from Standard & Poor's (95% of the general account portfolio and 94% of the GIC portfolio in 1994). In the case of private placements and other unrated securities, comparable internal ratings are developed by CNA. These ratings are derived by management using available information on the issuer to assess the credit risk. Reference also may be made to similar instruments of the issuer that are rated by Standard & Poor's. In the case of unrated municipal bonds, an AAA rating may be assigned to issues with financial guarantee insurance.
CNA actively manages its high yield bonds and maintains the level of such investments at prudent levels. In 1994, the level of high yield investments within the GIC portfolio increased $34 million to $1.102 billion at year end. This increase is a result of the relative attractiveness of the high yield investment market in comparison to other investment opportunities during the year. Although the level of high yield investments has increased, the components of the high yield portfolio have shifted toward lower risk issues, with B and BB rated bonds comprising 95% of the high yield portfolio at December 31, 1994, compared to 91% at the end of 1993 and 82% at the end of 1992. High yield securities generally involve a greater degree of risk than that of investment grade securities. Expected returns should, however, compensate for the added risk. The risk is also considered in the interest rate assumptions in the underlying insurance products. Further, CNA's investment in real estate and mortgage loans amounted to less than one-half of one percent of its total assets, substantially below industry averages.
At December 31, 1994 and 1993, high yield securities within the general and GIC portfolios were carried at fair value and amounted to $2.1 billion and $1.8 billion, respectively. Amortized cost exceeded market value for high yield securities by approximately $138 million at December 31, 1994 compared to December 31, 1993 when market value exceeded amortized cost by $72 million.
Included in CNA's 1994 AAA-rated fixed income securities (general and GIC portfolios) are $4.6 billion of asset-backed securities, consisting of approximately 50% in collateralized mortgage obligations ("CMO's"), 34% in U.S. government agency issued pass-through certificates, and 16% in corporate asset-backed obligations. The majority of CMO's held are U.S. government agency issues which are actively traded in liquid markets and are priced monthly by broker-dealers. CNA limits the risks associated with interest rate fluctuations and prepayment by concentrating its CMO investments in planned amortization classes with relatively short principal repayment windows. CNA generally does not invest in complex mortgage derivatives without readily ascertainable market prices.
ITEM 2.
ITEM 2. PROPERTIES
A. Home Office
CNA Plaza, owned by Continental Assurance Company, is a 1,421,000 square foot office complex located at 333 S. Wabash, Chicago, Illinois. The forty-five story office building serves as the home office for CNA and its insurance subsidiaries. An adjacent building (a 614,000 square foot building located at 55 E. Jackson Blvd.), jointly owned by Continental Casualty Company and Continental Assurance Company, is partially situated on grounds under leases expiring in 2058. Approximately 35% of the adjacent building is rented to non-affiliates.
B. Field Offices
CNA also maintains four regional offices and forty branch offices and processing centers in major cities throughout the United States. This office space is leased except for offices located in three CNA owned buildings.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Incorporated herein by reference from Note J to the Consolidated Financial Statements in the 1994 Annual Report to Shareholders.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Incorporated herein by reference from page 73 of the 1994 Annual Report to Shareholders.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Incorporated herein by reference from page 2 of the 1994 Annual Report to Shareholders.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Incorporated herein by reference from pages 12 through 27 of the 1994 Annual Report to Shareholders.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Consolidated Balance Sheet - December 31, 1994 and 1993
Statement of Consolidated Operations - Years Ended December 3l, 1994, 1993 and 1992
Statement of Consolidated Stockholders' Equity - Years Ended December 31, 1994, 1993 and 1992
Statement of Consolidated Cash Flows - Years Ended December 31, 1994, 1993 and 1992
Notes to Consolidated Financial Statements
Independent Auditors' Report
The above Consolidated Financial Statements, the related Notes to the Consolidated Financial Statements and the Independent Auditors' Report are incorporated herein by reference from pages 28 through 72 of the 1994 Annual Report to Shareholders.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required in Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information required in Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required in Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required in Part III has been omitted as the Registrant intends to file a definitive proxy statement pursuant to Regulation 14A with the Securities and Exchange Commission not later than 120 days after the close of its fiscal year.
PART IV
ITEM 14.
ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS AND REPORTS ON FORM 8-K
Page (a) 1. FINANCIAL STATEMENTS: Number ------ A separate index to the Consolidated Financial Statements is presented in Part II, Item 8........................... 16
(a) 2. FINANCIAL STATEMENT SCHEDULES:
Schedule I Summary of Investments..................... 21
Schedule II Condensed Financial Information (Parent Company)................................... 22
Schedule III Supplementary Insurance Information........ 25
Schedule IV Reinsurance ............................... 26
Schedule V Valuation and Qualifying Accounts and Reserves................................... 26
Schedule VI Supplemental Information Concerning Property/Casualty Insurance Operations..... 27
Other schedules are omitted because of the absence of con- ditions under which they are required or because the required information is provided in the Consolidated Financial Statements or notes thereto.
Independent Auditors' Report ............................. 28
PART IV
ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS, AND REPORTS ON FORM 8-K (CONTINUED)
(a) 3. EXHIBITS:
Exhibit Description of Exhibit Number ---------------------- ------- (2) Plan of acquisition, reorganization, arrangement, liquidation or succession:
Securities Purchase Agreement, dated as of December 6, 1994, by and between CNA Financial Corporation and The Continental Corporation (with exhibits thereto) (Exhibit 1 to Form 8-K dated December 9, 1994 incorporated herein by reference.).. 2.1
Merger Agreement, dated as of December 6, 1994, by and among CNA Financial Corporation, Chicago Acquisition Corp. and The Continental Corporation (Exhibit 2 to Form 8-K dated December 9, 1994 incorporated herein by reference.)................... 2.2
(3) Articles of incorporation and by-laws:
Certificate of Incorporation of CNA Financial Corporation, as amended May 6, 1987 (Exhibit 3.1 to 1987 Form 10-K incorporated herein by reference.). 3.1
By-Laws of CNA Financial Corporation, as amended May 4, 1994.......................................... 3.2*
(4) Instruments defining the rights of security holders, including indentures:
CNA Financial Corporation hereby agrees to furnish to the Commission upon request copies of instruments with respect to long-term debt, pursuant to Item 601(b) (4) (iii) of Regulation S-K.............. -
PART IV
ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS, AND REPORTS ON FORM 8-K (CONTINUED)
(a) 3. EXHIBITS:
Exhibit Description of Exhibit Number ---------------------- -------
(10) Material contracts:
Continental Casualty Company "CNA" Annual Incentive Bonus Plan Provisions................................ 10.1*
Employment Agreement between CNA Financial Corporation and Dennis H. Chookaszian, dated February 22, 1993 (Exhibit 10.1 to 1992 Form 10-K incorporated herein by reference.)................... 10.2
Employment Agreement between CNA Financial Corporation and Philip L. Engel, dated February 22, 1993 (Exhibit 10.2 to 1992 Form 10-K incorporated herein by reference.)............................... 10.3
Continuing Services Agreement between CNA Financial Corporation and Edward J. Noha, dated February 27, 1991 (Exhibit 6.0 to 1991 Form 8-K, filed March 18, 1991, incorporated herein by reference.)............. 10.4
CNA Employees' Retirement Benefit Equalization Plan, as amended through January 1, 1993 (Exhibit 10.4 to 1992 Form 10-K incorporated herein by reference.).... 10.5
CNA Employees' Supplemental Savings Plan, as amended through January 1, 1993 (Exhibit 10.6 to 1992 Form 10-K incorporated herein by reference.)......... 10.6
PART IV
ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS, AND REPORTS ON FORM 8-K (CONTINUED)
(a) 3. EXHIBITS:
Exhibit Description of Exhibit Number ---------------------- ------- (10) Material contracts (continued):
Federal Income Tax Allocation Agreement dated February 29, 1980 between CNA Financial Corporation and Loews Corporation (Exhibit 10.2 to 1987 Form 10-K incorporated herein by reference.)......... 10.7
Agreement between Fibreboard Corporation and Continental Casualty Company, dated April 9, 1993 (Exhibit A to 1993 Form 8-K filed April 12, 1993 incorporated herein by reference.)................... 10.8
Settlement Agreement entered into on October 12, 1993 by and among Fibreboard Corporation, Continental Casualty Company, CNA Casualty of California, Columbia Casualty Company and Pacific Indemnity Company together the "Parties" (Exhibit 10.1 to September 30, 1993 Form 10-Q incorporated herein by reference.).......................................... 10.9
Continental-Pacific Agreement entered into October 12, 1993 between Continental Casualty Company and Pacific Indemnity Company (Exhibit 10.2 to September 30, 1993 Form 10-Q incorporated herein by reference.)....................................... 10.10
Global Settlement Agreement among Fibreboard Corporation, Continental Casualty Company, CNA Casualty Company of California, Columbia Casualty Company, Pacific Indemnity Company and the Settlement Class dated December 23, 1993 (Exhibit 10.11 to 1993 Form 10-K incorporated herein by refernce................................... 10.11
Glossary of Terms in Global Settlement Agreement, Trust Agreement, Trust Distribution Process and Defendant Class Settlement Agreement as of December 23, 1993 (Exhibit 10.12 to 1993 Form 10-K incorporated herein by reference..................... 10.12
Fibreboard Asbestos Corporation Trust Agreement dated December 23, 1993 (Exhibit 10.13 to 1993 Form-K incorporated herein by reference.)................... 10.13
Trust Distribution Process - Annex A to the Trust Agreement as of December 23, 1993 (Exhibit 10.14 to 1993 Form 10-K incorporated herein by reference.).... 10.14
PART IV
ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS, AND REPORTS ON FORM 8-K (CONTINUED)
(a) 3. EXHIBITS:
Exhibit Description of Exhibit Number ---------------------- -------
Defendant Class Settlement Agreement dated December 22, 1993 (Exhibit 10.15 to 1993 Form-K incorporated herin by reference.).................... 10.15
Escrow Agreement among Continental Casualty Company, Pacific Indemnity Company and The First National Bank of Chicago dated December 23, 1993 (Exhibit 10.16 to 1993 Form 10-K incorporated herein by reference.).. 10.16
PART IV
ITEM 14. FINANCIAL STATEMENTS, SCHEDULES, EXHIBITS, AND REPORTS ON FORM 8-K (CONTINUED)
(a) 3. EXHIBITS:
Exhibit Description of Exhibit Number ---------------------- -------
(11) Computation of Net Income per Common Share........... 11.1*
(12) Statements regarding computation of ratios:
Computation of Ratio of Earnings to Fixed Charges.... 12.1*
Computation of Ratio of Net Income, As Adjusted, to Fixed Charges..................................... 12.2*
(13) 1994 Annual Report................................... 13.1*
(21) Subsidiaries of CNA.................................. 21.1*
(23) Consent of Deloitte & Touche LLP..................... 23.1*
(27) Financial Data Schedule.............................. 27*
(28) Information from reports furnished to state insurance regulatory authorities:
Property/Casualty Reserve Reconciliation-Statutory Basis to Generally Accepted Accounting Principles.... 28.1*
Schedule P from Continental Casualty Company's 1994 Consolidated Annual Statutory Statement provided to state insurance regulatory authorities............... 28.2*
*Filed herewith
(b) REPORTS ON FORM 8-K:
In a report on Form 8-K dated December 6, 1994, CNA issued a press release which stated that CNA and The Continental Corporation (Continental) signed an agreement under which CNA will acquire Continental through a cash merger for $1.1 billion.
In a report on Form 8-K dated December 9, 1994, CNA through its Continental Casualty subsidiary, consummated its purchase of certain securities of the Continental Corporation ("Continental"), as contemplated by the Securities Purchase Agreement dated as of December 6, 1994, by and between the CNA and Continental, for cash consideration of $275 million.
SCHEDULE I
CNA FINANCIAL CORPORATION SUMMARY OF INVESTMENTS
SCHEDULE II
CNA FINANCIAL CORPORATION (PARENT COMPANY) CONDENSED FINANCIAL INFORMATION
SCHEDULE II (CONTINUED)
CNA FINANCIAL CORPORATION (PARENT COMPANY) CONDENSED FINANCIAL INFORMATION
SCHEDULE II (CONTINUED)
CNA FINANCIAL CORPORATION (PARENT COMPANY) CONDENSED FINANCIAL INFORMATION
NOTES TO CONDENSED FINANCIAL INFORMATION
In October 1993, a shelf registration statement was filed with the Securities and Exchange Commission which made $900 million of debt securities available for issuance from time to time. In addition, $100 million from a previous shelf registration remained available for issuance.
In November 1993, CNA sold $250 million principal amount of 6.25% senior notes due 2003 and $250 million principal amount of 7.25% debentures due 2023 at effective rates per annum of 6.4% and 7.3%, respectively. An additional $500 million of securities and/or preferred stock is available for issuance under the shelf registration statement.
b. CNA has reimbursed, or will reimburse, its subsidiaries for general management and administrative expenses, unallocated loss adjustment expenses and investment expense in the amounts of $194.3 million, $193.1 million and $165.6 million in 1994, 1993, and 1992, respectively.
c. CNA contributed $475 millionin capital to Continental Casualty Company in 1993. There were no capital contributions by CNA in 1994 or 1992.
CNA FINANCIAL CORPORATION SCHEDULE III SUPPLEMENTARY INSURANCE INFORMATION
SCHEDULE IV
CNA FINANCIAL CORPORATION REINSURANCE
The effects of reinsurance on premium revenues are shown in the following schedule:
The impact of reinsurance on life insurance in-force is shown in the following schedule:
SCHEDULE V
CNA FINANCIAL CORPORATION VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
SCHEDULE VI
CNA FINANCIAL CORPORATION SUPPLEMENTAL INFORMATION CONCERNING PROPERTY/CASUALTY INSURANCE OPERATIONS
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders CNA Financial Corporation
We have audited the consolidated financial statements of CNA Financial Corporation (an affiliate of Loews Corporation) and subsidiaries as of December 31, 1994 and 1993 and for each of the three years in the period ended December 31, 1994, and have issued our report thereon dated February 15, 1995, which report includes an explanatory paragraph as to certain accounting changes; such consolidated financial statements and report are included in the Company's 1994 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the financial statement schedules of CNA Financial Corporation and subsidiaries listed in Item 14. These financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects, the information set forth therein.
Deloitte & Touche LLP Chicago, Illinois February 15, 1995
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
CNA Financial Corporation
By Laurence A. Tisch ----------------------------- Laurence A. Tisch Chief Executive Officer (Principal Executive Officer)
By Peter E. Jokiel ----------------------------- Peter E. Jokiel Senior Vice President and Chief Financial Officer
Date: March 23, 1995
SIGNATURES --(CONTINUED)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
SIGNATURE TITLE
Antoinette Cook Bush Director ------------------------------ Antoinette Cook Bush
Dennis H. Chookaszian Director ------------------------------ Dennis H. Chookaszian
Philip L. Engel Director ------------------------------ Philip L. Engel
Robert P. Gwinn Director ------------------------------ Robert P. Gwinn
Edward J. Noha Chairman of the Board ------------------------------ and Director Edward J. Noha Dated: Richard L. Thomas Director March 23, 1995 ------------------------------ Richard L. Thomas
James S. Tisch ------------------------------ Director James S. Tisch
Laurence A. Tisch Chief Executive Officer ------------------------------ and Director Laurence A. Tisch
Preston R. Tisch Director ------------------------------ Preston R. Tisch
Marvin Zonis Director ------------------------------ Marvin Zonis