UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2009
OR
¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Transition Period From to
Commission File Number 1-6541
LOEWS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware | 13-2646102 | |
(State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
667 Madison Avenue, New York, N.Y. 10065-8087
(Address of principal executive offices) (Zip Code)
(212) 521-2000
(Registrants telephone number, including area code)
NOT APPLICABLE
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨ Not Applicable ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer |
x |
Accelerated filer |
¨ | |||
Non-accelerated filer |
¨ |
Smaller reporting company |
¨ |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Class |
Outstanding at October 28, 2009 | |
Common stock, $0.01 par value | 429,631,666 shares |
2
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED BALANCE SHEETS
(Unaudited)
September 30, 2009 |
December 31, 2008 |
|||||||
(Dollar amounts in millions, except per share data) | ||||||||
Assets: |
||||||||
Investments: |
||||||||
Fixed maturities, amortized cost of $35,656 and $34,767 |
$ | 35,475 | $ | 29,451 | ||||
Equity securities, cost of $927 and $1,402 |
1,320 | 1,185 | ||||||
Limited partnership investments |
2,097 | 1,781 | ||||||
Short term investments |
6,369 | 6,033 | ||||||
Total investments |
45,261 | 38,450 | ||||||
Cash |
156 | 131 | ||||||
Receivables |
11,522 | 11,672 | ||||||
Property, plant and equipment |
13,200 | 12,892 | ||||||
Deferred income taxes |
993 | 2,928 | ||||||
Goodwill |
856 | 856 | ||||||
Other assets |
1,534 | 1,432 | ||||||
Deferred acquisition costs of insurance subsidiaries |
1,138 | 1,125 | ||||||
Separate account business |
452 | 384 | ||||||
Total assets |
$ | 75,112 | $ | 69,870 | ||||
Liabilities and Equity: |
||||||||
Insurance reserves: |
||||||||
Claim and claim adjustment expense |
$ | 26,906 | $ | 27,593 | ||||
Future policy benefits |
7,864 | 7,529 | ||||||
Unearned premiums |
3,392 | 3,405 | ||||||
Policyholders funds |
200 | 243 | ||||||
Total insurance reserves |
38,362 | 38,770 | ||||||
Payable to brokers |
2,112 | 679 | ||||||
Short term debt |
9 | 71 | ||||||
Long term debt |
8,695 | 8,187 | ||||||
Reinsurance balances payable |
339 | 316 | ||||||
Other liabilities |
3,957 | 4,328 | ||||||
Separate account business |
452 | 384 | ||||||
Total liabilities |
53,926 | 52,735 | ||||||
Preferred stock, $0.10 par value: |
||||||||
Authorized 100,000,000 shares |
||||||||
Common stock, $0.01 par value: |
||||||||
Authorized 1,800,000,000 shares |
||||||||
Issued 435,326,260 and 435,091,667 shares |
4 | 4 | ||||||
Additional paid-in capital |
3,931 | 3,340 | ||||||
Retained earnings |
13,563 | 13,375 | ||||||
Accumulated other comprehensive loss |
(329 | ) | (3,586 | ) | ||||
17,169 | 13,133 | |||||||
Less treasury stock, at cost (4,712,100 shares) |
(143 | ) | ||||||
Total shareholders equity |
17,026 | 13,133 | ||||||
Noncontrolling interests |
4,160 | 4,002 | ||||||
Total equity |
21,186 | 17,135 | ||||||
Total liabilities and equity |
$ | 75,112 | $ | 69,870 |
See accompanying Notes to Consolidated Condensed Financial Statements.
3
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
(In millions, except per share data) | ||||||||||||||||
Revenues: |
||||||||||||||||
Insurance premiums |
$ | 1,707 | $ | 1,799 | $ | 5,035 | $ | 5,385 | ||||||||
Net investment income |
726 | 355 | 1,908 | 1,531 | ||||||||||||
Investment gains (losses): |
||||||||||||||||
Other-than-temporary impairment losses |
(232 | ) | (584 | ) | (1,330 | ) | (840 | ) | ||||||||
Portion of other-than-temporary impairment losses recognized in Other comprehensive income |
84 | 173 | ||||||||||||||
Net impairment losses recognized in earnings |
(148 | ) | (584 | ) | (1,157 | ) | (840 | ) | ||||||||
Transactional realized investment gains (losses) |
48 | (66 | ) | 229 | 28 | |||||||||||
Total investment losses |
(100 | ) | (650 | ) | (928 | ) | (812 | ) | ||||||||
Gain on issuance of subsidiary stock |
2 | |||||||||||||||
Contract drilling revenues |
885 | 882 | 2,664 | 2,589 | ||||||||||||
Other |
520 | 584 | 1,616 | 1,809 | ||||||||||||
Total |
3,738 | 2,970 | 10,295 | 10,504 | ||||||||||||
Expenses: |
||||||||||||||||
Insurance claims and policyholders benefits |
1,282 | 1,519 | 3,919 | 4,380 | ||||||||||||
Amortization of deferred acquisition costs |
365 | 355 | 1,063 | 1,083 | ||||||||||||
Contract drilling expenses |
307 | 314 | 907 | 872 | ||||||||||||
Impairment of natural gas and oil properties |
1,036 | |||||||||||||||
Other operating expenses |
709 | 741 | 2,202 | 1,982 | ||||||||||||
Interest |
117 | 82 | 321 | 259 | ||||||||||||
Total |
2,780 | 3,011 | 9,448 | 8,576 | ||||||||||||
Income (loss) before income tax |
958 | (41 | ) | 847 | 1,928 | |||||||||||
Income tax (expense) benefit |
(266 | ) | 56 | (68 | ) | (537 | ) | |||||||||
Income from continuing operations |
692 | 15 | 779 | 1,391 | ||||||||||||
Discontinued operations, net: |
||||||||||||||||
Results of operations |
(1 | ) | 7 | (2 | ) | 350 | ||||||||||
Gain on disposal |
4,362 | |||||||||||||||
Net income |
691 | 22 | 777 | 6,103 | ||||||||||||
Amounts attributable to noncontrolling interests |
(223 | ) | (159 | ) | (616 | ) | (615 | ) | ||||||||
Net income (loss) attributable to Loews Corporation |
$ | 468 | $ | (137 | ) | $ | 161 | $ | 5,488 | |||||||
Net income (loss) attributable to: |
||||||||||||||||
Loews common stock: |
||||||||||||||||
Income (loss) from continuing operations |
$ | 469 | $ | (144 | ) | $ | 163 | $ | 776 | |||||||
Discontinued operations, net |
(1 | ) | 7 | (2 | ) | 4,501 | ||||||||||
Loews common stock |
468 | (137 | ) | 161 | 5,277 | |||||||||||
Former Carolina Group stock - discontinued operations, net |
211 | |||||||||||||||
Total |
$ | 468 | $ | (137 | ) | $ | 161 | $ | 5,488 |
4
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended September 30, |
Nine Months Ended September 30, | ||||||||||||
2009 | 2008 | 2009 | 2008 | ||||||||||
(In millions, except per share data) | |||||||||||||
Basic net income (loss) per Loews common share: |
|||||||||||||
Income (loss) from continuing operations |
$ | 1.08 | $ | (0.33 | ) | $ | 0.37 | $ | 1.58 | ||||
Discontinued operations, net |
0.02 | 9.16 | |||||||||||
Net income (loss) |
$ | 1.08 | $ | (0.31 | ) | $ | 0.37 | $ | 10.74 | ||||
Diluted net income (loss) per Loews common share: |
|||||||||||||
Income (loss) from continuing operations |
$ | 1.08 | $ | (0.33 | ) | $ | 0.37 | $ | 1.58 | ||||
Discontinued operations, net |
0.02 | 9.14 | |||||||||||
Net income (loss) |
$ | 1.08 | $ | (0.31 | ) | $ | 0.37 | $ | 10.72 | ||||
Basic and Diluted net income per former Carolina Group share: |
|||||||||||||
Discontinued operations, net |
$ | - | $ | 1.95 | |||||||||
Basic weighted average number of shares outstanding: |
|||||||||||||
Loews common stock |
432.75 | 436.32 | 434.30 | 491.19 | |||||||||
Former Carolina Group stock |
- | 108.47 | |||||||||||
Diluted weighted average number of shares outstanding: |
|||||||||||||
Loews common stock |
433.48 | 436.32 | 434.89 | 492.40 | |||||||||
Former Carolina Group stock |
- | 108.60 |
See accompanying Notes to Consolidated Condensed Financial Statements.
5
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
(In millions) | ||||||||||||||||
Net income |
$ | 691 | $ | 22 | $ | 777 | $ | 6,103 | ||||||||
Other comprehensive income (loss) |
||||||||||||||||
Changes in: |
||||||||||||||||
Net unrealized losses on investments with other-than-temporary impairments |
(36 | ) | (70 | ) | ||||||||||||
Net other unrealized gains (losses) on investments |
1,893 | (1,205 | ) | 3,784 | (2,226 | ) | ||||||||||
Total unrealized gains (losses) on available-for-sale investments |
1,857 | (1,205 | ) | 3,714 | (2,226 | ) | ||||||||||
Unrealized gains (losses) on cash flow hedges |
(55 | ) | 256 | (52 | ) | 53 | ||||||||||
Foreign currency |
39 | (44 | ) | 109 | (61 | ) | ||||||||||
Pension liability |
3 | (4 | ) | 3 | 21 | |||||||||||
Other comprehensive income (loss) |
1,844 | (997 | ) | 3,774 | (2,213 | ) | ||||||||||
Comprehensive income (loss) |
2,535 | (975 | ) | 4,551 | 3,890 | |||||||||||
Amounts attributable to noncontrolling interests |
(424 | ) | (35 | ) | (1,024 | ) | (364 | ) | ||||||||
Total comprehensive income (loss) attributable to Loews Corporation |
$ | 2,111 | $ | (1,010 | ) | $ | 3,527 | $ | 3,526 |
See accompanying Notes to Consolidated Condensed Financial Statements.
6
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF EQUITY
(Unaudited)
Total | Loews Corporation Shareholders | Noncontrolling Interests |
||||||||||||||||||||||||
Loews Common Stock |
Additional Paid-in Capital |
Retained Earnings |
Accumulated Other Comprehensive Income (Loss) |
Common Stock Held in Treasury |
||||||||||||||||||||||
(In millions) | ||||||||||||||||||||||||||
Balance, January 1, 2009, as reported |
$ | 17,122 | $ | 4 | $ | 3,283 | $ | 13,425 | $ | (3,586 | ) | $ | - | $ | 3,996 | |||||||||||
Adjustment to initially apply updated guidance that clarifies the accounting for convertible debt instruments that may be settled in cash upon conversion |
13 | 57 | (50 | ) | 6 | |||||||||||||||||||||
Balance, January 1, 2009, as restated |
17,135 | 4 | 3,340 | 13,375 | (3,586 | ) | - | 4,002 | ||||||||||||||||||
Adjustment to initially apply updated accounting guidance on reporting noncontrolling interests in Consolidated Financial Statements |
536 | (536 | ) | |||||||||||||||||||||||
Balance, January 1, 2009, as adjusted |
17,135 | 4 | 3,876 | 13,375 | (3,586 | ) | - | 3,466 | ||||||||||||||||||
Adjustment to initially apply updated accounting guidance which amended the other-than-temporary impairment loss model for fixed maturity securities |
109 | (109 | ) | |||||||||||||||||||||||
Purchase of subsidiary shares from noncontrolling interests |
(2) | 15 | (17 | ) | ||||||||||||||||||||||
Issuance of equity securities by subsidiary |
180 | 29 | 151 | |||||||||||||||||||||||
Net income |
777 | 161 | 616 | |||||||||||||||||||||||
Other comprehensive income |
3,774 | 3,366 | 408 | |||||||||||||||||||||||
Dividends paid |
(563) | (81 | ) | (482 | ) | |||||||||||||||||||||
Issuance of Loews common stock |
5 | 5 | ||||||||||||||||||||||||
Purchase of Loews treasury stock |
(143) | (143 | ) | |||||||||||||||||||||||
Stock-based compensation |
15 | 12 | 3 | |||||||||||||||||||||||
Other |
8 | (6 | ) | (1 | ) | 15 | ||||||||||||||||||||
Balance, September 30, 2009 |
$ | 21,186 | $ | 4 | $ | 3,931 | $ | 13,563 | $ | (329 | ) | $ | (143 | ) | $ | 4,160 |
See accompanying Notes to Consolidated Condensed Financial Statements.
7
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF EQUITY
(Unaudited)
Total | Loews Corporation Shareholders | Noncontrolling Interests |
|||||||||||||||||||||||||||||
Loews Common Stock |
Former Carolina Group Stock |
Additional Paid-in Capital |
Retained Earnings |
Accumulated Other Comprehensive Income (Loss) |
Common Stock Held in Treasury |
||||||||||||||||||||||||||
(In millions) | |||||||||||||||||||||||||||||||
Balance, January 1, 2008, as reported |
$ | 21,489 | $ | 5 | $ | 1 | $ | 3,967 | $ | 13,691 | $ | (65 | ) | $ | (8 | ) | $ | 3,898 | |||||||||||||
Adjustment to initially apply updated guidance on accounting for convertible debt instruments that may be settled in cash upon conversion |
13 | 57 | (50 | ) | 6 | ||||||||||||||||||||||||||
Balance, January 1, 2008, as restated |
21,502 | 5 | 1 | 4,024 | 13,641 | (65 | ) | (8 | ) | 3,904 | |||||||||||||||||||||
Purchase of subsidiary shares from noncontrolling interests |
(95) | (95 | ) | ||||||||||||||||||||||||||||
Issuance of equity securities by subsidiary |
243 | 243 | |||||||||||||||||||||||||||||
Adjustments related to purchase of subsidiary Class B units |
105 | 105 | |||||||||||||||||||||||||||||
Net income |
6,103 | 5,488 | 615 | ||||||||||||||||||||||||||||
Other comprehensive loss |
(2,213) | (1,962 | ) | (251 | ) | ||||||||||||||||||||||||||
Dividends paid |
(547) | (193 | ) | (354 | ) | ||||||||||||||||||||||||||
Purchase of Loews treasury stock |
(12) | (12 | ) | ||||||||||||||||||||||||||||
Issuance of Loews common stock |
4 | 4 | |||||||||||||||||||||||||||||
Redemption of former Carolina Group stock |
(542) | (1 | ) | (602 | ) | 53 | 8 | ||||||||||||||||||||||||
Exchange of Lorillard common stock for Loews common stock |
(4,650) | (4,650 | ) | ||||||||||||||||||||||||||||
Stock-based compensation |
20 | 17 | 3 | ||||||||||||||||||||||||||||
Retirement of treasury stock |
(1 | ) | (700 | ) | (3,949 | ) | 4,650 | ||||||||||||||||||||||||
Other |
4 | 4 | |||||||||||||||||||||||||||||
Balance, September 30, 2008 |
$ | 19,922 | $ | 4 | $ | - | $ | 3,345 | $ | 14,385 | $ | (1,974 | ) | $ | (12 | ) | $ | 4,174 |
See accompanying Notes to Consolidated Condensed Financial Statements.
8
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30 | 2009 | 2008 | ||||||
(In millions) | ||||||||
Operating Activities: |
||||||||
Net income |
$ | 777 | $ | 6,103 | ||||
Adjustments to reconcile net income to net cash provided (used) by operating activities, net |
2,183 | (3,356 | ) | |||||
Changes in operating assets and liabilities, net: |
||||||||
Reinsurance receivables |
760 | 691 | ||||||
Other receivables |
(27 | ) | (131 | ) | ||||
Federal income tax |
(190 | ) | (360 | ) | ||||
Deferred acquisition costs |
(13 | ) | 4 | |||||
Insurance reserves |
(488 | ) | (238 | ) | ||||
Reinsurance balances payable |
23 | (34 | ) | |||||
Other liabilities |
(207 | ) | (172 | ) | ||||
Trading securities |
96 | (1,145 | ) | |||||
Other, net |
(134 | ) | (127 | ) | ||||
Net cash flow operating activities - continuing operations |
2,780 | 1,235 | ||||||
Net cash flow operating activities - discontinued operations |
(16 | ) | 142 | |||||
Net cash flow operating activities - total |
2,764 | 1,377 | ||||||
Investing Activities: |
||||||||
Purchases of fixed maturities |
(18,099 | ) | (39,989 | ) | ||||
Proceeds from sales of fixed maturities |
15,507 | 36,545 | ||||||
Proceeds from maturities of fixed maturities |
2,568 | 3,374 | ||||||
Purchases of equity securities |
(262 | ) | (170 | ) | ||||
Proceeds from sales of equity securities |
511 | 177 | ||||||
Purchases of property, plant and equipment |
(2,170 | ) | (2,937 | ) | ||||
Change in collateral on loaned securities and derivatives |
(4 | ) | (57 | ) | ||||
Change in short term investments |
(799 | ) | 1,567 | |||||
Other, net |
45 | (76 | ) | |||||
Net cash flow investing activities - continuing operations |
(2,703 | ) | (1,566 | ) | ||||
Net cash flow investing activities - discontinued operations, including proceeds from dispositions |
16 | 620 | ||||||
Net cash flow investing activities - total |
(2,687 | ) | (946 | ) |
9
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30 | 2009 | 2008 | ||||||
(In millions) | ||||||||
Financing Activities: |
||||||||
Dividends paid |
$ | (81 | ) | $ | (193 | ) | ||
Dividends paid to noncontrolling interests |
(482 | ) | (354 | ) | ||||
Purchases of treasury shares |
(143 | ) | (12 | ) | ||||
Purchases of subsidiary treasury shares |
(2 | ) | (70 | ) | ||||
Issuance of common stock |
5 | 4 | ||||||
Proceeds from subsidiaries equity issuances |
180 | 246 | ||||||
Principal payments on debt |
(568 | ) | (902 | ) | ||||
Issuance of debt |
1,014 | 1,320 | ||||||
Receipts of investment contract account balances |
3 | 3 | ||||||
Return of investment contract account balances |
(10 | ) | (421 | ) | ||||
Excess tax benefits from share-based payment arrangements |
4 | |||||||
Other |
24 | 26 | ||||||
Net cash flow financing activities - continuing operations |
(60 | ) | (349 | ) | ||||
Net cash flow financing activities - discontinued operations |
||||||||
Net cash flow financing activities - total |
(60 | ) | (349 | ) | ||||
Effect of foreign exchange rate on cash - continuing operations |
8 | (6 | ) | |||||
Net change in cash |
25 | 76 | ||||||
Net cash transactions from: |
||||||||
Continuing operations to discontinued operations |
782 | |||||||
Discontinued operations to continuing operations |
(782 | ) | ||||||
Cash, beginning of period |
131 | 160 | ||||||
Cash, end of period |
$ | 156 | $ | 236 | ||||
Cash, end of period: |
||||||||
Continuing operations |
$ | 156 | $ | 236 | ||||
Discontinued operations |
||||||||
Total |
$ | 156 | $ | 236 |
See accompanying Notes to Consolidated Condensed Financial Statements.
10
Loews Corporation and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
Loews Corporation is a holding company. Its subsidiaries are engaged in the following lines of business: commercial property and casualty insurance (CNA Financial Corporation (CNA), a 90% owned subsidiary); the operation of offshore oil and gas drilling rigs (Diamond Offshore Drilling, Inc. (Diamond Offshore), a 50.4% owned subsidiary); exploration, production and marketing of natural gas and natural gas liquids (HighMount Exploration & Production LLC (HighMount), a wholly owned subsidiary); the operation of interstate natural gas transmission pipeline systems including integrated storage facilities (Boardwalk Pipeline Partners, LP (Boardwalk Pipeline), a 72% owned subsidiary); and the operation of hotels (Loews Hotels Holding Corporation (Loews Hotels), a wholly owned subsidiary). Unless the context otherwise requires, the terms Company, Loews and Registrant as used herein mean Loews Corporation excluding its subsidiaries and the term Net income (loss) -Loews as used herein means Net income (loss) attributable to Loews Corporation.
In June of 2008, the Company disposed of its entire ownership interest in its wholly owned subsidiary, Lorillard, Inc. (Lorillard). Accordingly, amounts related to Lorillard have been reclassified and are reported as Discontinued Operations. See Note 14 and the Companys 2008 Annual Report on Form 10-K.
In the opinion of management, the accompanying unaudited Consolidated Condensed Financial Statements reflect all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position as of September 30, 2009 and December 31, 2008 and the results of operations and comprehensive income (loss) for the three and nine months ended September 30, 2009 and 2008 and changes in cash flows for the nine months ended September 30, 2009 and 2008. The Companys management evaluated subsequent events through November 2, 2009.
Net income (loss) for the third quarter and first nine months of each of the years is not necessarily indicative of net income (loss) for that entire year.
Reference is made to the Notes to Consolidated Financial Statements in the 2008 Annual Report on Form 10-K which should be read in conjunction with these Consolidated Condensed Financial Statements.
Supplementary cash flow information As discussed above, in June of 2008, the Company disposed of its entire ownership interest in Lorillard resulting in a non-cash gain on disposal of $4.3 billion. Investing activities includes previously net accrued capital expenditures of $206 million for the nine months ended September 30, 2009. For the nine months ended September 30, 2008, investing activities excludes $168 million of net accrued capital expenditures.
Accounting standards update In December of 2007, the Financial Accounting Standards Board (FASB) issued updated accounting guidance on reporting of Noncontrolling Interests in Consolidated Financial Statements. The updated accounting guidance requires all entities to report noncontrolling (minority) interests in subsidiaries as a component of equity in the Consolidated Financial Statements. Therefore, the Noncontrolling interest in the equity section includes the appropriate reclassification of balances for CNA, Diamond Offshore and Boardwalk Pipeline formerly recognized as Minority interest liability on the Consolidated Balance Sheets. Moreover, the updated accounting guidance requires that transactions between an entity and noncontrolling interests be treated as equity transactions. Prior to the adoption of the updated accounting guidance, the Company recorded a gain on the sale of common equity of a subsidiary equal to the amount of proceeds received in excess of the carrying value of the units sold. Upon adoption of the updated accounting guidance, the Companys deferred gains related to the issuances of Boardwalk Pipeline common units ($536 million at January 1, 2009) were recognized in Additional paid-in capital, which previously were included in minority interest liability in the Consolidated Condensed Balance Sheets.
In February of 2008, the FASB delayed the effective date of applying updated accounting guidance in regards to nonrecurring fair value measurements of nonfinancial assets and nonfinancial liabilities until the fiscal year beginning after November 15, 2008. As of January 1, 2009, the Company adopted the updated accounting guidance as it relates to reporting units and indefinite-lived intangible assets measured at fair value for the purposes of impairment testing and asset retirement obligations. The adoption of these provisions had no impact on the Companys financial condition or results of operations.
11
In March of 2008, the FASB issued updated accounting guidance for disclosures about derivative instruments and hedging activities. The updated accounting guidance is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entitys financial position, financial performance and cash flows. The Companys adoption of the updated accounting guidance had no impact on its financial condition or results of operations. See Note 4.
In May of 2008, the FASB issued updated accounting guidance on accounting for convertible debt instruments that may be settled in cash upon conversion. The updated accounting guidance specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entitys nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. As required, the Companys Consolidated Condensed Financial Statements have been retrospectively adjusted to reflect the effect of adoption of the updated accounting guidance. The adoption of the updated accounting guidance increased Property, plant and equipment $16 million, Total assets $13 million and Total equity $13 million and decreased Deferred income taxes $3 million at January 1, 2009 and 2008. The adoption of the updated accounting guidance had no effect on previously stated basic and diluted earnings per share.
In April of 2009, the FASB issued updated accounting guidance that requires disclosures about fair value of financial instruments in interim as well as annual financial statements. The Companys adoption of this updated accounting guidance did not impact the financial condition or results of operations of the Company. See Note 3.
In April of 2009, the FASB issued updated accounting guidance which amended the other-than-temporary impairment (OTTI) loss model for fixed maturity securities. A fixed maturity security is impaired if the fair value of the security is less than its amortized cost basis, which is its cost adjusted for accretion, amortization and previously recorded OTTI losses. The updated accounting guidance requires an OTTI loss equal to the difference between fair value and amortized cost to be recognized in earnings if the Company intends to sell the fixed maturity security or if it is more likely than not the Company will be required to sell the fixed maturity security before recovery of its amortized cost basis.
The remaining fixed maturity securities in an unrealized loss position are evaluated to determine if a credit loss exists. If the Company does not expect to recover the entire amortized cost basis of a fixed maturity security, the security is deemed to be other-than-temporarily impaired for credit reasons. For these securities, the updated accounting guidance requires the bifurcation of OTTI losses into a credit component and a non-credit component. The credit component is recognized in earnings and represents the difference between the present value of the future cash flows that the Company expects to collect and a fixed maturity securitys amortized cost basis. The non-credit component is recognized in other comprehensive income (OCI) and represents the difference between fair value and the present value of the future cash flows that the Company expects to collect.
Prior to the adoption of the updated accounting guidance, OTTI losses were not bifurcated between credit and non-credit components. The difference between fair value and amortized cost was recognized in earnings for all securities for which the Company did not expect to recover the amortized cost basis, or for which the Company did not have the ability and intent to hold until recovery of fair value to amortized cost.
The adoption of the updated accounting guidance as of April 1, 2009 resulted in a cumulative effect adjustment of $109 million, after tax and noncontrolling interests, reclassified to Accumulated other comprehensive income (loss) (AOCI) from Retained earnings on the Consolidated Condensed Statements of Equity. The cumulative effect adjustment represents the non-credit component of those previously impaired fixed maturity securities that are still considered OTTI, and the entire amount previously recorded as an OTTI loss on fixed maturity securities no longer considered OTTI as of April 1, 2009.
In April of 2009, the FASB issued updated accounting guidance on determining fair value when the volume and level of activity for an asset or liability has significantly decreased and indentifying transactions that are not orderly. The updated accounting guidance requires entities to assess whether certain factors exist that indicate that the volume and level of market activity for an asset or liability have decreased or that transactions are not orderly. If, after evaluating those factors, the evidence indicates there has been a significant decrease in the volume and level of activity in relation to normal market activity, observed transactional values or quoted prices may not be determinative of fair value and adjustment to the observed transactional values or quoted prices may be necessary to estimate fair value. The updated accounting guidance also prospectively expands and increases the frequency of existing disclosures related primarily to additional security types and valuation methodologies. The Companys adoption of this updated accounting guidance did not impact the financial condition or results of operations of the Company. The Company has complied with the additional prospective disclosure requirements in Note 3.
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Updated accounting guidance not yet adopted In June of 2009, the FASB issued updated accounting guidance that amends the requirements for determination of the primary beneficiary of a variable interest entity, requires an ongoing assessment of whether an entity is the primary beneficiary and requires enhanced interim and annual disclosures that will provide users of financial statements information regarding an enterprises involvement in a variable interest entity. The updated accounting guidance is effective for annual reporting periods beginning after November 15, 2009. The adoption of the updated accounting guidance is not expected to have a material impact on the Companys financial condition or results of operations.
2. Investments
Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
(In millions) | ||||||||||||||||
Net investment income consisted of: |
||||||||||||||||
Fixed maturity securities |
$ | 496 | $ | 501 | $ | 1,458 | $ | 1,495 | ||||||||
Short term investments |
9 | 36 | 33 | 125 | ||||||||||||
Limited partnerships |
156 | (77 | ) | 245 | (70 | ) | ||||||||||
Equity securities |
11 | 18 | 39 | 62 | ||||||||||||
Trading portfolio |
65 | (117 | ) | 163 | (66 | ) | ||||||||||
Other |
2 | 6 | 6 | 27 | ||||||||||||
Total investment income |
739 | 367 | 1,944 | 1,573 | ||||||||||||
Investment expenses |
(13 | ) | (12 | ) | (36 | ) | (42 | ) | ||||||||
Net investment income |
$ | 726 | $ | 355 | $ | 1,908 | $ | 1,531 | ||||||||
Investment gains (losses) are as follows: |
||||||||||||||||
Fixed maturity securities |
$ | (112 | ) | $ | (315 | ) | $ | (862 | ) | $ | (475 | ) | ||||
Equity securities |
19 | (376 | ) | (133 | ) | (405 | ) | |||||||||
Derivative instruments |
(13 | ) | 35 | 51 | 47 | |||||||||||
Short term investments |
2 | 5 | 11 | 12 | ||||||||||||
Other |
4 | 1 | 5 | 9 | ||||||||||||
Investment losses (a) |
(100 | ) | (650 | ) | (928 | ) | (812 | ) | ||||||||
Gain on issuance of subsidiary stock |
2 | |||||||||||||||
(100 | ) | (650 | ) | (928 | ) | (810 | ) | |||||||||
Income tax benefit |
33 | 227 | 318 | 284 | ||||||||||||
Amounts attributable to noncontrolling interests |
6 | 44 | 61 | 54 | ||||||||||||
Investment losses, net - Loews |
$ | (61 | ) | $ | (379 | ) | $ | (549 | ) | $ | (472 | ) |
(a) | Includes gross realized gains of $168, $85, $449 and $296 and gross realized losses of $261, $776, $1,444 and $1,176 on available-for-sale securities for the three and nine months ended September 30, 2009 and 2008. |
13
The components of OTTI losses recognized in earnings by asset type are as follows:
Three Months Ended September 30, |
Nine Months Ended September 30, | |||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||
(In millions) | ||||||||||||
Fixed maturity securities available-for-sale: |
||||||||||||
Asset-backed securities: |
||||||||||||
Residential mortgage-backed securities |
$ | 108 | $ | 29 | $ | 376 | $ | 142 | ||||
Commercial mortgage-backed securities |
4 | 1 | 185 | 57 | ||||||||
Other asset-backed securities |
31 | 10 | ||||||||||
Total asset-backed securities |
112 | 30 | 592 | 209 | ||||||||
States, municipalities and political subdivisions-tax-exempt securities |
12 | 1 | 27 | 1 | ||||||||
Corporate and other taxable bonds |
24 | 247 | 308 | 288 | ||||||||
Redeemable preferred stock |
9 | |||||||||||
Total fixed maturities available-for-sale |
148 | 278 | 936 | 498 | ||||||||
Equity securities available-for-sale: |
||||||||||||
Common stock |
51 | 4 | 79 | |||||||||
Preferred stock |
255 | 217 | 263 | |||||||||
Total equity securities available-for-sale |
- | 306 | 221 | 342 | ||||||||
Net OTTI losses recognized in earnings |
$ | 148 | $ | 584 | $ | 1,157 | $ | 840 |
A security is impaired if the fair value of the security is less than its cost adjusted for accretion, amortization and previously recorded OTTI losses, otherwise defined as an unrealized loss. When a security is impaired, the impairment is evaluated to determine whether it is temporary or other-than-temporary.
Significant judgment is required in the determination of whether an OTTI loss has occurred for a security. CNA follows a consistent and systematic process for determining and recording an OTTI loss. CNA has established a committee responsible for the OTTI process. This committee, referred to as the Impairment Committee, is made up of three officers appointed by CNAs Chief Financial Officer. The Impairment Committee is responsible for evaluating securities in an unrealized loss position on at least a quarterly basis.
The Impairment Committees assessment of whether an OTTI loss has occurred incorporates both quantitative and qualitative information. Fixed maturity securities that CNA intends to sell, or it more likely than not will be required to sell before recovery of amortized cost, are considered to be other-than-temporarily impaired and the entire difference between the amortized cost basis and fair value of the security is recognized as an OTTI loss in earnings. The remaining fixed maturity securities in an unrealized loss position are evaluated to determine if a credit loss exists. In order to determine if a credit loss exists, the factors considered by the Impairment Committee include (i) the financial condition and near term prospects of the issuer, (ii) whether the debtor is current on interest and principal payments, (iii) credit ratings of the securities and (iv) general market conditions and industry or sector specific outlook. CNA also considers results and analysis of cash flow modeling for asset-backed securities, and when appropriate, other fixed maturity securities. The focus of the analysis for asset-backed securities is on assessing the sufficiency and quality of underlying collateral and timing of cash flows based on scenario tests. If the present value of the modeled expected cash flows equals or exceeds the amortized cost of a security, no credit loss is judged to exist and the asset-backed security is deemed to be temporarily impaired. If the present value of the expected cash flows is less than amortized cost, the security is judged to be other-than-temporarily impaired for credit reasons and that shortfall, referred to as the credit component, is recognized as an OTTI loss in earnings. The difference between the adjusted amortized cost basis and fair value, referred to as the non-credit component, is recognized as an OTTI loss in OCI.
CNA performs the discounted cash flow analysis using distressed scenarios to determine future expectations regarding recoverability. For asset-backed securities significant assumptions enter into these cash flow projections including delinquency rates, probable risk of default, loss severity upon a default, over collateralization and interest coverage triggers, credit support from lower level tranches and impacts of rating agency downgrades. The discount rate utilized is either the yield at acquisition or, for lower rated structured securities, the current yield.
CNA applies the same impairment model as described above for the majority of the non-redeemable preferred stock securities. For all other equity securities, in determining whether the security is other-than-temporarily impaired, the Impairment Committee considers a number of factors including, but not limited to: (i) the length of
14
time and the extent to which the fair value has been less than amortized cost, (ii) the financial condition and near term prospects of the issuer, (iii) the intent and ability of CNA to retain its investment for a period of time sufficient to allow for an anticipated recovery in value and (iv) general market conditions and industry or sector specific outlook.
Prior to the adoption of the updated accounting guidance related to OTTI in the second quarter of 2009 as further discussed in Note 1, CNA applied the impairment model described in the paragraph above to both fixed maturity and equity securities.
The amortized cost and fair values of securities are as follows:
September 30, 2009 | Cost or Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses | Unrealized OTTI Losses | ||||||||||||||
Less Than 12 Months |
12 Months or Greater |
Estimated Fair Value |
||||||||||||||||
(In millions) | ||||||||||||||||||
Fixed maturity securities: |
||||||||||||||||||
U.S. Treasury securities and obligations of government agencies |
$ | 223 | $ | 27 | $ | 1 | $ | 249 | ||||||||||
Asset-backed securities: |
||||||||||||||||||
Residential mortgage-backed securities |
7,346 | 81 | 371 | $ | 500 | 6,556 | $ | 190 | ||||||||||
Commercial mortgage-backed securities |
760 | 4 | 4 | 161 | 599 | 6 | ||||||||||||
Other asset-backed securities |
701 | 12 | 1 | 40 | 672 | |||||||||||||
Total asset-backed securities |
8,807 | 97 | 376 | 701 | 7,827 | 196 | ||||||||||||
States, municipalities and political subdivisions-tax exempt securities |
7,434 | 295 | 75 | 168 | 7,486 | |||||||||||||
Corporate and other taxable bonds |
17,752 | 1,233 | 281 | 214 | 18,490 | 25 | ||||||||||||
Redeemable preferred stock |
49 | 3 | 1 | 51 | ||||||||||||||
Fixed maturities available-for-sale |
34,265 | 1,655 | 733 | 1,084 | 34,103 | 221 | ||||||||||||
Fixed maturities, trading |
1,391 | 3 | 7 | 15 | 1,372 | |||||||||||||
Total fixed maturities |
35,656 | 1,658 | 740 | 1,099 | 35,475 | 221 | ||||||||||||
Equity securities: |
||||||||||||||||||
Common stock |
63 | 381 | 2 | 442 | ||||||||||||||
Preferred stock |
579 | 39 | 18 | 67 | 533 | |||||||||||||
Equity securities available-for-sale |
642 | 420 | 18 | 69 | 975 | |||||||||||||
Equity securities, trading |
285 | 112 | 15 | 37 | 345 | |||||||||||||
Total equity securities |
927 | 532 | 33 | 106 | 1,320 | |||||||||||||
Total |
$ | 36,583 | $ | 2,190 | $ | 773 | $ | 1,205 | $ | 36,795 | $ | 221 | ||||||
December 31, 2008 | ||||||||||||||||||
Fixed maturity securities: |
||||||||||||||||||
U.S. Treasury securities and obligations of government agencies |
$ | 2,862 | $ | 69 | $ | 1 | $ | 2,930 | ||||||||||
Asset-backed securities |
9,670 | 24 | 961 | $ | 969 | 7,764 | ||||||||||||
States, municipalities and political subdivisions-tax exempt securities |
8,557 | 90 | 609 | 623 | 7,415 | |||||||||||||
Corporate and other taxable bonds |
12,993 | 275 | 1,164 | 1,374 | 10,730 | |||||||||||||
Redeemable preferred stock |
72 | 1 | 23 | 3 | 47 | |||||||||||||
Fixed maturities available-for-sale |
34,154 | 459 | 2,758 | 2,969 | 28,886 | |||||||||||||
Fixed maturities, trading |
613 | 1 | 19 | 30 | 565 | |||||||||||||
Total fixed maturities |
34,767 | 460 | 2,777 | 2,999 | 29,451 | |||||||||||||
Equity securities: |
||||||||||||||||||
Equity securities available-for-sale |
1,018 | 195 | 16 | 324 | 873 | |||||||||||||
Equity securities, trading |
384 | 52 | 78 | 46 | 312 | |||||||||||||
Total equity securities |
1,402 | 247 | 94 | 370 | 1,185 | |||||||||||||
Total |
$ | 36,169 | $ | 707 | $ | 2,871 | $ | 3,369 | $ | 30,636 |
The amount of pretax net unrealized losses on available-for-sale securities reclassified out of AOCI into earnings was $92 million and $989 million for the three months and nine months ended September 30, 2009.
15
Activity for the three months ended September 30, 2009 and for the period from April 1, 2009 to September 30, 2009, related to the pretax fixed maturity credit loss component reflected within Retained earnings for securities still held at September 30, 2009 was as follows:
Three Months ended September 30, 2009 |
Period from April 1, 2009 to September 30, 2009 |
|||||||
(In millions) | ||||||||
Beginning balance of credit losses on fixed maturity securities |
$ | 212 | $ | 192 | ||||
Additional credit losses for which an OTTI loss was previously recognized |
57 | 78 | ||||||
Additional credit losses for which an OTTI loss was not previously recognized |
65 | 149 | ||||||
Reductions for securities sold during the period |
(114 | ) | (150 | ) | ||||
Reduction for securities the Company intends to sell or more likely than not will be required to sell |
(11 | ) | (60 | ) | ||||
Ending balance of credit losses on fixed maturity securities |
$ | 209 | $ | 209 |
Based on current facts and circumstances, the Company has determined that no additional OTTI losses related to the securities in an unrealized loss position presented in the September 30, 2009 summary of fixed maturity and equity securities table above are required to be recorded. A discussion of some of the factors reviewed in making that determination is presented below.
The classification between investment grade and non-investment grade presented in the discussion below is based on a ratings methodology that takes into account ratings from the three major providers, Standard & Poors (S&P), Moodys Investor Services, Inc. (Moodys) and Fitch Ratings (Fitch) in that order of preference. If a security is not rated by any of the three, the Company formulates an internal rating. For securities with credit support from third party guarantees, the rating reflects the greater of the underlying rating of the issuer or the insured rating.
The market disruption that emerged during 2008 has significantly subsided in the third quarter of 2009. The government has initiated programs intended to stabilize and improve markets and the economy. While the ultimate impact of these programs remains uncertain and economic conditions in the U.S. remain challenging, financial markets have shown improvement in the third quarter. Risk free interest rates approached multi-year lows and corporate credit spreads continued to narrow resulting in improvement in the Companys unrealized position. However, fair market values in the asset-backed sector continue to be depressed due to continued concerns with underlying residential and commercial collateral.
Common stock holdings at September 30, 2009 were in a gross unrealized gain of $381 million. The majority of this gain was CNAs common stock holdings in Verisk Analytics Inc. (Verisk), which began trading on October 7, 2009 after an initial public offering (IPO). The gross unrealized gain reflects this security valued using the IPO price as a significant input. CNA sold all of its common stock holdings in the IPO resulting in a pretax realized investment gain of $370 million that will be reflected in the fourth quarter of 2009.
Asset-Backed Securities
The fair value of total asset-backed holdings at September 30, 2009 was $7,827 million which was comprised of over 2,126 different asset-backed structured securities. The fair value of these securities does not tend to be influenced by the credit of the issuer but rather the characteristics and projected cash flows of the underlying collateral. Each security has deal-specific tranche structures, credit support that results from the unique deal structure, particular collateral characteristics and other distinct security terms. As a result, seemingly common factors such as delinquency rates and collateral performance affect each security differently. The exposure to sub-prime residential mortgage (sub-prime) collateral and Alternative A residential mortgages that have lower than normal standards of loan documentation (Alt-A) collateral is measured by the original deal structure. Of these securities, 224 have underlying collateral that is either considered sub-prime or Alt-A in nature.
Residential mortgage-backed securities include 315 structured securities in a gross unrealized loss position. In addition, there were 49 agency mortgage-backed pass-through securities which are guaranteed by agencies of the U.S. Government in a gross unrealized loss position. The aggregate severity of the gross unrealized loss was approximately 16.9% of amortized cost.
16
Commercial mortgage-backed securities include 41 securities in a gross unrealized loss position. The aggregate severity of the gross unrealized loss was approximately 24.3% of amortized cost.
Other asset-backed securities include 27 securities in a gross unrealized loss position. The aggregate severity of the gross unrealized loss was approximately 12.3% of amortized cost.
The asset-backed securities in a gross unrealized loss position by ratings distribution are as follows:
September 30, 2009 | Amortized Cost |
Estimated Fair Value |
Gross Unrealized Loss | ||||||
(In millions) | |||||||||
U.S. Government Agencies |
$ | 409 | $ | 400 | $ | 9 | |||
AAA |
2,730 | 2,363 | 367 | ||||||
AA |
490 | 384 | 106 | ||||||
A |
457 | 342 | 115 | ||||||
BBB |
422 | 336 | 86 | ||||||
Non-investment grade and equity tranches |
1,652 | 1,258 | 394 | ||||||
Total |
$ | 6,160 | $ | 5,083 | $ | 1,077 |
The Company believes the unrealized losses are primarily attributable to broader economic conditions, liquidity concerns and wider than historical bid/ask spreads brought about as a result of portfolio liquidations and is not indicative of the quality of the underlying collateral. The Company has no current intent to sell these securities, nor is it more likely than not that it will be required to sell prior to recovery of amortized cost. Generally, non-investment grade securities consist of investments which were investment grade at the time of purchase but have subsequently been downgraded and primarily consist of holdings senior to the equity tranche. Additionally, the Company believes that the unrealized losses on these securities were not due to factors regarding credit worthiness, collateral shortfalls, or substantial changes in future cash flow expectations and; accordingly, the Company has determined that there are no additional OTTI losses to be recorded at September 30, 2009.
States, Municipalities and Political Subdivisions Tax-Exempt Securities
The tax-exempt portfolio consists primarily of special revenue and assessment bonds, representing 82.0% of the overall portfolio, followed by general obligation political subdivision bonds at 15.0% and state general obligation bonds at 3.0%.
The unrealized losses on the Companys investments in tax-exempt municipal securities are due to market conditions in certain sectors or states that continue to lag behind the broader municipal market recovery. Market conditions in the tax-exempt sector have improved during 2009. However, yields for certain issuers and types of securities, such as auction rate and tobacco securitizations, continue to be higher than historical norms relative to after tax returns on other fixed income alternatives. The holdings for all tax-exempt securities in this category include 249 securities in a gross unrealized loss position. The aggregate severity of the total gross unrealized losses was approximately 8.4% of amortized cost.
The ratings distribution of tax-exempt securities in a gross unrealized loss position are as follows:
September 30, 2009 | Amortized Cost |
Estimated Fair Value |
Gross Unrealized Loss | ||||||
(In millions) | |||||||||
AAA |
$ | 1,127 | $ | 1,089 | $ | 38 | |||
AA |
664 | 591 | 73 | ||||||
A |
333 | 315 | 18 | ||||||
BBB |
712 | 600 | 112 | ||||||
Non-investment grade |
48 | 46 | 2 | ||||||
Total |
$ | 2,884 | $ | 2,641 | $ | 243 |
17
The largest exposures at September 30, 2009 as measured by gross unrealized losses were special revenue bonds issued by several states backed by tobacco settlement funds with gross unrealized losses of $106 million, and several separate issues of Puerto Rico sales tax revenue bonds with gross unrealized losses of $45 million. All of these securities are investment grade.
The Company has no current intent to sell these securities, nor is it more likely than not that it will be required to sell prior to recovery of amortized cost. Additionally, the Company believes that the unrealized losses on these securities were not due to factors regarding credit worthiness; accordingly, the Company has determined that there are no additional OTTI losses to be recorded at September 30, 2009.
Corporate and Other Taxable Bonds
The holdings in this category include 405 securities in a gross unrealized loss position. The aggregate severity of the gross unrealized losses was approximately 11.6% of amortized cost.
The corporate and other taxable bonds in a gross unrealized loss position across industry sectors and by ratings distribution are as follows:
September 30, 2009 | Amortized Cost |
Estimated Fair Value |
Gross Unrealized Loss | ||||||
(In millions) | |||||||||
Industry Sectors: |
|||||||||
Communications |
$ | 287 | $ | 276 | $ | 11 | |||
Consumer, Cyclical |
490 | 434 | 56 | ||||||
Consumer, Non-cyclical |
275 | 256 | 19 | ||||||
Energy |
315 | 296 | 19 | ||||||
Financial |
1,962 | 1,670 | 292 | ||||||
Industrial |
235 | 211 | 24 | ||||||
Utilities |
469 | 419 | 50 | ||||||
Other |
252 | 228 | 24 | ||||||
Total |
$ | 4,285 | $ | 3,790 | $ | 495 |
September 30, 2009 | Amortized Cost |
Estimated Fair Value |
Gross Unrealized Loss | ||||||
(In millions) | |||||||||
Ratings distribution: |
|||||||||
AAA |
$ | 63 | $ | 57 | $ | 6 | |||
AA |
80 | 79 | 1 | ||||||
A |
951 | 864 | 87 | ||||||
BBB |
1,900 | 1,686 | 214 | ||||||
Non-investment grade |
1,291 | 1,104 | 187 | ||||||
Total |
$ | 4,285 | $ | 3,790 | $ | 495 |
The unrealized losses on corporate and other taxable bonds are primarily attributable to lingering impacts of the broader credit market deterioration throughout 2008 that resulted in widening of credit spreads over risk free interest rates beyond historical norms. These conditions continue in certain sectors, such as financial, that the market continues to view as out of favor. Overall conditions in the corporate bond market have significantly improved throughout 2009 resulting in improvement in the Companys unrealized position. The Company has no current intent to sell these securities, nor is it more likely than not that it will be required to sell prior to recovery of amortized cost. Additionally, the Company believes that the unrealized losses were not due to factors regarding credit worthiness; accordingly, the Company has determined that there are no additional OTTI losses to be recorded at September 30, 2009.
The Company has invested in securities with characteristics of both debt and equity investments, often referred to as hybrid debt securities. Such securities are typically debt instruments issued with long or extendable maturity dates, may provide for the ability to defer interest payments without defaulting and are usually lower in the capital
18
structure of the issuer than traditional bonds. The financial industry sector presented above includes hybrid debt securities with an aggregate fair value of $711 million and an aggregate amortized cost of $899 million.
Non-Redeemable Preferred Stock
The unrealized losses on the Companys investments in non-redeemable preferred stock were caused by factors similar to those that affected the Companys corporate bond portfolio. Approximately 78.9% of the gross unrealized losses in this category come from securities issued by financial institutions and 21.1% from utilities. The holdings in this category include 23 securities in a gross unrealized loss position.
Non-redeemable preferred stocks in a gross unrealized loss position by ratings distribution are as follows:
September 30, 2009 | Amortized Cost |
Estimated Fair Value |
Gross Unrealized Loss | ||||||
(In millions) | |||||||||
A |
$ | 95 | $ | 81 | $ | 14 | |||
BBB |
396 | 331 | 65 | ||||||
Non-investment grade |
18 | 12 | 6 | ||||||
Total |
$ | 509 | $ | 424 | $ | 85 |
The majority of securities in this category relate to the banking and mortgage industries. These securities continue to experience what the Company believes to be temporarily depressed valuations. The Company has no current intent to sell these securities, nor is it more likely than not it will be required to sell prior to recovery of amortized cost. Additionally, the Company believes that the unrealized losses on these securities were not due to factors regarding credit worthiness; accordingly, the Company has determined that there are no additional OTTI losses to be recorded at September 30, 2009. This evaluation was made on the basis that these securities possess characteristics similar to debt securities and that the issuers maintain their ability to pay dividends.
Contractual Maturity
The following table summarizes available-for-sale fixed maturity securities by contractual maturity at September 30, 2009 and December 31, 2008. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid with or without call or prepayment penalties. Securities not due at a single date are allocated based on weighted average life.
September 30, 2009 | December 31, 2008 | |||||||||||
Amortized Cost |
Estimated Fair Value |
Amortized Cost |
Estimated Fair Value | |||||||||
(In millions) | ||||||||||||
Due in one year or less |
$ | 1,206 | $ | 1,176 | $ | 3,105 | $ | 2,707 | ||||
Due after one year through five years |
10,058 | 9,990 | 10,295 | 9,210 | ||||||||
Due after five years through ten years |
8,999 | 8,929 | 5,929 | 4,822 | ||||||||
Due after ten years |
14,002 | 14,008 | 14,825 | 12,147 | ||||||||
Total |
$ | 34,265 | $ | 34,103 | $ | 34,154 | $ | 28,886 |
Auction Rate Securities
The investment portfolio includes auction rate securities which are primarily issued by student loan agencies from ten states and are substantially guaranteed by the Federal Family Education Loan Program. The fair value of auction rate securities held at September 30, 2009 was $945 million, with no gross unrealized gains and gross unrealized losses of $75 million. The average rating on these holdings was AAA. At September 30, 2009, three auction rate securities, with a fair value of $68 million and gross unrealized losses of $20 million, were paying below market penalty rates.
Limited Partnerships
The carrying value of limited partnerships as of September 30, 2009 and December 31, 2008 was approximately $2.1 billion and $1.8 billion. At September 30, 2009, limited partnerships comprising 52.2% of the total carrying
19
value are reported on a current basis through September 30, 2009 with no reporting lag, 38.7% are reported on a one month lag and the remainder are reported on more than a one month lag. The Company had 82 and 85 active limited partnership investments as of September 30, 2009 and December 31, 2008. The number of limited partnerships held and the strategies employed provide diversification to the limited partnership portfolio and the overall invested asset portfolio. The Company does not generally invest in highly leveraged partnerships.
Of the limited partnerships held, 91.3% or approximately $1.9 billion in carrying value at September 30, 2009 and 89.5% or approximately $1.6 billion in carrying value at December 31, 2008, employ strategies that generate returns through investing in securities that are marketable while engaging in various management techniques primarily in public fixed income and equity markets. These hedge fund strategies include both long and short positions in fixed income, equity and derivative instruments. The hedge fund strategies may seek to generate gains from mispriced or undervalued securities, price differentials between securities, distressed investments, sector rotation, or various arbitrage disciplines. Within hedge fund strategies, approximately 46.8% are equity related, 29.7% pursue a multi-strategy approach, 19.0% are focused on distressed investments and 4.5% are fixed income related.
Limited partnerships representing 5.6% or $117 million at September 30, 2009 and 7.1% or $126 million at December 31, 2008 were invested in private equity. The remaining 3.1% or $65 million at September 30, 2009 and 3.4% or $61 million at December 31, 2008 were invested in various other partnerships including real estate. The ten largest limited partnership positions held totaled $1,184 million and $915 million as of September 30, 2009 and December 31, 2008. Based on the most recent information available regarding the Companys percentage ownership of the individual limited partnerships, the carrying value reflected on the Consolidated Condensed Balance Sheets represents approximately 4.2% and 3.4% of the aggregate partnership equity at September 30, 2009 and December 31, 2008, and the related income reflected on the Consolidated Condensed Statements of Operations represents 4.5% and 3.0% of the changes in partnership equity for all limited partnership investments for the nine months ended September 30, 2009 and 2008.
The risks associated with limited partnership investments may include losses due to leveraging, short-selling, derivatives or other speculative investment practices. The use of leverage increases volatility generated by the underlying investment strategies.
Investment Commitments
As of September 30, 2009, the Company had committed approximately $254 million to future capital calls from various third-party limited partnership investments in exchange for an ownership interest in the related partnerships.
The Company invests in multiple bank loan participations as part of its overall investment strategy and has committed to additional future purchases and sales. The purchase and sale of these investments are recorded on the date that the legal agreements are finalized and cash settlement is made. As of September 30, 2009, the Company had commitments to purchase $296 million and sell $217 million of various bank loan participations. When loan participation purchases are settled and recorded they may contain both funded and unfunded amounts. An unfunded loan represents an obligation by the Company to provide additional amounts under the terms of the loan participation. The funded portions are reflected on the Consolidated Condensed Balance Sheets, while any unfunded amounts are not recorded until a draw is made under the loan facility. As of September 30, 2009, the Company had obligations on unfunded bank loan participations in the amount of $9 million.
3. Fair Value
Fair value is the price that would be received upon sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The following fair value hierarchy is used in selecting inputs, with the highest priority given to Level 1, as these are the most transparent or reliable:
| Level 1 Quoted prices for identical instruments in active markets. |
| Level 2 Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs are observable in active markets. |
| Level 3 Valuations derived from valuation techniques in which one or more significant inputs are not observable. |
20
The Company attempts to establish fair value as an exit price in an orderly transaction consistent with normal settlement market conventions. The Company is responsible for the valuation process and seeks to obtain quoted market prices for all securities. When quoted market prices in active markets are not available, the Company uses a number of methodologies to establish fair value estimates, including discounted cash flow models, prices from recently executed transactions of similar securities or broker/dealer quotes, utilizing market observable information to the extent possible. In conjunction with modeling activities, the Company may use external data as inputs. The modeled inputs are consistent with observable market information, when available, or with the Companys assumptions as to what market participants would use to value the securities. The Company also uses pricing services as a significant source of data. The Company monitors all pricing inputs to determine if the markets from which the data is gathered are active. As further validation of the Companys valuation process, the Company samples its past fair value estimates and compares the valuations to actual transactions executed in the market on similar dates.
The fair values of CNAs life settlement contracts investments are included in Other assets. The fair values of discontinued operations investments are included in Other liabilities. Assets and liabilities measured at fair value on a recurring basis are summarized in the tables below:
September 30, 2009 | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
(In millions) | ||||||||||||||||
Fixed maturity securities: |
||||||||||||||||
U.S. Treasury securities and obligations of government agencies |
$ | 153 | $ | 96 | $ | 249 | ||||||||||
Asset-backed securities: |
||||||||||||||||
Residential mortgage-backed securities |
5,819 | $ | 737 | 6,556 | ||||||||||||
Commercial mortgage-backed securities |
388 | 211 | 599 | |||||||||||||
Other asset-backed securities |
384 | 288 | 672 | |||||||||||||
Total asset-backed securities |
6,591 | 1,236 | 7,827 | |||||||||||||
States, municipalities and political subdivisions-tax-exempt securities |
6,716 | 770 | 7,486 | |||||||||||||
Corporate and other taxable bonds |
139 | 17,599 | 752 | 18,490 | ||||||||||||
Redeemable preferred stock |
49 | 2 | 51 | |||||||||||||
Fixed maturities available-for-sale |
292 | 31,051 | 2,760 | 34,103 | ||||||||||||
Fixed maturities, trading |
1,130 | 26 | 216 | 1,372 | ||||||||||||
Total fixed maturities |
$ | 1,422 | $ | 31,077 | $ | 2,976 | $ | 35,475 | ||||||||
Equity securities: |
||||||||||||||||
Common stock |
$ | 63 | $ | 373 | $ | 6 | $ | 442 | ||||||||
Preferred stock |
418 | 111 | 4 | 533 | ||||||||||||
Equity securities available-for-sale |
481 | 484 | 10 | 975 | ||||||||||||
Equity securities, trading |
345 | 345 | ||||||||||||||
Total equity securities |
$ | 826 | $ | 484 | $ | 10 | $ | 1,320 | ||||||||
Short term investments |
$ | 5,330 | $ | 1,031 | $ | 8 | $ | 6,369 | ||||||||
Receivables |
59 | 8 | 67 | |||||||||||||
Life settlement contracts |
129 | 129 | ||||||||||||||
Separate account business |
59 | 353 | 40 | 452 | ||||||||||||
Payable to brokers |
(1,104 | ) | (157 | ) | (25 | ) | (1,286 | ) | ||||||||
Discontinued operations investments |
25 | 107 | 16 | 148 | ||||||||||||
December 31, 2008 | ||||||||||||||||
Fixed maturity securities |
$ | 2,358 | $ | 24,383 | $ | 2,710 | $ | 29,451 | ||||||||
Equity securities |
881 | 94 | 210 | 1,185 | ||||||||||||
Short term investments |
5,425 | 608 | 6,033 | |||||||||||||
Receivables |
182 | 40 | 222 | |||||||||||||
Life settlement contracts |
129 | 129 | ||||||||||||||
Separate account business |
40 | 306 | 38 | 384 | ||||||||||||
Payable to brokers |
(168 | ) | (260 | ) | (112 | ) | (540 | ) | ||||||||
Discontinued operations investments |
83 | 59 | 15 | 157 |
21
The table below presents reconciliations for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended September 30, 2009 and 2008:
Net Realized Gains (Losses) and Net Change in Unrealized Gains (Losses) |
Unrealized Level 3 Assets Held at |
||||||||||||||||||||||||||||||
2009 | Beginning Balance |
Included in Net Income (Loss) (a) |
Included in OCI |
Purchases, Sales, Issuances and Settlements |
Transfers into Level 3 |
Transfers out of Level 3 |
Balance, September 30 |
||||||||||||||||||||||||
(In millions) | |||||||||||||||||||||||||||||||
Fixed maturity securities: |
|||||||||||||||||||||||||||||||
Asset-backed securities: |
|||||||||||||||||||||||||||||||
Residential mortgage-backed securities |
$ | 808 | $ | 1 | $ | 62 | $ | 20 | $ | (154 | ) | $ | 737 | $ | (1 | ) | |||||||||||||||
Commercial mortgage-backed securities |
175 | (3 | ) | 28 | 11 | 211 | (3 | ) | |||||||||||||||||||||||
Other asset-backed securities |
141 | 1 | 14 | 132 | 288 | ||||||||||||||||||||||||||
Total asset-backed securities |
1,124 | (1 | ) | 104 | 163 | (154 | ) | 1,236 | (4 | ) | |||||||||||||||||||||
States, municipalities and political subdivisions-tax-exempt securities |
785 | 19 | (34 | ) | 770 | ||||||||||||||||||||||||||
Corporate and other taxable bonds |
730 | (10 | ) | 67 | 43 | $ | 5 | (83 | ) | 752 | (10 | ) | |||||||||||||||||||
Redeemable preferred stock |
1 | 1 | 2 | ||||||||||||||||||||||||||||
Fixed maturities available-for-sale |
2,640 | (11 | ) | 191 | 172 | 5 | (237 | ) | 2,760 | (14 | ) | ||||||||||||||||||||
Fixed maturities, trading |
229 | 5 | (18 | ) | 216 | 3 | |||||||||||||||||||||||||
Total fixed maturities |
$ | 2,869 | $ | (6 | ) | $ | 191 | $ | 154 | $ | 5 | $ | (237 | ) | $ | 2,976 | $ | (11 | ) | ||||||||||||
Equity securities: |
|||||||||||||||||||||||||||||||
Common stock |
$ | 190 | $ | (184 | ) | $ | 6 | ||||||||||||||||||||||||
Preferred stock |
19 | (15 | ) | 4 | |||||||||||||||||||||||||||
Equity securities available-for-sale |
$ | 209 | $ | (199 | ) | $ | 10 | ||||||||||||||||||||||||
Short term investments |
$ | 1 | $ | 7 | $ | 8 | |||||||||||||||||||||||||
Life settlement contracts |
$ | 126 | $ | 8 | (5 | ) | 129 | $ | 5 | ||||||||||||||||||||||
Separate account business |
38 | 3 | $ | (1 | ) | 40 | |||||||||||||||||||||||||
Discontinued operations investments |
13 | 3 | 16 | ||||||||||||||||||||||||||||
Derivative financial instruments, net |
(7 | ) | (12 | ) | (10 | ) | 12 | (17 | ) | (4 | ) |
22
Net Realized Gains (Losses) and Net Change in Unrealized Gains (Losses) |
Unrealized Level 3 Assets Held at | ||||||||||||||||||||||||||||
2008 | Beginning Balance |
Included in Net Income (Loss) (a) |
Included in OCI |
Purchases, Sales, Issuances and Settlements |
Transfers into Level 3 |
Transfers out of Level 3 |
Balance, September 30 |
||||||||||||||||||||||
(In millions) | |||||||||||||||||||||||||||||
Fixed maturity securities |
$ | 3,434 | $ | (36 | ) | $ | (103 | ) | $ | (127) | $ | 138 | $ | (87 | ) | $ | 3,219 | $ | (27) | ||||||||||
Equity securities |
263 | (1 | ) | (1 | ) | (24) | (23 | ) | 214 | 1 | |||||||||||||||||||
Short term investments |
- | - | |||||||||||||||||||||||||||
Life settlement contracts |
118 | 4 | (1) | 121 | 3 | ||||||||||||||||||||||||
Separate account business |
45 | (7 | ) | (1) | 6 | 43 | |||||||||||||||||||||||
Discontinued operations investments |
23 | (2 | ) | (1) | 20 | ||||||||||||||||||||||||
Derivative financial instruments, net |
(83 | ) | 50 | 31 | 24 | 22 | 76 | ||||||||||||||||||||||
The table below presents reconciliations for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2009 and 2008: | |||||||||||||||||||||||||||||
2009 | |||||||||||||||||||||||||||||
(In millions) | |||||||||||||||||||||||||||||
Fixed maturity securities: |
|||||||||||||||||||||||||||||
Asset-backed securities: |
|||||||||||||||||||||||||||||
Residential mortgage-backed securities |
$ | 782 | $ | (22 | ) | $ | 98 | $ | (28 | ) | $ | 71 | $ | (164 | ) | $ | 737 | $ | (13) | ||||||||||
Commercial mortgage-backed securities |
186 | (168 | ) | 170 | (3 | ) | 26 | 211 | (166) | ||||||||||||||||||||
Other asset-backed securities |
139 | (29 | ) | 54 | 90 | 153 | (119 | ) | 288 | (31) | |||||||||||||||||||
Total asset-backed securities |
1,107 | (219 | ) | 322 | 59 | 250 | (283 | ) | 1,236 | (210) | |||||||||||||||||||
States, municipalities and political subdivisions-tax-exempt securities |
750 | 74 | (54 | ) | 770 | ||||||||||||||||||||||||
Corporate and other taxable bonds |
622 | (15 | ) | 113 | 110 | 23 | (101 | ) | 752 | (15) | |||||||||||||||||||
Redeemable preferred stock |
13 | (9 | ) | 9 | 7 | (18 | ) | 2 | (9) | ||||||||||||||||||||
Fixed maturities available-for-sale |
2,492 | (243 | ) | 518 | 122 | 273 | (402 | ) | 2,760 | (234) | |||||||||||||||||||
Fixed maturities, trading |
218 | 14 | (20 | ) | 4 | 216 | 7 | ||||||||||||||||||||||
Total fixed maturities |
$ | 2,710 | $ | (229 | ) | $ | 518 | $ | 102 | $ | 277 | $ | (402 | ) | $ | 2,976 | $ | (227) | |||||||||||
23
Net Realized Gains (Losses) and Net Change in Unrealized Gains (Losses) |
Unrealized Level 3 Assets Held at |
||||||||||||||||||||||||||||||
2009 | Beginning Balance |
Included in Net Income (Loss) (a) |
Included in OCI |
Purchases, Sales, Issuances and Settlements |
Transfers into Level 3 |
Transfers out of Level 3 |
Balance, September 30 |
||||||||||||||||||||||||
(In millions) | |||||||||||||||||||||||||||||||
Equity securities: |
|||||||||||||||||||||||||||||||
Common stock |
$ | 191 | $ | (1 | ) | $ | (184 | ) | $ | 6 | |||||||||||||||||||||
Preferred stock |
19 | (15 | ) | 4 | |||||||||||||||||||||||||||
Equity securities available-for-sale |
$ | 210 | $ | (1 | ) | $ | (199 | ) | $ | 10 | |||||||||||||||||||||
Short term investments |
$ | 1 | $ | 7 | $ | 8 | |||||||||||||||||||||||||
Life settlement contracts |
$ | 129 | $ | 24 | (24 | ) | 129 | $ | 7 | ||||||||||||||||||||||
Separate account business |
38 | 3 | $ | (1 | ) | 40 | |||||||||||||||||||||||||
Discontinued operations investments |
15 | 3 | (2 | ) | 16 | ||||||||||||||||||||||||||
Derivative financial instruments, net |
(72 | ) | 23 | (22 | ) | 54 | (17 | ) | (11 | ) | |||||||||||||||||||||
2008 | |||||||||||||||||||||||||||||||
Fixed maturity securities |
$ | 2,909 | $ | (160 | ) | $ | (373 | ) | $ | (46 | ) | $ | 1,392 | $ | (503 | ) | $ | 3,219 | $ | (166 | ) | ||||||||||
Equity securities |
199 | (4 | ) | (4 | ) | 24 | 22 | (23 | ) | 214 | (4 | ) | |||||||||||||||||||
Short term investments |
85 | (85 | ) | - | |||||||||||||||||||||||||||
Life settlement contracts |
115 | 34 | (28 | ) | 121 | 8 | |||||||||||||||||||||||||
Separate account business |
30 | (11 | ) | (2 | ) | 26 | 43 | ||||||||||||||||||||||||
Discontinued operations investments |
42 | (2 | ) | (3 | ) | (17 | ) | 20 | |||||||||||||||||||||||
Derivative financial instruments, net |
(19) | 29 | 34 | (22 | ) | 22 | 7 |
(a) | Net realized and unrealized gains and losses are reported in Net income (loss) as follows: |
Major Category of Assets and Liabilities | Consolidated Condensed Statements of Operations Line Items | |
Fixed maturity securities available-for-sale |
Investment gains (losses) | |
Fixed maturity securities, trading |
Net investment income | |
Equity securities available-for-sale |
Investment gains (losses) | |
Equity securities, trading |
Net investment income | |
Derivative financial instruments held in a trading portfolio |
Net investment income | |
Derivative financial instruments, other |
Investment gains (losses) and Other revenues | |
Life settlement contracts |
Other revenues |
24
Securities shown in the Level 3 tables may be transferred in or out based on the availability of observable market information used to verify pricing sources or used in pricing models. The availability of observable market information varies based on market conditions and trading volume and may cause securities to move in and out of Level 3 from reporting period to reporting period.
For the nine months ended September 30, 2009, transfers into Level 3 related primarily to structured securities with underlying auto loan collateral and structured securities with residential and commercial mortgage collateral. These were previously valued using observable prices for similar securities, but due to decreased market activity, fair value is determined by cash flow models using market observable and unobservable inputs. Unobservable inputs include estimates of future cash flows and the maturity assumption.
Securities transferred out of Level 3 included a large common stock holding in Verisk, which began trading on October 7, 2009 after an IPO as discussed in Note 2. The Verisk holding had been previously valued using a discounted cash flow analysis model, adjusted for the Companys assumption regarding an inherent lack of liquidity in the security. This security has been transferred to Level 2 based on the use of the observable IPO price as a significant input.
In addition, for the nine months ended September 30, 2009, transfers out of Level 3 related primarily to structured securities with underlying auto loan collateral and structured securities with residential mortgage collateral. These structured securities with underlying auto loan and residential mortgage loan collateral are currently valued using observable market information and inputs from external pricing sources.
The following section describes the valuation methodologies used to measure different financial instruments at fair value, including an indication of the level in the fair value hierarchy in which the instrument is generally classified.
Fixed Maturity Securities
Level 1 securities include highly liquid government bonds within the U.S. Treasury securities and corporate and other taxable bond categories for which quoted market prices are available. Level 1 securities may also include securities that have firm sale commitments and prices that are not recorded until the settlement date. The remaining fixed maturity securities are valued using pricing for similar securities, recently executed transactions, cash flow models with yield curves, broker/dealer quotes and other pricing models utilizing observable inputs. The valuation for most fixed maturity securities is classified as Level 2. Securities within Level 2 include certain corporate bonds, municipal bonds, asset-backed securities, mortgage-backed pass-through securities and redeemable preferred stock. Securities are generally assigned to Level 3 in cases where broker/dealer quotes are significant inputs to the valuation and there is a lack of transparency as to whether these quotes are based on information that is observable in the marketplace. Level 3 securities include certain corporate bonds, asset-backed securities, municipal bonds and redeemable preferred stock. Within corporate bonds and municipal bonds, Level 3 securities also include tax-exempt auction rate certificates. Fair value of auction rate securities is determined utilizing a pricing model with three primary inputs. The interest rate and spread inputs are observable from like instruments while the maturity date assumption is unobservable due to the uncertain nature of the principal prepayments prior to maturity.
Equity Securities
Level 1 securities include publicly traded securities valued using quoted market prices. Level 2 securities are primarily non-redeemable preferred securities and common stocks valued using pricing for similar securities, recently executed transactions, broker/dealer quotes and other pricing models utilizing observable inputs. Level 3 securities include equity securities that are priced using internal models with inputs that are not market observable.
Derivative Financial Instruments
Exchange traded derivatives are valued using quoted market prices and are classified within Level 1 of the fair value hierarchy. Level 2 derivatives include currency forwards valued using observable market forward rates. Over-the-counter derivatives, principally interest rate swaps, credit default swaps, equity warrants and options are valued using inputs including broker/dealer quotes and are classified within Level 2 or Level 3 of the valuation hierarchy, depending on the amount of transparency as to whether these quotes are based on information that is observable in the marketplace.
25
Short Term Investments
The valuation of securities that are actively traded or have quoted prices are classified as Level 1. These securities include money market funds and U.S. Treasury bills. Level 2 includes commercial paper, for which all inputs are observable. Level 3 securities include bank debt securities purchased within one year of maturity where broker/dealer quotes are significant inputs to the valuation and there is a lack of transparency to the market inputs used.
Life Settlement Contracts
The fair values of life settlement contracts are estimated using discounted cash flows based on CNAs own assumptions for mortality, premium expense, and the rate of return that a buyer would require on the contracts, as no comparable market pricing data is available.
Discontinued Operations Investments
Assets relating to CNAs discontinued operations include fixed maturity securities and short term investments. The valuation methodologies for these asset types have been described above.
Separate Account Business
Separate account business includes fixed maturity securities, equities and short term investments. The valuation methodologies for these asset types have been described above.
Assets and Liabilities Not Measured at Fair Value
The Company did not have any financial instrument assets which are not measured at fair value. The carrying amount and estimated fair value of the Companys financial instrument liabilities which are not measured at fair value on the Consolidated Condensed Balance Sheets are listed in the table below.
September 30, 2009 | December 31, 2008 | |||||||||||
Carrying Amount |
Estimated Fair Value |
Carrying Amount |
Estimated Fair Value | |||||||||
(In millions) | ||||||||||||
Financial liabilities: |
||||||||||||
Premium deposits and annuity contracts |
$ | 107 | $ | 110 | $ | 111 | $ | 113 | ||||
Short term debt |
9 | 9 | 71 | 71 | ||||||||
Long term debt |
8,695 | 8,686 | 8,187 | 7,166 |
The following methods and assumptions were used in estimating the fair value of these financial liabilities.
Premium deposits and annuity contracts were valued based on cash surrender values, estimated fair values or policyholder liabilities, net of amounts ceded related to sold businesses.
Fair value of debt was based on quoted market prices when available. When quoted market prices were not available, the fair value for debt was based on quoted market prices of comparable instruments adjusted for differences between the quoted instruments and the instruments being valued or is estimated using discounted cash flow analyses, based on current incremental borrowing rates for similar types of borrowing arrangements.
4. Derivative Financial Instruments
The Company invests in certain derivative instruments for a number of purposes, including: (i) asset and liability management activities, (ii) income enhancements for its portfolio management strategy, and (iii) to benefit from anticipated future movements in the underlying markets. If such movements do not occur as anticipated, then significant losses may occur.
Monitoring procedures include senior management review of daily detailed reports of existing positions and valuation fluctuations to ensure that open positions are consistent with the Companys portfolio strategy.
The Company does not believe that any of the derivative instruments utilized by it are unusually complex, nor do these instruments contain embedded leverage features which would expose the Company to a higher degree of risk.
26
The Company uses derivatives in the normal course of business, primarily in an attempt to reduce its exposure to market risk (principally interest rate risk, equity stock price risk, commodity price risk and foreign currency risk) stemming from various assets and liabilities and credit risk (the ability of an obligor to make timely payment of principal and/or interest). The Companys principal objective under such risk strategies is to achieve the desired reduction in economic risk, even if the position does not receive hedge accounting treatment.
CNAs use of derivatives is limited by statutes and regulations promulgated by the various regulatory bodies to which it is subject, and by its own derivative policy. The derivative policy limits the authorization to initiate derivative transactions to certain personnel. Derivatives entered into for hedging, regardless of the choice to designate hedge accounting, shall have a maturity that effectively correlates to the underlying hedged asset or liability. The policy prohibits the use of derivatives containing greater than one-to-one leverage with respect to changes in the underlying price, rate or index. The policy also prohibits the use of borrowed funds, including funds obtained through securities lending, to engage in derivative transactions.
The Company has exposure to economic losses due to interest rate risk arising from changes in the level of, or volatility of, interest rates. The Company attempts to mitigate its exposure to interest rate risk in the normal course of portfolio management which includes rebalancing its existing portfolios of assets and liabilities. In addition, various derivative financial instruments are used to modify the interest rate risk exposures of certain assets and liabilities. These strategies include the use of interest rate swaps, interest rate caps and floors, options, futures, forwards and commitments to purchase securities. These instruments are generally used to lock interest rates or market values, to shorten or lengthen durations of fixed maturity securities or investment contracts, or to hedge (on an economic basis) interest rate risks associated with investments and variable rate debt. The Company infrequently designates these types of instruments as hedges against specific assets or liabilities.
The Company is exposed to equity price risk as a result of its investment in equity securities and equity derivatives. Equity price risk results from changes in the level or volatility of equity prices, which affect the value of equity securities, or instruments that derive their value from such securities. The Company attempts to mitigate its exposure to such risks by limiting its investment in any one security or index. The Company may also manage this risk by utilizing instruments such as options, swaps, futures and collars to protect appreciation in securities held.
The Company has exposure to credit risk arising from the uncertainty associated with a financial instrument obligors ability to make timely principal and/or interest payments. The Company attempts to mitigate this risk by limiting credit concentrations, practicing diversification, and frequently monitoring the credit quality of issuers and counterparties. In addition, the Company may utilize credit derivatives such as credit default swaps (CDS) to modify the credit risk inherent in certain investments. CDS involve a transfer of credit risk from one party to another in exchange for periodic payments.
Foreign exchange rate risk arises from the possibility that changes in foreign currency exchange rates will impact the fair value of financial instruments denominated in a foreign currency. The Companys foreign transactions are primarily denominated in Australian dollars, Brazilian reais, British pounds, Canadian dollars and the European Monetary Unit. The Company typically manages this risk via asset/liability currency matching and through the use of foreign currency futures and forwards. Beginning in May of 2009, Diamond Offshore began a hedging strategy and designated certain of its qualifying foreign currency forward exchange contracts as cash flow hedges.
In addition to the derivatives used for risk management purposes described above, the Company may also use derivatives for purposes of income enhancement. Income enhancement transactions are entered into with the intention of providing additional income or yield to a particular portfolio segment or instrument. Income enhancement transactions are limited in scope and primarily involve the sale of covered options in which the Company receives a premium in exchange for selling a call or put option.
The Company will also use CDS to sell credit protection against a specified credit event. In selling credit protection, CDS are used to replicate fixed income securities when credit exposure to certain issuers is not available or when it is economically beneficial to transact in the derivative market compared to the cash market alternative. Credit risk includes both the default event risk and market value exposure due to fluctuations in credit spreads. In selling CDS protection, the Company receives a periodic premium in exchange for providing credit protection on a single name reference obligation or a credit derivative index. If there is an event of default as defined by the CDS agreement, the Company is required to pay the counterparty the referenced notional amount of the CDS contract and in exchange the Company is entitled to receive the referenced defaulted security or the cash equivalent.
The table below summarizes CDS contracts where the Company sold credit protection as of September 30, 2009. The fair value of these contracts represents the amount that the Company would have to pay to exit these derivative
27
positions. The maximum amount of future payments assumes no residual value in the defaulted securities that the Company would receive as part of the contract terminations and is equal to the notional value of the CDS contracts. The largest single reference obligation as of September 30, 2009 represented 75.8% of the total notional value and was rated BBB.
September 30, 2009 | Fair Value of Credit Default |
Maximum Amount of Future Payments under Credit Default Swaps |
Weighted Average Years | |||||
(In millions of dollars) | ||||||||
BBB |
$ | 25 | 0.2 | |||||
B |
8 | 3.4 | ||||||
Total |
$ | - | $ | 33 | 1.0 |
Credit exposure associated with non-performance by the counterparties to derivative instruments is generally limited to the uncollateralized fair value of the asset related to the instruments recognized on the Consolidated Condensed Balance Sheets. The Company attempts to mitigate the risk of non-performance by monitoring the creditworthiness of counterparties and diversifying derivatives to multiple counterparties. The Company generally requires that all over-the-counter derivative contracts be governed by an International Swaps and Derivatives Association (ISDA) Master Agreement, and exchanges collateral under the terms of these agreements with its derivative investment counterparties depending on the amount of the exposure and the credit rating of the counterparty. The Company does not offset its net derivative positions against the fair value of the collateral provided. The fair value of collateral provided by the Company was $16 million at September 30, 2009 and primarily consisted of cash and U.S. Treasury Bills. The fair value of cash collateral received from counterparties was $2 million at September 30, 2009.
The agreements governing HighMounts derivative instruments contain certain covenants, including a maximum debt to capitalization ratio. If HighMount does not comply with these covenants, the counterparties to the derivative instruments could terminate the agreements and request payment on those derivative instruments in net liability positions. The aggregate fair value of HighMounts derivative instruments that are in a liability position was $169 million at September 30, 2009. HighMount was not required to post any collateral under the governing agreements.
See Note 3 for information regarding the fair value of derivative instruments.
28
A summary of the aggregate contractual or notional amounts and gross estimated fair values related to derivative financial instruments follows. Equity options purchased are included in Equity securities, and all other derivative assets are reported as Receivables. Derivative liabilities are included in Payable to brokers on the Consolidated Condensed Balance Sheets. Embedded derivative instruments subject to bifurcation are reported together with the host contract, at fair value. The contractual or notional amounts for derivatives are used to calculate the exchange of contractual payments under the agreements and may not be representative of the potential for gain or loss on these instruments.
September 30, 2009 | ||||||||||
Contractual/ Notional Amount |
Estimated Fair Value | |||||||||
Asset | (Liability) | |||||||||
(In millions) | ||||||||||
With hedge designation |
||||||||||
Interest rate risk: |
||||||||||
Interest rate swaps |
$ | 1,600 | $ | (149 | ) | |||||
Foreign exchange: |
||||||||||
Forwards short |
85 | $ | 6 | |||||||
Commodities: |
||||||||||
Forwards short |
611 | 55 | (21 | ) | ||||||
Options purchased |
12 | |||||||||
written |
9 | 4 | ||||||||
Without hedge designation |
||||||||||
Equity markets: |
||||||||||
Options purchased |
212 | 49 | ||||||||
written |
249 | (16 | ) | |||||||
Interest rate risks: |
||||||||||
Interest rate swaps short |
500 | (1 | ) | |||||||
Futures short |
304 | |||||||||
Credit default swaps purchased protection |
159 | 2 | (12 | ) | ||||||
sold protection |
33 | |||||||||
Other |
13 | |||||||||
Total |
$ | 3,787 | $ | 116 | $ | (199 | ) |
Derivatives without hedge designation For derivatives not held in a trading portfolio, new derivative transactions entered into totaled approximately $7.7 billion and $18.2 billion in notional value while derivative termination activity totaled approximately $8.1 billion and $19.5 billion during the three and nine months ended September 30, 2009. The activity during the three and nine months ended September 30, 2009 was primarily attributable to interest rate futures, interest rate options and interest rate swaps.
29
A summary of the recognized gains (losses) related to derivative financial instruments without hedge designation follows. The derivatives held for trading purposes were carried at fair value with the related gains and losses included within Net investment income on the Consolidated Condensed Statements of Operations.
Three Months Ended September 30, 2009 |
Nine Months Ended September 30, 2009 |
|||||||
(In millions) | ||||||||
Included in Net investment income: |
||||||||
Equity markets: |
||||||||
Options purchased |
$ | (19 | ) | $ | (39 | ) | ||
written |
17 | 47 | ||||||
Futures long |
2 | 13 | ||||||
Currency forwards long |
(6 | ) | ||||||
short |
1 | 8 | ||||||
Interest rate risk: |
||||||||
Credit default swaps purchased protection |
(20 | ) | (8 | ) | ||||
sold protection |
20 | 12 | ||||||
Options on government securities short |
(7 | ) | 7 | |||||
Futures long |
5 | |||||||
short |
(5 | ) | (16 | ) | ||||
Other |
(9 | ) | (3 | ) | ||||
Included in Investment gains (losses): |
||||||||
Equity options written |
15 | |||||||
Interest rate risk: |
||||||||
Interest rate swaps |
59 | |||||||
Credit default swaps purchased protection |
(11 | ) | (46 | ) | ||||
sold protection |
2 | |||||||
Futures short |
(2 | ) | 21 | |||||
Included in Other revenues: |
||||||||
Currency forwards - short |
9 | |||||||
Total |
$ | (33 | ) | $ | 80 |
Cash flow hedges A significant portion of the Companys hedge strategies represents cash flow hedges of the variable price risk associated with the purchase and sale of natural gas and other energy-related products. As of September 30, 2009, approximately 88.6 billion cubic feet of natural gas equivalents was hedged by qualifying cash flow hedges. Approximately 80.4% of these derivatives have settlement dates in 2009 and 2010. The Company and certain of its subsidiaries also use interest rate swaps to hedge its exposure to variable interest rates or risk attributable to changes in interest rates on long term debt. The effective portion of the hedges is amortized to interest expense over the term of the related notes. Any ineffectiveness is recorded currently in Investment gains (losses) in the Consolidated Condensed Statements of Operations. For the three and nine months ended September 30, 2009, the net amounts recognized due to ineffectiveness were less than $1 million.
30
The following table summarizes the effective portion of the net derivative gains or losses included in OCI and the amount reclassified into Net income for derivatives designated as cash flow hedges:
Three Months Ended September 30, 2009 | Amount of Gain (Loss) Recognized in OCI |
Location of Gain (Loss) Reclassified from OCI into Income |
Amount of Gain (Loss) Reclassified from OCI into Income |
|||||||
(In millions) | ||||||||||
Commodities |
$ | (13 | ) | Other revenues | $ | 67 | ||||
Foreign exchange |
2 | Contract drilling expenses | 2 | |||||||
Interest rate risks |
(23 | ) | Interest | (19 | ) | |||||
Total |
$ | (34 | ) | $ | 50 | |||||
Nine Months Ended September 30, 2009 | ||||||||||
(In millions) | ||||||||||
Commodities |
$ | 90 | Other revenues |
$ | 206 | |||||
Foreign exchange |
8 | Contract drilling expenses |
2 | |||||||
Interest rate risks |
(19 | ) | Interest |
(50 | ) | |||||
Total |
$ | 79 | $ | 158 |
The Company also enters into short sales as part of its portfolio management strategy. Short sales are commitments to sell a financial instrument not owned at the time of sale, usually done in anticipation of a price decline. These sales resulted in proceeds of $1,073 million with fair value liabilities of $1,087 million at September 30, 2009. These positions are marked to market and gains or losses are included in the Consolidated Condensed Statements of Operations.
5. Earnings Per Share
Companies with complex capital structures are required to present basic and diluted earnings per share. Basic earnings per share excludes dilution and is computed by dividing net income (loss) attributable to each class of common stock by the weighted average number of common shares of each class of common stock outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock.
Prior to the disposal of its entire ownership interest in Lorillard, the Company had two classes of common stock: former Carolina Group stock, a tracking stock intended to reflect the economic performance of a group of the Companys assets and liabilities, called the former Carolina Group, principally consisting of Lorillard, Inc. and Loews common stock, representing the economic performance of the Companys remaining assets, including the interest in the former Carolina Group not represented by former Carolina Group stock.
The attribution of income (loss) to each class of common stock for the three and nine months ended September 30, 2009 and 2008 was as follows:
Three Months Ended September 30, |
Nine Months Ended September 30, |
|||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||
(In millions, except %) | ||||||||||||||
Loews common stock: |
||||||||||||||
Consolidated net income (loss) - Loews |
$ | 468 | $ | (137 | ) | $ | 161 | $ | 5,488 | |||||
Less income attributable to former Carolina Group stock |
211 | |||||||||||||
Income (loss) |
$ | 468 | $ | (137 | ) | $ | 161 | $ | 5,277 | |||||
Former Carolina Group stock: |
||||||||||||||
Income available to former Carolina Group stock |
$ | 339 | ||||||||||||
Weighted average economic interest of the former Carolina Group |
62.4 | % | ||||||||||||
Income attributable to former Carolina Group stock |
$ | - | $ | - | $ | - | $ | 211 |
31
The following is a reconciliation of basic weighted shares outstanding to diluted weighted shares:
Three Months Ended September 30, |
Nine Months Ended September 30, | |||||||
2009 | 2008 | 2009 | 2008 | |||||
(In millions) | ||||||||
Loews common stock: |
||||||||
Weighted average shares outstanding-basic |
432.75 | 436.32 | 434.30 | 491.19 | ||||
Stock options and stock appreciation rights |
0.73 | 0.59 | 1.21 | |||||
Weighted average shares outstanding-diluted |
433.48 | 436.32 | 434.89 | 492.40 | ||||
Former Carolina Group stock: |
||||||||
Weighted average shares outstanding-basic |
108.47 | |||||||
Stock options and stock appreciation rights |
0.13 | |||||||
Weighted average shares outstanding-diluted |
- | - | - | 108.60 |
Certain options and SARs were not included in the diluted weighted shares amount due to the exercise price being greater than the average stock price for the respective periods. For the three months ended September 30, 2008, as a result of the net loss, no potential shares attributable to exercises under stock-based employee compensation plans were included in the calculation of loss per share as the effect would have been antidilutive. The number of weighted average shares not included in the diluted computations is as follows:
Three Months Ended September 30, |
Nine Months Ended September 30, | |||||||
2009 | 2008 | 2009 | 2008 | |||||
Loews common stock |
3,052,572 | 5,343,396 | 3,347,638 | 1,337,264 | ||||
Former Carolina Group stock |
- | - | - | 255,983 |
6. Receivables
September 30, 2009 |
December 31, 2008 | |||||
(In millions) | ||||||
Reinsurance |
$ | 7,001 | $ | 7,761 | ||
Other insurance |
1,931 | 2,039 | ||||
Receivable from brokers |
1,331 | 936 | ||||
Accrued investment income |
434 | 360 | ||||
Federal income taxes |
465 | 382 | ||||
Other |
984 | 844 | ||||
Total |
12,146 | 12,322 | ||||
Less: allowance for doubtful accounts on reinsurance receivables |
357 | 366 | ||||
allowance for other doubtful accounts |
267 | 284 | ||||
Receivables |
$ | 11,522 | $ | 11,672 |
32
7. Property, Plant and Equipment
September 30, 2009 |
December 31, 2008 | |||||
(In millions) | ||||||
Land |
$ | 70 | $ | 70 | ||
Buildings and building equipment |
646 | 635 | ||||
Offshore drilling equipment |
6,418 | 5,668 | ||||
Machinery and equipment |
1,233 | 1,375 | ||||
Pipeline equipment |
6,401 | 3,978 | ||||
Natural gas and oil proved and unproved properties |
3,482 | 3,345 | ||||
Construction in process |
748 | 2,210 | ||||
Leaseholds and leasehold improvements |
79 | 75 | ||||
Total |
19,077 | 17,356 | ||||
Less accumulated depreciation, depletion and amortization |
5,877 | 4,464 | ||||
Property, plant and equipment |
$ | 13,200 | $ | 12,892 |
Diamond Offshore
During 2009, Diamond Offshore acquired the Ocean Courage and the Ocean Valor, two newbuild, semisubmersible drilling rigs for an aggregate cost of $950 million, exclusive of final commissioning and initial mobilization costs, drill string and other necessary capital spares. Final payment for the Ocean Valor was funded on September 30, 2009 and the purchase of the rig was completed on October 1, 2009. Therefore, the $490 million disbursed on September 30, 2009 has been presented in Construction in process.
HighMount Impairment of Natural Gas and Oil Properties
At March 31, 2009, HighMount recorded a non-cash ceiling test impairment charge of $1,036 million ($660 million after tax) related to its carrying value of natural gas and oil properties. The impairment was recorded as a credit to Accumulated depreciation, depletion and amortization. The write-down was the result of declines in commodity prices at March 31, 2009. Had the effects of HighMounts cash flow hedges not been considered in calculating the ceiling limitation, the impairment would have been $1,230 million ($784 million after tax).
Boardwalk Pipeline Expansion Projects
In 2009, Boardwalk Pipeline placed in service its Gulf Crossing project and Fayetteville and Greenville Laterals and the remaining compression facilities associated with its Southeast Expansion project. Additionally, Boardwalk Pipeline placed into service the remaining portion of Phase III of the western Kentucky Storage expansion project. As a result, approximately $2.4 billion was transferred from Construction in process to Pipeline equipment. The assets will generally be depreciated over a term of 35 years.
8. Claim and Claim Adjustment Expense Reserves
CNAs property and casualty insurance claim and claim adjustment expense reserves represent the estimated amounts necessary to resolve all outstanding claims, including claims that are incurred but not reported (IBNR) as of the reporting date. CNAs reserve projections are based primarily on detailed analysis of the facts in each case, CNAs experience with similar cases and various historical development patterns. Consideration is given to such historical patterns as field reserving trends and claims settlement practices, loss payments, pending levels of unpaid claims and product mix, as well as court decisions, economic conditions and public attitudes. All of these factors can affect the estimation of claim and claim adjustment expense reserves.
Establishing claim and claim adjustment expense reserves, including claim and claim adjustment expense reserves for catastrophic events that have occurred, is an estimation process. Many factors can ultimately affect the final settlement of a claim and, therefore, the necessary reserve. Changes in the law, results of litigation, medical costs, the cost of repair materials and labor rates can all affect 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. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably estimable than long-tail claims, such as general liability and professional liability claims. Adjustments to prior year reserve estimates, if necessary, are reflected in the results of operations in the period that the need for such adjustments is determined.
33
Catastrophes are an inherent risk of the property and casualty insurance business and have contributed to material period-to-period fluctuations in the Companys results of operations and/or equity. CNA reported catastrophe losses, net of reinsurance, of $23 million and $79 million for the three and nine months ended September 30, 2009 for events occurring in those periods. Catastrophe losses in 2009 related primarily to tornadoes, floods, hail and wind. CNA reported catastrophe losses, net of reinsurance, of $248 million and $348 million for the three and nine months ended September 30, 2008 for events occurring in those periods. Catastrophe losses in 2008 related primarily to Hurricanes Gustav and Ike. There can be no assurance that CNAs ultimate cost for catastrophes will not exceed current estimates.
The following provides discussion of CNAs asbestos and environmental pollution (A&E) reserves.
A&E Reserves
CNAs property and casualty insurance subsidiaries have actual and potential exposures related to A&E claims. The following table provides data related to CNAs A&E claim and claim adjustment expense reserves.
September 30, 2009 | December 31, 2008 | |||||||||||||||
Asbestos | Environmental Pollution |
Asbestos | Environmental Pollution |
|||||||||||||
(In millions) | ||||||||||||||||
Gross reserves |
$ | 1,912 | $ | 345 | $ | 2,112 | $ | 392 | ||||||||
Ceded reserves |
(821 | ) | (119 | ) | (910 | ) | (130 | ) | ||||||||
Net reserves |
$ | 1,091 | $ | 226 | $ | 1,202 | $ | 262 |
Asbestos
There was no asbestos-related net claim and claim adjustment expense reserve development recorded for the nine months ended September 30, 2009. CNA recorded $18 million of unfavorable asbestos-related net claim and claim adjustment expense reserve development for the nine months ended September 30, 2008. CNA paid asbestos-related claims, net of reinsurance recoveries, of $111 million and $125 million for the nine months ended September 30, 2009 and 2008.
The ultimate cost of reported claims, and in particular A&E claims, is subject to a great many uncertainties, including future developments of various kinds that CNA does not control and that are difficult or impossible to foresee accurately. With respect to the litigation identified, pending rulings are critical to the evaluation of the ultimate cost to CNA. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.
Some asbestos-related defendants have asserted that their insurance policies are not subject to aggregate limits on coverage. CNA has such claims from a number of insureds. Some of these claims involve insureds facing exhaustion of products liability aggregate limits in their policies, who have asserted that their asbestos-related claims fall within so-called non-products liability coverage contained within their policies rather than products liability coverage, and that the claimed non-products coverage is not subject to any aggregate limit. It is difficult to predict the ultimate size of any of the claims for coverage purportedly not subject to aggregate limits or predict to what extent, if any, the attempts to assert non-products claims outside the products liability aggregate will succeed. CNAs policies also contain other limits applicable to these claims and CNA has additional coverage defenses to certain claims. CNA has attempted to manage its asbestos exposure by aggressively seeking to settle claims on acceptable terms. There can be no assurance that any of these settlement efforts will be successful, or that any such claims can be settled on terms acceptable to CNA. Where CNA cannot settle a claim on acceptable terms, CNA aggressively litigates the claim. However, adverse developments with respect to such matters could have a material adverse effect on the Companys results of operations and/or equity.
34
Certain asbestos claim litigation in which CNA is currently engaged is described below:
A.P. Green. On February 13, 2003, CNA announced it had resolved asbestos-related coverage litigation and claims involving A.P. Green Industries, A.P. Green Services and BigelowLiptak Corporation. Under the agreement, CNA is required to pay $70 million, net of reinsurance recoveries, over a ten year period commencing after the final approval of a bankruptcy plan of reorganization. The settlement received initial bankruptcy court approval on August 18, 2003. The debtors plan of reorganization includes an injunction to protect CNA from any future claims. The bankruptcy court issued an opinion on September 24, 2007 recommending confirmation of that plan. On July 25, 2008, the District Court affirmed the Bankruptcy Courts ruling. Several insurers have appealed that ruling to the Third Circuit Court of Appeals; that appeal was argued on May 21, 2009 and the parties are awaiting the courts decision.
Keasbey. CNA is engaged in insurance coverage litigation in New York State Court, filed in 2003, with a defendant class of underlying plaintiffs who have asbestos bodily injury claims against the former Robert A. Keasbey Company (Keasbey) (Continental Casualty Co. v. Employers Ins. of Wausau et al., No. 601037/03 (N.Y. County)). Keasbey, currently a dissolved corporation, was a seller and installer of asbestos-containing insulation products in New York and New Jersey. Thousands of plaintiffs have filed bodily injury claims against Keasbey. However, under New York court rules, asbestos claims are not cognizable unless they meet certain minimum medical impairment standards. Since 2002, when these court rules were adopted, only a small portion of such claims have met medical impairment criteria under New York court rules and as to the remaining claims, Keasbeys involvement at a number of work sites is a highly contested issue.
CNA issued Keasbey primary policies for 1970-1987 and excess policies for 1971-1978. CNA has paid an amount substantially equal to the policies aggregate limits for products and completed operations claims in the confirmed CNA policies. Claimants against Keasbey allege, among other things, that CNA owes coverage under sections of the policies not subject to the aggregate limits, an allegation CNA vigorously contests in the lawsuit. In the litigation, CNA and the claimants seek declaratory relief as to the interpretation of various policy provisions.
On December 30, 2008, a New York appellate court entered a unanimous decision in favor of CNA on multiple alternative grounds including findings that claims arising out of Keasbeys asbestos insulating activities are included within the products hazard/completed operations coverage, which has been exhausted; and that the defendant claimant class is subject to the affirmative defenses that CNA may have had against Keasbey, barring all coverage claims. The New York Court of Appeals has denied leave for a further appeal and, subject to a motion to reargue, the December 30, 2008 ruling in favor of CNA is final.
Burns & Roe. CNA has insurance coverage disputes related to asbestos bodily injury claims against a bankrupt insured, Burns & Roe Enterprises, Inc. (Burns & Roe). CNA allegedly provided primary liability coverage to Burns & Roe from 1956-1969 and 1971-1974, along with certain project-specific policies from 1964-1970. In September of 2007, CNA entered into an agreement in the Burns & Roe bankruptcy proceeding which provides that claims allegedly covered by CNA policies will be adjudicated in the tort system, with any coverage disputes related to those claims to be decided in coverage litigation. That agreement was included in the Burns & Roe Bankruptcy Plan which became final on June 15, 2009 and was not appealed. The potential outcome will depend on whether the plaintiffs can successfully prosecute their claims in the tort system and, further, whether those claims are covered by the CNA policies. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.
Direct Action Case Montana. On March 22, 2002, a direct action was filed in Montana (Pennock, et al. v. Maryland Casualty, et al. First Judicial District Court of Lewis & Clark County, Montana) by eight individual plaintiffs (all employees of W.R. Grace & Co. (W.R. Grace)) and their spouses against CNA, Maryland Casualty and the State of Montana. This action alleges that the carriers failed to warn of or otherwise protect W.R. Grace employees from the dangers of asbestos at a W.R. Grace vermiculite mining facility in Libby, Montana. The Montana direct action is currently stayed because of W.R. Graces pending bankruptcy. On April 7, 2008, W.R. Grace announced a settlement in principle with the asbestos personal injury claimants committee subject to confirmation of a plan of reorganization by the bankruptcy court. The confirmation hearing is held in two phases. The first phase was held in June 2009. The second phase began in September 2009 and will continue through January 2010. The settlement in principle with the asbestos claimants has no present impact on the stay currently imposed on the Montana direct action and with respect to such claims, numerous factual and legal issues remain to be resolved that are critical to the final result, the outcome of which cannot be predicted with any reliability. These factors include: (i) the unclear nature and scope of any alleged duties owed to people exposed to asbestos and the resulting uncertainty as to the potential pool of potential claimants; (ii) the potential application of Statutes of
35
Limitation to many of the claims which may be made depending on the nature and scope of the alleged duties; (iii) the unclear nature of the required nexus between the acts of the defendants and the right of any particular claimant to recovery; (iv) the diseases and damages claimed by such claimants; (v) the extent that such liability would be shared with other potentially responsible parties; and (vi) the impact of bankruptcy proceedings on claims resolution. Accordingly, the extent of losses beyond any amounts that may be accrued are not readily determinable at this time.
CNA is vigorously defending these and other cases and believes that it has meritorious defenses to the claims asserted. However, there are numerous factual and legal issues to be resolved in connection with these claims, and it is extremely difficult to predict the outcome or ultimate financial exposure represented by these matters. Adverse developments with respect to any of these matters could have a material adverse effect on CNAs business, insurer financial strength and debt ratings, and the Companys results of operations and/or equity.
Environmental Pollution
There was no environmental pollution net claim and claim adjustment expense reserve development recorded for the nine months ended September 30, 2009. CNA recorded $3 million of unfavorable environmental pollution net claim and claim adjustment expense reserve development for the nine months ended September 30, 2008. CNA paid environmental pollution-related claims, net of reinsurance recoveries, of $36 million and $51 million for the nine months ended September 30, 2009 and 2008.
Net Prior Year Development
The following tables and discussion include the net prior year development recorded for Standard Lines, Specialty Lines and Other Insurance. Favorable net prior year development of $75 million was recorded in the Life & Group Non-Core segment for the nine months ended September 30, 2009. Included in this amount is the impact of a settlement reached in September of 2009 with Willis Limited that resolves litigation related to the placement of personal accident reinsurance. Under the settlement agreement, Willis Limited agreed to pay CNA a total of $130 million, which is reported as a loss recovery of $94 million, net of reinsurance. For the nine months ended September 30, 2008 for the Life & Group Non-Core segment, unfavorable net prior year development of $10 million was recorded.
The net prior year development presented below includes premium development due to its direct relationship to claim and allocated claim adjustment expense reserve development. The net prior year development presented below includes the impact of commutations, but excludes the impact of increases or decreases in the allowance for uncollectible reinsurance.
Three Month Comparison
Three Months Ended September 30, 2009 | Standard Lines |
Specialty Lines |
Other Insurance |
Total | |||||||||||
(In millions) | |||||||||||||||
Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development: |
|||||||||||||||
Core (Non-A&E) |
$ | (13 | ) | $ | (47 | ) | $ | 1 | $ | (59 | ) | ||||
A&E |
|||||||||||||||
Pretax (favorable) unfavorable net prior year development before impact of premium development |
(13 | ) | (47 | ) | 1 | (59 | ) | ||||||||
Pretax (favorable) unfavorable premium development |
12 | 12 | |||||||||||||
Total pretax (favorable) unfavorable net prior year development |
$ | (1 | ) | $ | (47 | ) | $ | 1 | $ | (47 | ) |
36
Three Months Ended September 30, 2008 | Standard Lines |
Specialty Lines |
Other Insurance |
Total | ||||||||||||
(In millions) | ||||||||||||||||
Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development: |
||||||||||||||||
Core (Non-A&E) |
$ | (4 | ) | $ | (68 | ) | $ | 1 | $ | (71 | ) | |||||
A&E |
13 | 13 | ||||||||||||||
Pretax (favorable) unfavorable net prior year development before impact of premium development |
(4 | ) | (68 | ) | 14 | (58 | ) | |||||||||
Pretax (favorable) unfavorable premium development |
3 | (2 | ) | (3 | ) | (2 | ) | |||||||||
Total pretax (favorable) unfavorable net prior year development |
$ | (1 | ) | $ | (70 | ) | $ | 11 | $ | (60 | ) |
2009 Net Prior Year Development
Standard Lines
The favorable claim and allocated claim adjustment expense reserve development was primarily due to favorable experience in general liability, partially offset by unfavorable experience in workers compensation.
Approximately $56 million of favorable development was primarily due to claims closing favorable to expectations on non-construction defect general liability exposures in accident years 2003 and prior.
Approximately $47 million of unfavorable development was due to increased paid and incurred severity on workers compensation business, primarily in accident years 2004, 2007 and 2008 on small and middle markets business.
Specialty Lines
The favorable claim and allocated claim adjustment expense reserve development was primarily due to favorable experience in professional liability, directors and officers and surety business.
Approximately $20 million of favorable development was recorded for professional liability coverages driven by lower than expected large claim frequency, primarily related to accountants and lawyers in accident years 2004 through 2006. Approximately $11 million of favorable development was primarily related to directors and officers coverages in accident years 2003 through 2006. This favorable development related primarily to lower than expected large claim frequency. An additional $7 million of favorable development was recorded for surety business primarily in accident years 2004, due to claims closing favorable to expectations, and 2006, due to lower than expected claim frequency.
2008 Net Prior Year Development
Standard Lines
The favorable claim and allocated claim adjustment expense reserve development was primarily due to favorable experience in general liability and property coverages offset by unfavorable experience in workers compensation (including excess workers compensation coverages) and large account business.
For general liability excluding construction defect, $228 million in favorable claim and allocated claim adjustment expense reserve development was due to decreased frequency and severity of claims across multiple accident years. The improvement was due to underwriting initiatives and favorable outcomes on individual claims. Favorable development of $207 million associated with construction defect exposures was due to lower severity resulting from various claim handling initiatives and lower than expected frequency of claims, primarily in accident years 1999 and prior. Claims handling initiatives have resulted in an increase in the number of claims closed without payment and increased recoveries from other parties involved in the claims. The lower construction defect frequency is due to underwriting initiatives designed to limit the exposure to future construction defect claims. For property exposures, $31 million of favorable development was primarily the result of decreased frequency and severity in recent years. The remaining favorable development was the result of favorable experience across several miscellaneous coverages in Standard Lines.
37
Unfavorable development of $248 million for workers compensation was primarily the result of the impact of claim cost inflation on lifetime medical and home health care claims in accident years 1999 and prior. The changes were driven by increased life expectancy due to advances in medical care and increasing medical inflation. Unfavorable development of $161 million for large account business was also driven primarily by workers compensation claim cost inflation primarily in accident years 2001 and prior. Unfavorable development of $90 million on excess workers compensation was due to claims in accident years 2002 and prior. Increasing medical inflation, increased life expectancy resulting from advances in medical care, and reviews of individual claims have resulted in higher cost estimates of existing claims and a higher estimate of the number of claims expected to reach excess layers. The remaining unfavorable development was driven primarily by commercial auto liability coverages in recent accident years due to an increase in frequency.
Specialty Lines
The favorable claim and allocated claim adjustment expense reserve development was primarily due to favorable experience in medical professional liability and surety business, partially offset by unfavorable experience in professional liability coverages.
Favorable claim and allocated claim adjustment expense reserve development of approximately $52 million for medical professional liability was primarily due to better than expected frequency of large losses in accident years 2005 and 2006 for healthcare facilities and medical technology firms. Favorable development of approximately $22 million for surety coverages was due to better than expected frequency in accident years 2002 through 2006. The remaining favorable development was due primarily to favorable outcomes on individual claims in accident years 2004 through 2006 for miscellaneous professional and general liability coverages.
Unfavorable development of approximately $18 million for professional liability coverages was primarily due to an increase in the frequency of large claims in older accident years.
Other Insurance
The unfavorable claim and allocated claim adjustment expense reserve development was primarily related to the commutation of a ceded reinsurance arrangement. The unfavorable development was offset by a release of a previously established allowance for uncollectible reinsurance.
Nine Month Comparison
Nine Months Ended September 30, 2009 | Standard Lines |
Specialty Lines |
Other Insurance |
Total | ||||||||||||
(In millions) | ||||||||||||||||
Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development: |
||||||||||||||||
Core (Non-A&E) |
$ | (123 | ) | $ | (128 | ) | $ | 6 | $ | (245 | ) | |||||
A&E |
||||||||||||||||
Pretax (favorable) unfavorable net prior year development before impact of premium development |
(123 | ) | (128 | ) | 6 | (245 | ) | |||||||||
Pretax (favorable) unfavorable premium development |
88 | (3 | ) | (3 | ) | 82 | ||||||||||
Total pretax (favorable) unfavorable net prior year development |
$ | (35 | ) | $ | (131 | ) | $ | 3 | $ | (163 | ) |
38
Nine Months Ended September 30, 2008 | Standard Lines |
Specialty Lines |
Other Insurance |
Total | ||||||||||||
(In millions) | ||||||||||||||||
Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development: |
||||||||||||||||
Core (Non-A&E) |
$ | (54 | ) | $ | (50 | ) | $ | 9 | $ | (95 | ) | |||||
A&E |
21 |