CNA FINANCIAL CORP - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2004


o	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 1-5823

CNA FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)


Delaware		36-6169860
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

CNA Plaza
Chicago, Illinois		60685
(Address of principal executive offices)		(Zip Code)

(312) 822-5000
(Registrant’s telephone number, including area code)

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 ü No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes ü No o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.


Class	Outstanding at April 26, 2004
Common Stock, Par value $2.50		255,946,852

CNA FINANCIAL CORPORATION
PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)


	March 31,			December 31,
	2004			2003
(In millions, except share data)
Assets
Investments:
Fixed maturity securities at fair value (amortized cost of $27,432 and $27,564)	$	28,691		$	28,678
Equity securities at fair value (cost of $239 and $293)		504			527
Mortgage loans and real estate (less accumulated depreciation of $11 and $10)		25			25
Policy loans		1			175
Limited partnership investments		1,659			1,117
Other invested assets		14			40
Short-term investments, at cost which approximates fair value		6,127			7,538

Total investments		37,021			38,100
Cash		81			139
Reinsurance receivables (less allowance for doubtful accounts of $591 and $573)		14,238			15,681
Insurance receivables (less allowance for doubtful accounts of $390 and $375)		2,732			2,695
Accrued investment income		302			323
Receivables for securities sold		1,124			836
Deferred acquisition costs		1,345			2,533
Prepaid reinsurance premiums		1,148			1,252
Federal income taxes recoverable (includes $496 and $594 due from Loews Corporation)		506			607
Deferred income taxes		649			600
Property and equipment at cost (less accumulated depreciation of $657 and $727)		280			314
Goodwill and other intangible assets		162			162
Assets related to businesses held for sale		6,291			—
Other assets		936			1,583
Separate account business		745			3,678

Total assets	$	67,560		$	68,503

Liabilities and Stockholders’ Equity
Liabilities:
Insurance reserves:
Claim and claim adjustment expense	$	31,183		$	31,730
Unearned premiums		4,833			4,891
Future policy benefits		4,503			8,161
Policyholders’ funds		1,853			601
Collateral on loaned securities and derivatives		371			442
Payables for securities purchased		1,586			1,902
Participating policyholders’ funds		117			118
Short term debt		264			263
Long term debt (includes $346 and $0 of surplus notes due to Loews Corporation)		1,980			1,641
Reinsurance balances payable		3,329			3,432
Liabilities related to businesses held for sale		5,471			—
Other liabilities		2,152			2,436
Separate account business		745			3,678

Total liabilities		58,387			59,295

Commitments and contingencies (Notes F, G, I and K)
Minority interest		263			256
Stockholders’ equity:
Preferred stock (12,500,000 shares authorized)		1,500			1,500
Series H Issue (no par value; $100,000 stated value; 7,500 shares issued; held by Loews Corporation)
Series I Issue (no par value; $23,200 stated value; 32,327 shares issued convertible to 32,327,015 shares of common stock; held by Loews Corporation)
Common stock ($2.50 par value; 500,000,000 shares authorized; 225,850,270 shares issued; and 223,617,337 shares outstanding)		565			565
Additional paid-in capital		1,031			1,031
Retained earnings		5,035			5,160
Accumulated other comprehensive income		924			841
Treasury stock (2,232,933 shares), at cost		(69	)		(69	)

		8,986			9,028
Notes receivable for the issuance of common stock		(76	)		(76	)

Total stockholders’ equity		8,910			8,952

Total liabilities and stockholders’ equity	$	67,560		$	68,503

The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements
(Unaudited).

CNA FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)


Three months ended March 31	2004			2003
(In millions, except per share data)
Revenues
Net earned premiums	$	2,168		$	2,381
Net investment income		473			432
Realized investment losses, net of participating policyholders’ and minority interests		(458	)		(76	)
Other revenues		82			108

Total revenues		2,265			2,845

Claims, Benefits and Expenses
Insurance claims and policyholders’ benefits		1,620			1,870
Amortization of deferred acquisition costs		433			458
Other operating expenses		350			379
Interest		35			34

Total claims, benefits and expenses		2,438			2,741

Income (loss) before income tax and minority interest		(173	)		104
Income tax (expense) benefit		54			(18	)
Minority interest		(6	)		(3	)

Net income (loss)	$	(125	)	$	83

Basic and Diluted Earnings (Loss) Per Share
Basic and diluted earnings (loss) per share available to common stockholders	$	(0.55	)	$	0.30

Weighted average outstanding common stock and common stock equivalents		255.9			223.6

The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements
(Unaudited).

CNA FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)


Three months ended March 31	2004			2003
(In millions)
Cash Flows from Operating Activities
Net income (loss)	$	(125	)	$	83
Adjustments to reconcile net income (loss) to net cash flows provided by operating activities:
Change in bad debt provision for insurance and reinsurance receivables		33			—
Minority interest		6			3
Loss on disposal of property and equipment		—			12
Deferred income tax provision		(77	)		12
Realized investment losses, net of participating policyholders’ and minority interests		458			76
Equity method income		(75	)		(26	)
Amortization of bond discount		1			(21	)
Depreciation		19			24
Changes in:
Receivables		197			(371	)
Deferred acquisition costs		10			(57	)
Accrued investment income		(30	)		(47	)
Federal income taxes payable/recoverable		108			(75	)
Prepaid reinsurance premiums		103			(117	)
Reinsurance balances payable		(71	)		28
Insurance reserves		(365	)		528
Other, net		(151	)		(7	)
Net purchases of trading securities		(4	)		—
Total adjustments		162			(38	)

Net cash flows provided by operating activities		37			45

Cash Flows from Investing Activities
Purchases of fixed maturity securities		(14,475	)		(17,802	)
Proceeds from fixed maturity securities:
Sales		10,867			15,492
Maturities, calls and redemptions		1,443			958
Purchases of equity securities		(30	)		(71	)
Proceeds from sales of equity securities		36			61
Change in short-term investments		1,820			1,668
Change in collateral on loaned securities and derivatives		(71	)		(133	)
Change in other investments		7			4
Purchases of property and equipment		(11	)		(31	)
Other, net		(27	)		(14	)

Net cash flows provided (used) by investing activities		(441	)		132

Net Cash Flows from Financing Activities
Principal payments on debt		(6	)		(129	)
Proceeds from issuance of surplus notes		346			—
Returns and deposits of policyholder account balances on investment contracts		6			(7	)
Other		—			(1	)

Net cash flows provided (used) by financing activities		346			(137	)

Net change in cash		(58	)		40
Cash, beginning of period		139			126

Cash, end of period	$	81		$	166

Supplemental Disclosures of Cash Flow Information:
Cash paid (received):
Interest	$	16		$	19
Federal income taxes		(79	)		63
Non-cash transactions:
Notes receivable for the issuance of common stock		—			1

The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements
(Unaudited).

CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Note A. Basis of Presentation

The Condensed Consolidated Financial Statements (Unaudited) include the accounts of CNA Financial Corporation (CNAF) and its controlled subsidiaries. Collectively, CNAF and its subsidiaries are referred to as CNA or the Company. CNA’s property and casualty insurance operations are primarily conducted by Continental Casualty Company (CCC) and The Continental Insurance Company (CIC). CNA’s life and group insurance operations are primarily conducted by Continental Assurance Company (CAC) and Valley Forge Life Insurance Company (VFL). Loews Corporation (Loews) owned approximately 90% of the outstanding common stock and 100% of the Series H and Series I preferred stock of CNAF as of March 31, 2004. Conversion of the Series I preferred stock into approximately 32.3 million shares of CNAF common stock occurred on April 20, 2004, as a result of which Loews owns approximately 91% of CNAF’s approximately 255.9 million outstanding shares of common stock.

In February of 2004, CNA entered into a definitive agreement to sell its individual life insurance business to Swiss Re Life & Health America Inc. The transaction is expected to be completed on April 30, 2004, subject to certain customary closing conditions. As of March 31, 2004, CNA has classified the assets and liabilities of the individual life insurance business including the Nashville, Tennessee insurance servicing and administration building as assets and liabilities related to businesses held for sale. See Note Q for further information.

CNA Group Life Assurance Company (CNAGLA) was sold to Hartford Financial Services Group, Inc. on December 31, 2003. The results of the group benefits business sold are included in the Condensed Consolidated Statement of Operations for the three months ended March 31, 2003.

The accompanying Condensed Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Certain financial information that is normally included in annual financial statements, including certain financial statement footnotes, prepared in accordance with GAAP, is not required for interim reporting purposes and has been condensed or omitted. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in CNAF’s Form 10-K filed with the Securities and Exchange Commission (SEC) for the year ended December 31, 2003.

The interim financial data as of March 31, 2004 and for the three months ended March 31, 2004 and 2003 is unaudited. However, in the opinion of management, the interim data includes all adjustments, consisting of normal recurring accruals, necessary for a fair statement of the Company’s results for the interim periods. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. All significant intercompany amounts have been eliminated.

Certain amounts applicable to prior periods have been reclassified to conform to the current period presentation.

Note B. Accounting Pronouncements

In January of 2003, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 (FIN 46). In December of 2003, the FASB issued FIN 46 (revised December 2003), Consolidation of Variable Interest Entities, an interpretation of ARB No. 51 (FIN 46R) which replaces FIN 46 and clarifies the application of Accounting Research Bulletin No. 51 Consolidated Financial Statements (ARB 51). As per ARB 51, a general rule for preparation of consolidated financial statements of a parent and its subsidiary is ownership by the parent, either directly or indirectly, of over fifty percent of the outstanding

CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)

voting shares of a subsidiary. However, application of the majority voting interest requirement of ARB 51 to certain types of entities may not identify the party with a controlling financial interest because the controlling financial interest may be achieved through arrangements that do not involve voting interest. FIN 46R clarifies applicability of ARB 51 to entities in which the equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. FIN 46R requires an entity to consolidate a variable interest entity (VIE) even though the entity does not, either directly or indirectly, own over fifty percent of the outstanding voting shares.

FIN 46R is applicable for financial statements issued for reporting periods that end after March 15, 2004. The Company has determined that the adoption of FIN 46R does not have a significant impact on the results of operations or equity of the Company.

In December of 2003, the FASB revised SFAS No. 132, Employers’ Disclosures about Pensions and Other Postretirement Benefits (SFAS 132) to require additional disclosures related to pensions and post retirement benefits. While retaining the existing disclosure requirements for pensions and postretirement benefits, additional disclosures are required related to pension plan assets, obligations, contributions and net benefit costs, beginning with fiscal years ending after December 15, 2003. Additional disclosures pertaining to benefit payments are required for fiscal years ending after June 30, 2004. The SFAS 132 revisions also include additional disclosure requirements for interim financial reports beginning after December 15, 2003. CNA has implemented the revised interim disclosures in these financial statements and will implement the annual benefit payment disclosures in subsequent annual financial statements.

In July of 2003, the Accounting Standards Executive Committee (AcSEC) of the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 03-01, Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts (SOP 03-01). SOP 03-01 provides guidance on accounting and reporting by insurance enterprises for certain nontraditional long-duration contracts and for separate accounts. SOP 03-01 is effective for financial statements for fiscal years beginning after December 15, 2003. SOP 03-01 may not be applied retroactively to prior years’ financial statements, and initial application should be as of the beginning of an entity’s fiscal year, therefore prior year amounts have not been conformed to the current year presentation.

CNA adopted SOP 03-01 as of January 1, 2004. The assets and liabilities of certain guaranteed investment contracts and indexed group annuity contracts that were previously segregated and reported as separate accounts no longer qualify for separate account presentation. Prior to the adoption of SOP 03-01, the asset and liability presentation of these affected contracts were categorized as separate account assets and liabilities in the Condensed Consolidated Balance Sheet. The results of operations from separate account business were primarily classified as other revenue in the Condensed Consolidated Statements of Operations. In accordance with the provisions of SOP 03-01, the classification and presentation of certain balance sheet and income statement items have been modified within these financial statements. Accordingly, the investment securities previously classified as separate account assets have now been reclassified to the general account and will be reported based on their investment classification whether available-for-sale or trading securities. The investment portfolio for the indexed group annuity contracts is classified as held for trading purposes and is carried at fair value, with both the net realized and unrealized gains (losses) included within net investment income in the Condensed Consolidated Statement of Operations.

CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)

The Company continues to have contracts that meet the criteria for separate account presentation. The assets and liabilities of these contracts are legally segregated and reported as assets and liabilities of the separate account business. Substantially all assets of the separate account business are carried at fair value. Separate account liabilities are carried at contract values.

The following table provides the balance sheet presentation of assets and liabilities for certain guaranteed investment contracts and indexed group annuity contracts upon adoption of SOP 03-01, including the classification of the indexed group annuity contract investments as trading securities.


	January 1,		March 31,
	2004		2004 (a)
(In millions)
Assets
Investments:
Fixed maturity securities, available-for-sale	$	1,220	$	1,245
Fixed maturity securities, trading		304		393
Equity securities		4		4
Limited partnerships		419		463
Short term investments, available-for-sale		55		47
Short term investments, trading		414		389

Total investments		2,416		2,541
Accrued investment income		13		12
Receivables for securities sold		97		83
Other assets		1		—

Total assets	$	2,527	$	2,636

Liabilities
Liabilities:
Insurance reserves:
Claim and claim adjustment expense		1		1
Future policy benefits		617		605
Policyholders’ funds		1,324		1,345
Collateral on loaned securities and derivatives		17		2
Payables for securities purchased		43		101
Other liabilities		47		62

Total liabilities	$	2,049	$	2,116

(a) Includes $73 million of Investments transferred to Assets related to Businesses Held for Sale and $72 million of Future Policy Benefits Reserves transferred to Liabilities related to Businesses Held for Sale. See Note Q for further discussion.

Note C. Earnings (Loss) Per Share

Earnings (loss) per share available to common stockholders is based on weighted-average outstanding shares. Basic and diluted earnings per share is computed by dividing income available to common stockholders by the weighted-average number of shares of common stock or common stock equivalents outstanding for the period. The weighted average number of shares outstanding for computing basic and diluted earnings per share was 255.9 million and 223.6 million for the three months ended March 31, 2004 and 2003. Included in the weighted-average outstanding shares in 2004 is the effect of the Series I convertible preferred shares issued during the fourth quarter of 2003. The Series I Issue preferred stock had terms that made it economically equivalent to common stock; therefore the weighted average basic and diluted shares for the three months ended March 31, 2004 include the convertible preferred shares

CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)

assuming conversion to common shares. Conversion of the Series I preferred shares into approximately 32.3 million shares of CNAF common stock occurred on April 20, 2004.

Diluted earnings per share reflect the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. For the three months ended March 31, 2004, approximately one million shares attributable to the exercise of outstanding options were excluded from the calculation of diluted earnings per share because the effect was antidilutive. No shares were excluded from the calculation of diluted earnings per share for the three months ended March 31, 2003, but since the exercise price of these options was greater than the average market price of CNA common stock, these options have no dilutive effect.

The computation of earnings per share was as follows.

Earnings (Loss) Per Share


For the three months ended March 31	2004			2003
(In millions, except per share amounts)
Net income (loss)	$	(125	)	$	83
Less: undeclared preferred stock dividend		(16	)		(15	)

Net income (loss) available to common stockholders	$	(141	)	$	68

Weighted average outstanding common stock and common stock equivalents		255.9			223.6
Effect of dilutive securities, employee stock options		—			—

Adjusted weighted average outstanding common stock and common stock equivalents assuming conversions		255.9			223.6

Basic and diluted earnings (loss) per share available to common stockholders	$	(0.55	)	$	0.30

The Company applies the intrinsic value method by following Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related interpretations, in accounting for its stock-based compensation plan. Under the recognition and measurement principles of APB 25, no stock-based compensation cost has been recognized, as the exercise price of the granted options equaled the market price of the underlying stock at the grant date.

CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)

The following table illustrates the pro forma effect on net income (loss) and earnings (loss) per share, had the Company applied the fair value recognition provisions of SFAS 123 to stock-based employee compensation under the Company’s stock-based compensation plans.

Pro Forma Effect of SFAS 123 on Net Income (Loss) and Earnings (Loss) Per Share


For the three months ended March 31	2004			2003
(In millions, except per share amounts)
Net income (loss), as reported	$	(125	)	$	83
Less: Total stock-based compensation cost determined under the fair value method, net of tax		(1	)		—

Pro forma net income (loss)	$	(126	)	$	83

Less: undeclared preferred stock dividend		(16	)		(15	)

Pro forma net income (loss) available to common stockholders		(142	)		68

Basic and diluted earnings (loss) per share, as reported	$	(0.55	)	$	0.30

Basic and diluted earnings (loss) per share, pro forma	$	(0.55	)	$	0.30

Note D. Investments

The significant components of net investment income are presented in the following table.

Net Investment Income


For the three months ended March 31	2004			2003
(In millions)
Fixed maturity securities	$	407		$	420
Short term investments		16			20
Limited partnerships		75			23
Equity securities		4			5
Income from trading portfolio (a)		20			—
Interest on funds withheld and other deposits		(50	)		(47	)
Other		10			25

Gross investment income		482			446
Investment expense		(9	)		(14	)

Net investment income	$	473		$	432

(a) The change in net unrealized gains on trading securities still held, included in net investment income, was $4 million for the three months ended March 31, 2004.

CNA FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS, Continued
(UNAUDITED)

The components of net realized investment results from available-for-sale securities are presented in the following table.

Net Realized Investment Gains (Losses)


Three months ended March 31	2004			2003
(In millions)
Realized investment gains (losses):
Fixed maturity securities:
U.S. Government bonds	$	10		$	38
Corporate and other taxable bonds		6			(118	)
Tax-exempt bonds		73			19
Asset-backed bonds		39			18
Redeemable preferred stock		1			(5	)

Total fixed maturity securities		129			(48	)
Equity securities		11			—
Derivative securities		(32	)		(22	)
Short term investments		—			4
Impairment loss on Individual Life business (see Note Q)		(569	)		—
Other		4			(13	)

Net realized investment gains (losses) before allocation to participating policyholders’ and minority interests		(457	)		(79	)
Allocated to participating policyholders’ and minority interest		(1	)		3

Realized investment losses	$	(458	)	$	(76	)

Realized investment losses for the three months ended March 31, 2004 included a $569 million pretax impairment loss on assets related to businesses held for sale in connection with the anticipated sale of CNA’s Individual Life business. See Note Q for further discussion of the Individual Life transaction.

Realized investment losses for the three months ended March 31, 2003 included $255 million of pretax impairment losses for other-than-temporary declines in fair values for fixed maturity and equity securities. These impairment losses were primarily for securities in certain market sectors, including the airline, healthcare and energy industries. There were no impairment losses for other-than-temporary declines in fair value for fixed maturity and equity securities for the three months ended March 31, 2004.


Item		Page
Number		Number
	PART I. Financial Information
1.	Condensed Consolidated Financial Statements (Unaudited):
	Condensed Consolidated Balance Sheets at March 31, 2004 and at December 31, 2003		3
	Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2004 and 2003		4
	Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2004 and 2003		5
	Notes to Condensed Consolidated Financial Statements		6
2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		40
3.	Quantitative and Qualitative Disclosures about Market Risk		88
4.	Disclosure Controls and Procedures		94
	PART II. Other Information
1.	Legal Proceedings		95
2.	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities		95
4.	Submission of Matters to a Vote of Security Holders		95
6.	Exhibits and Reports on Form 8-K		95
	Signatures		97