Form 10-Q
Table of Contents

 

 

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 June 30, 2010

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

(Registrant’s 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   ¨     No   x     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 July 23, 2010

Common stock, $0.01 par value     418,252,199 shares

 

 

 


Table of Contents

INDEX

 

 

     Page
No.

Part I.  Financial Information

  

Item 1.  Financial Statements (unaudited)

  

Consolidated Condensed Balance Sheets
June 30, 2010 and December 31, 2009

   3

Consolidated Condensed Statements of Operations
Three and six months ended June 30, 2010 and 2009

   4

Consolidated Condensed Statements of Comprehensive Income
Three and six months ended June  30, 2010 and 2009

   5

Consolidated Condensed Statement of Equity
June 30, 2010

   6

Consolidated Condensed Statements of Cash Flows
Six months ended June 30, 2010 and 2009

   7

Notes to Consolidated Condensed Financial Statements

   9

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

   47

Item 3.  Quantitative and Qualitative Disclosures about Market Risk

   76

Item 4.  Controls and Procedures

   76

Part II.  Other Information

   77

Item 1.  Legal Proceedings

   77

Item 1A.  Risk Factors

   77

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

   79

Item 6.  Exhibits

   80

 

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PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements.

Loews Corporation and Subsidiaries

CONSOLIDATED CONDENSED BALANCE SHEETS

(Unaudited)

 

      June 30,
2010
    December 31,
2009
 
(Dollar amounts in millions, except per share data)             

Assets:

    

Investments:

    

Fixed maturities, amortized cost of $37,729 and $35,824

   $ 38,897      $ 35,816   

Equity securities, cost of $891 and $943

     935        1,007   

Limited partnership investments

     2,256        1,996   

Short term investments

     5,622        7,215   
   

Total investments

     47,710        46,034   

Cash

     91        190   

Receivables

     9,765        10,212   

Property, plant and equipment

     12,626        13,274   

Deferred income taxes

     561        627   

Goodwill

     856        856   

Other assets

     1,908        1,346   

Deferred acquisition costs of insurance subsidiaries

     1,095        1,108   

Separate account business

     447        423   
   

Total assets

   $ 75,059      $ 74,070   
   

Liabilities and Equity:

    

Insurance reserves:

    

Claim and claim adjustment expense

   $ 25,968      $ 26,816   

Future policy benefits

     8,217        7,981   

Unearned premiums

     3,303        3,274   

Policyholders’ funds

     172        192   
   

Total insurance reserves

     37,660        38,263   

Payable to brokers

     308        540   

Short term debt

     247        10   

Long term debt

     8,809        9,475   

Other liabilities

     4,861        4,274   

Separate account business

     447        423   
   

Total liabilities

     52,332        52,985   
   

Preferred stock, $0.10 par value:

    

Authorized – 100,000,000 shares

    

Common stock, $0.01 par value:

    

Authorized – 1,800,000,000 shares

    

Issued – 425,557,499 and 425,497,522 shares

     4        4   

Additional paid-in capital

     3,749        3,637   

Retained earnings

     14,426        13,693   

Accumulated other comprehensive income (loss)

     295        (419
   
     18,474        16,915   

Less treasury stock, at cost (7,305,300 and 427,200 shares)

     (269     (16
   

Total shareholders’ equity

     18,205        16,899   

Noncontrolling interests

     4,522        4,186   
   

Total equity

     22,727        21,085   
   

Total liabilities and equity

   $ 75,059      $ 74,070   
   

See accompanying Notes to Consolidated Condensed Financial Statements.

 

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Loews Corporation and Subsidiaries

CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

 

      Three Months Ended
June 30,
    Six Months Ended
June 30,
 
      2010     2009     2010     2009  
(In millions, except per share data)                         

Revenues:

        

Insurance premiums

   $ 1,608      $ 1,656      $ 3,223      $ 3,328   

Net investment income

     526        735        1,143        1,182   

Investment gains (losses):

        

Other-than-temporary impairment losses

     (58     (484     (148     (1,098

Portion of other-than-temporary impairment losses recognized in Other comprehensive income (loss)

     1        89        31        89   
   

Net impairment losses recognized in earnings

     (57     (395     (117     (1,009

Other net investment gains

     68        98        149        181   
   

Total investment gains (losses)

     11        (297     32        (828

Contract drilling revenues

     812        923        1,656        1,779   

Other

     529        517        1,145        1,096   
   

Total

     3,486        3,534        7,199        6,557   
   

Expenses:

        

Insurance claims and policyholders’ benefits

     1,147        1,295        2,455        2,637   

Amortization of deferred acquisition costs

     345        349        687        698   

Contract drilling expenses

     349        306        654        600   

Impairment of natural gas and oil properties

           1,036   

Other operating expenses

     715        718        1,447        1,494   

Interest

     127        110        257        204   
   

Total

     2,683        2,778        5,500        6,669   
   

Income (loss) before income tax

     803        756        1,699        (112

Income tax (expense) benefit

     (262     (197     (535     198   
   

Net income

     541        559        1,164        86   

Amounts attributable to noncontrolling interests

     (175     (219     (378     (393
   

Net income (loss) attributable to Loews Corporation

   $ 366      $ 340      $ 786      $ (307
   

Basic net income (loss) per share

   $ 0.88      $ 0.78      $ 1.87      $ (0.70
   

Diluted net income (loss) per share

   $ 0.87      $ 0.78      $ 1.87      $ (0.70
   

Dividends per share

   $ 0.0625      $ 0.0625      $ 0.125      $ 0.125   
   

Weighted-average shares outstanding:

        

Shares of common stock

     418.64        435.07        420.69        435.09   

Dilutive potential shares of common stock

     0.74        0.56        0.79     
   

Total weighted-average shares outstanding assuming dilution

     419.38        435.63        421.48        435.09   
   

See accompanying Notes to Consolidated Condensed Financial Statements.

 

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Loews Corporation and Subsidiaries

CONSOLIDATED CONDENSED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

     

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
      2010     2009     2010     2009  
(In millions)                         

Net income

   $ 541      $ 559      $ 1,164      $ 86   
   

Other comprehensive income (loss)

        

Changes in:

        

Net unrealized gains (losses) on investments with other- than-temporary impairments

     17        (34     42        (34

Net other unrealized gains on investments

     373        1,492        680        1,891   
   

Total unrealized gains on available-for-sale investments

     390        1,458        722        1,857   

Unrealized gains (losses) on cash flow hedges

     6        (12     67        3   

Foreign currency

     16        77        6        70   

Pension liability

     2        1        4     
   

Other comprehensive income

     414        1,524        799        1,930   
   

Comprehensive income

     955        2,083        1,963        2,016   

Amounts attributable to noncontrolling interests

     (219     (377     (464     (600
   

Total comprehensive income attributable to Loews Corporation

   $ 736      $ 1,706      $ 1,499      $ 1,416   
   

See accompanying Notes to Consolidated Condensed Financial Statements.

 

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Loews Corporation and Subsidiaries

CONSOLIDATED CONDENSED STATEMENT OF EQUITY

(Unaudited)

 

           Loews Corporation Shareholders        
      Total     Loews
Common
Stock
   Additional
Paid-in
Capital
   Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
   

Common
Stock

Held in
Treasury

    Noncontrolling
Interests
 
(In millions)                                         

Balance, January 1, 2010

   $ 21,085      $ 4    $ 3,637    $ 13,693      $ (419   $ (16   $ 4,186   

Sale of subsidiary common units

     279           83        1          195   

Net income

     1,164              786            378   

Other comprehensive income

     799                713          86   

Dividends paid

     (356           (53         (303

Purchase of Loews treasury stock

     (253               (253  

Issuance of Loews common stock

     1           1         

Stock-based compensation

     11           9            2   

Other

     (3        19            (22
   

Balance, June 30, 2010

   $ 22,727      $ 4    $ 3,749    $ 14,426      $ 295      $ (269   $ 4,522   
   

See accompanying Notes to Consolidated Condensed Financial Statements.

 

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Loews Corporation and Subsidiaries

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

 

Six Months Ended June 30    2010     2009  
(In millions)             

Operating Activities:

    

Net income

   $ 1,164      $ 86   

Adjustments to reconcile net income to net cash provided by operating activities, net

     446        1,849   

Changes in operating assets and liabilities, net:

    

Reinsurance receivables

     374        424   

Other receivables

     (40     (382

Deferred acquisition costs

     13        (20

Insurance reserves

     (437     (245

Other liabilities

     (27     (246

Trading securities

     (589     177   

Other, net

     (104     9   
   

Net cash flow operating activities

     800        1,652   
   

Investing Activities:

    

Purchases of fixed maturities

     (9,478     (12,402

Proceeds from sales of fixed maturities

     6,388        11,083   

Proceeds from maturities of fixed maturities

     1,866        1,723   

Purchases of equity securities

     (62     (240

Proceeds from sales of equity securities

     128        441   

Purchases of property, plant and equipment

     (473     (1,380

Sales of property, plant and equipment

     591        7   

Change in short term investments

     1,058        (897

Other, net

     (170     10   
   

Net cash flow investing activities

   $ (152   $ (1,655
   

See accompanying Notes to Consolidated Condensed Financial Statements.

 

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Loews Corporation and Subsidiaries

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

 

Six Months Ended June 30    2010     2009  
(In millions)             

Financing Activities:

    

Dividends paid

   $ (53   $ (54

Dividends paid to noncontrolling interests

     (303     (321

Purchases of treasury shares

     (266     (32

Purchases of treasury shares by subsidiary

       (2

Issuance of common stock

     1        2   

Proceeds from sale of subsidiary stock

     333     

Principal payments on debt

     (556     (260

Issuance of debt

     125        666   

Policyholders’ investment contract net deposits (withdrawals)

     (6     (8

Other, net

     (20     12   
   

Net cash flow financing activities

     (745     3   
   

Effect of foreign exchange rate on cash

     (2     5   
   

Net change in cash

     (99     5   

Cash, beginning of period

     190        131   
   

Cash, end of period

   $ 91      $ 136   
   

See accompanying Notes to Consolidated Condensed Financial Statements.

 

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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 pipeline systems (Boardwalk Pipeline Partners, LP (“Boardwalk Pipeline”), a 66% owned subsidiary); and the operation of hotels (Loews Hotels Holding Corporation (“Loews Hotels”), a wholly owned subsidiary). In the first quarter of 2010 the Company sold 11.5 million common units of its subsidiary, Boardwalk Pipeline, for $333 million, reducing the Company’s ownership interest from 72% to 66%. 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 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 June 30, 2010 and December 31, 2009 and the results of operations and comprehensive income for the three and six months ended June 30, 2010 and 2009 and changes in cash flows for the six months ended June 30, 2010 and 2009.

Net income (loss) for the second quarter and first half 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 2009 Annual Report on Form 10-K which should be read in conjunction with these Consolidated Condensed Financial Statements.

The Company presents basic and diluted earnings per share on the Consolidated Condensed Statements of Operations. Basic earnings per share excludes dilution and is computed by dividing net income (loss) attributable to common stock by the weighted average number of common shares 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. Stock appreciation rights (“SARs”) of 2.6 and 2.5 million shares were not included in the diluted weighted average shares amount for the three and six months ended June 30, 2010 due to the exercise price being greater than the average stock price. For the three and six months ended June 30, 2009, 3.4 and 5.7 million shares, consisting solely of stock options and SARs, are not included in the diluted weighted average shares amount as their effects are antidilutive.

Sale of Assets – On April 30, 2010, HighMount completed the sale of exploration and production assets located in the Antrim Shale in Michigan and on May 28, 2010, HighMount completed the sale of exploration and production assets located in the Black Warrior Basin in Alabama. These sales did not have a material impact on the Consolidated Condensed Statements of Operations. HighMount used the net proceeds from the sale, of approximately $500 million, to reduce the outstanding debt under its term loans.

On July 7, 2010, Diamond Offshore completed the sale of one of its high performance, premium jack-up drilling rigs, the Ocean Shield, and will recognize a pretax gain of approximately $30 million in the third quarter of 2010.

Accounting changes – In June of 2009, the Financial Accounting Standards Board (“FASB”) issued updated accounting guidance which amended the requirements for determination of the primary beneficiary of a variable interest entity, required an ongoing assessment of whether an entity is the primary beneficiary and required enhanced interim and annual disclosures. The updated accounting guidance became effective for quarterly and annual reporting periods beginning after November 15, 2009, except for investment company type entities for which the requirements under this guidance have been deferred indefinitely. The adoption of this updated accounting guidance as of January 1, 2010 had no impact on the Company’s financial condition or results of operations.

 

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New accounting pronouncements not yet adopted – In March 2010, the FASB issued updated accounting guidance which amends the accounting and reporting requirements related to derivatives to provide clarifying language regarding when embedded credit derivative features, including those in synthetic collateralized debt and loan obligations, are considered embedded derivatives subject to potential bifurcation. The updated accounting guidance is effective for the first quarter beginning after June 15, 2010. The adoption of this updated accounting guidance is not expected to have a material impact on the Company’s financial condition or results of operations.

2. Investments

 

     

Three Months Ended

June 30,

   

Six Months Ended

June 30,

 
      2010     2009     2010     2009  
(In millions)                         

Net investment income consisted of:

        

Fixed maturity securities

   $ 519      $ 487      $ 1,029      $ 962   

Short term investments

     7        13        14        24   

Limited partnerships

     7        159        87        89   

Equity securities

     9        14        19        28   

Income (loss) from trading portfolio

     (5     72        16        98   

Other

     2        1        5        4   
   

Total investment income

     539        746        1,170        1,205   

Investment expenses

     (13     (11     (27     (23
   

Net investment income

   $ 526      $ 735      $ 1,143      $ 1,182   
   

Investment gains (losses) are as follows:

        

Fixed maturity securities

   $ 66      $ (392   $ 93      $ (750

Equity securities

     (28     64        (25     (152

Derivative instruments

     (18     33        (31     64   

Short term investments

     1        (5     4        9   

Other

     (10     3        (9     1   
   

Investment gains (losses) (a)

   $ 11      $ (297   $ 32      $ (828
   

 

(a) Includes gross realized gains of $133, $173, $235 and $281 and gross realized losses of $95, $501, $167 and $1,183 on available-for-sale securities for the three and six months ended June 30, 2010 and 2009.

 

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The components of other-than-temporary impairment (“OTTI”) losses recognized in earnings by asset type are as follows:

 

     Three Months Ended
June  30,
   Six Months Ended
June  30,
      2010    2009    2010    2009
(In millions)                    

Fixed maturity securities available-for-sale:

           

Asset-backed securities:

           

Residential mortgage-backed securities

   $ 11    $ 119    $ 37    $ 268

Commercial mortgage-backed securities

        165      2      181

Other asset-backed securities

     2         2      31
 

Total asset-backed securities

     13      284      41      480

States, municipalities and political subdivisions securities

     6      15      20      15

Corporate and other bonds

     24      94      42      284

Redeemable preferred stock

              9
 

Total fixed maturities available-for-sale

     43      393      103      788
 

Equity securities available-for-sale:

           

Common stock

     5      1      5      4

Preferred stock

     9      1      9      217
 

Total equity securities available-for-sale

     14      2      14      221
 

Net OTTI losses recognized in earnings

   $ 57    $ 395    $ 117    $ 1,009
 

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 CNA’s Chief Financial Officer. The Impairment Committee is responsible for evaluating securities in an unrealized loss position on at least a quarterly basis.

The Impairment Committee’s 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 Other comprehensive income.

 

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CNA performs the discounted cash flow analysis using stressed 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 non-redeemable preferred stock securities on the basis that these securities possess characteristics similar to debt securities and that the issuers maintain their ability to pay dividends. 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 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 adoption of the updated accounting guidance related to OTTI in the second quarter of 2009, 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 amortized cost and fair values of securities are as follows:

 

     Cost or
Amortized
Cost
   Gross
Unrealized
Gains
   Gross Unrealized Losses    Estimated
Fair Value
   Unrealized
OTTI
Losses
June 30, 2010         

Less Than

12 Months

  

12 Months

or Greater

     
(In millions)                              

Fixed maturity securities:

                 

U.S. Treasury securities and obligations of government agencies

   $ 146    $ 19          $ 165   

Asset-backed securities:

                 

Residential mortgage-backed securities

     6,527      133    $ 11    $ 326      6,323    $ 252

Commercial mortgage-backed securities

     1,052      18      2      77      991   

Other asset-backed securities

     733      17         17      733   
 

Total asset-backed securities

     8,312      168      13      420      8,047      252

States, municipalities and political subdivisions securities

     7,617      274      20      292      7,579   

Foreign government securities

     577      15      1         591   

Corporate and other bonds

     19,705      1,591      46      123      21,127      26

Redeemable preferred stock

     48      4         1      51   
 

Fixed maturities available- for-sale

     36,405      2,071      80      836      37,560      278

Fixed maturities, trading

     1,324      28      2      13      1,337   
 

Total fixed maturities

     37,729      2,099      82      849      38,897      278
 

Equity securities:

                 

Common stock

     77      12      1         88   

Preferred stock

     463      42      2      42      461   
 

Equity securities available-for-sale

     540      54      3      42      549   

Equity securities, trading

     351      86      21      30      386   
 

Total equity securities

     891      140      24      72      935   
 

Total

   $ 38,620    $ 2,239    $ 106    $ 921    $ 39,832    $ 278
 

 

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Table of Contents
     Cost or
Amortized
Cost
   Gross
Unrealized
Gains
   Gross Unrealized Losses    Estimated
Fair Value
   Unrealized
OTTI
Losses
December 31, 2009         

Less Than

12 Months

  

12 Months

or Greater

     
(In millions)                              

Fixed maturity securities:

                 

U.S. Treasury securities and obligations of government agencies

   $ 184    $ 16    $ 1       $ 199   

Asset-backed securities:

                 

Residential mortgage-backed securities

     7,470      72      43    $ 561      6,938    $ 246

Commercial mortgage-backed securities

     709      10      1      134      584      3

Other asset-backed securities

     858      14      1      39      832   
 

Total asset-backed securities

     9,037      96      45      734      8,354      249

States, municipalities and political subdivisions securities

     7,280      203      30      329      7,124   

Foreign government securities

     467      14      1      1      479   

Corporate and other bonds

     18,410      1,107      44      244      19,229      26

Redeemable preferred stock

     51      4         1      54   
 

Fixed maturities available- for-sale

     35,429      1,440      121      1,309      35,439      275

Fixed maturities, trading

     395      3         21      377   
 

Total fixed maturities

     35,824      1,443      121      1,330      35,816      275
 

Equity securities:

                 

Common stock

     61      14      1      1      73   

Preferred stock

     572      40         41      571   
 

Equity securities available-for-sale

     633      54      1      42      644     

Equity securities, trading

     310      109      10      46      363   
 

Total equity securities

     943      163      11      88      1,007     
 

Total

   $ 36,767    $ 1,606    $ 132    $ 1,418    $ 36,823    $ 275
 

The amount of pretax net unrealized gains on available-for-sale securities reclassified out of Accumulated other comprehensive income (“AOCI”) into earnings was $39 million and $71 million for the three and six months ended June 30, 2010. The amount of pretax net unrealized losses on available-for-sale securities reclassified out of AOCI into earnings was $328 million for the three months ended June 30, 2009.

Activity for the three and six months ended June 30, 2010 related to the pretax fixed maturity credit loss component reflected within Retained earnings for securities still held at June 30, 2010 was as follows:

 

     

Three Months
Ended
June 30 ,

2010

   

Six Months

Ended
June 30,

2010

 
(In millions)             

Beginning balance of credit losses on fixed maturity securities

   $ 171      $ 164   

Additional credit losses for which an OTTI loss was previously recognized

     11        22   

Credit losses for which an OTTI loss was not previously recognized

     3        8   

Reductions for securities sold during the period

     (14     (23
   

Ending balance of credit losses on fixed maturity securities

   $ 171      $ 171   
   

 

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Table of Contents

Activity for the three months ended June 30, 2009 related to the pretax fixed maturity credit loss component reflected within Retained earnings for securities still held at June 30, 2009 was as follows:

 

     

Three Months

Ended

June 30,

2009

 
(In millions)       

Beginning balance of credit losses on fixed maturity securities

   $ 192   

Additional credit losses for which an OTTI loss was previously recognized

     21   

Credit losses for which an OTTI loss was not previously recognized

     84   

Reductions for securities sold during the period

     (36

Reductions for securities the Company intends to sell or more likely than not will be required to sell

     (49
   

Ending balance of credit losses on fixed maturity securities

   $ 212   
   

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 June 30, 2010 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 & Poor’s, Moody’s Investors Service, Inc. and Fitch Ratings 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.

Asset-Backed Securities

The fair value of total asset-backed holdings at June 30, 2010 was $8,047 million which was comprised of 2,134 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. Of these securities, 175 have underlying collateral that is either considered sub-prime or Alt-A in nature. The exposure to sub-prime residential mortgage collateral and Alternative A residential mortgages that have lower than normal standards of loan documentation collateral is measured by the original deal structure.

Residential mortgage-backed securities include 232 structured securities in a gross unrealized loss position. In addition, there were 34 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 10.4% of amortized cost.

Commercial mortgage-backed securities include 42 securities in a gross unrealized loss position. The aggregate severity of the gross unrealized loss was approximately 12.7% of amortized cost. Other asset-backed securities include 19 securities in a gross unrealized loss position. The aggregate severity of the gross unrealized loss was approximately 8.8% of amortized cost.

 

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Table of Contents

The asset-backed securities in a gross unrealized loss position by ratings distribution are as follows:

 

June 30, 2010    Amortized
Cost
  

Estimated

Fair Value

   Gross
Unrealized
Losses
(In millions)               

U.S. Government Agencies

   $ 47    $ 42    $ 5

AAA

     1,697      1,571      126

AA

     411      371      40

A

     324      270      54

BBB

     342      311      31

Non-investment grade and equity tranches

     1,245      1,068      177
 

Total

   $ 4,066    $ 3,633    $ 433
 

The Company believes the unrealized losses are primarily attributable to broader economic conditions, liquidity concerns and wider than historical bid/ask spreads, and are 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 the ultimate collection of amortized cost and interest, collateral shortfalls, or substantial changes in future cash flow expectations; accordingly, the Company has determined that there are no additional OTTI losses to be recorded at June 30, 2010.

States, Municipalities and Political Subdivisions Securities

The holdings in this portfolio consist of both tax-exempt and taxable special revenue and assessment bonds, representing 72.7% of the overall portfolio, followed by general obligation political subdivision bonds at 18.7% and state general obligation bonds at 8.6%.

The unrealized losses on the Company’s investments in this portfolio are due to market conditions in certain sectors or states that continued to lag behind the broader municipal market performance. Yields for certain issuers and types of securities, such as zero coupon bonds, auction rate securities and tobacco securitizations, continue to be higher than historical norms relative to after tax returns on other fixed income alternatives. The holdings for all securities in this category include 240 securities in a gross unrealized loss position. The aggregate severity of the total gross unrealized losses was approximately 12.4% of amortized cost.

The states, municipalities and political subdivisions securities in a gross unrealized loss position by ratings distribution are as follows:

 

June 30, 2010    Amortized
Cost
  

Estimated

Fair Value

   Gross
Unrealized
Losses
(In millions)               

AAA

   $ 868    $ 819    $ 49

AA

     708      588      120

A

     438      416      22

BBB

     481      362      119

Non-investment grade

     22      20      2
 

Total

   $ 2,517    $ 2,205    $ 312
 

 

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Table of Contents

The largest exposures at June 30, 2010 as measured by gross unrealized losses were special revenue bonds issued by several states backed by tobacco settlement funds with gross unrealized losses of $110 million, and several separate issues of Puerto Rico sales tax revenue bonds with gross unrealized losses of $85 million. All of these securities are rated 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 the ultimate collection of principal and interest; accordingly, the Company has determined that there are no additional OTTI losses to be recorded at June 30, 2010.

Corporate and Other Bonds

The holdings in this category include 278 securities in a gross unrealized loss position. The aggregate severity of the gross unrealized losses was 5.7% of amortized cost.

The corporate and other bonds in a gross unrealized loss position by ratings distribution are as follows:

 

June 30, 2010    Amortized
Cost
  

Estimated

Fair Value

   Gross
Unrealized
Losses
(In millions)               

Ratings distribution:

        

AAA

   $ 36    $ 33    $ 3

AA

     149      148      1

A

     745      714      31

BBB

     1,243      1,153      90

Non-investment grade

     761      717      44
 

Total

   $ 2,934    $ 2,765    $ 169
 

The unrealized losses on corporate and other bonds, primarily in the financial sector of the portfolio, are attributable to the lingering impacts of the U.S. and European financial crisis over the past several years. Overall conditions in the corporate bond market have generally continued to improve during 2010, resulting in improvement in the Company’s 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 the ultimate collection of principal and interest; accordingly, the Company has determined that there are no additional OTTI losses to be recorded at June 30, 2010.

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 structure of the issuer than traditional bonds. The data in the table above includes financial industry sector hybrid debt securities with an aggregate fair value of $496 million and an aggregate amortized cost of $561 million.

 

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Table of Contents

Contractual Maturity

The following table summarizes available-for-sale fixed maturity securities by contractual maturity at June 30, 2010 and December 31, 2009. 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.

 

      June 30, 2010    December 31, 2009
      Amortized
Cost
  

Estimated

Fair Value

   Amortized
Cost
  

Estimated

Fair Value

(In millions)                    

Due in one year or less

   $ 2,096    $ 2,056    $ 1,240    $ 1,219

Due after one year through five years

     11,391      11,817      10,046      10,244

Due after five years through ten years

     9,107      9,424      10,647      10,539

Due after ten years

     13,811      14,263      13,496      13,437
 

Total

   $ 36,405    $ 37,560    $ 35,429    $ 35,439
 

Investment Commitments

As of June 30, 2010, the Company had committed approximately $237 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 various privately placed debt securities, including bank loans, 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 settlements are made. As of June 30, 2010, the Company had commitments to purchase $256 million and sell $104 million of such investments.

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.

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 Company’s 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 the pricing inputs to determine if the markets from which the data is gathered are active. As further validation of the Company’s valuation process, the Company samples past fair value estimates and compares the valuations to actual transactions executed in the market on similar dates.

 

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Table of Contents

The fair values of CNA’s life settlement contracts investments are included in Other assets. Equity options purchased are included in Equity Securities, and all other derivative assets are included in Receivables. Derivative liabilities are included in Payable to brokers. Assets and liabilities measured at fair value on a recurring basis are summarized in the tables below:

 

June 30, 2010    Level 1     Level 2     Level 3     Total  
(In millions)                         

Fixed maturity securities:

        

U.S. Treasury securities and obligations of government agencies

   $ 96      $ 69        $ 165   

Asset-backed securities:

        

Residential mortgage-backed securities

       5,664      $ 659        6,323   

Commercial mortgage-backed securities

       896        95        991   

Other asset-backed securities

       427        306        733   
   

Total asset-backed securities

            6,987        1,060        8,047   

States, municipalities and political subdivisions securities

       7,040        539        7,579   

Foreign government securities

     92        499          591   

Corporate and other bonds

       20,409        718        21,127   

Redeemable preferred stock

     3        47        1        51   
   

Fixed maturities available-for-sale

     191        35,051        2,318        37,560   

Fixed maturities, trading

     1,037        109        191        1,337   
   

Total fixed maturities

   $ 1,228      $ 35,160      $ 2,509      $ 38,897   
   

Equity securities available-for-sale

   $ 415      $ 130      $ 4      $ 549   

Equity securities, trading

     386            386   
   

Total equity securities

   $ 801      $ 130      $ 4      $ 935   
   

Short term investments

   $ 4,193      $ 1,408      $ 21      $ 5,622   

Receivables

       83        13        96   

Life settlement contracts

         134        134   

Separate account business

     32        378        37        447   

Payable to brokers

     (88     (97     (9     (194

Discontinued operations investments, included in Other assets

     8        124          132   

 

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Table of Contents
December 31, 2009    Level 1     Level 2     Level 3     Total  
(In millions)                         

Fixed maturity securities:

        

U.S. Treasury securities and obligations of government agencies

   $ 145      $ 54        $ 199   

Asset-backed securities:

        

Residential mortgage-backed securities

       6,309      $ 629        6,938   

Commercial mortgage-backed securities

       461        123        584   

Other asset-backed securities

       484        348        832   
   

Total asset-backed securities

            7,254        1,100        8,354   

States, municipalities and political subdivisions securities

       6,368        756        7,124   

Foreign government securities

     139        340          479   

Corporate and other bonds

       18,620        609        19,229   

Redeemable preferred stock

     3        49        2        54   
   

Fixed maturities available-for-sale

     287        32,685        2,467        35,439   

Fixed maturities, trading

     102        78        197        377   
   

Total fixed maturities

   $ 389      $ 32,763      $ 2,664      $ 35,816   
   

Equity securities available-for-sale

   $ 503      $ 130      $ 11      $ 644   

Equity securities, trading

     363            363   
   

Total equity securities

   $ 866      $ 130      $ 11      $ 1,007   
   

Short term investments

   $ 6,818      $ 397        $ 7,215   

Receivables

       53      $ 2        55   

Life settlement contracts

         130        130   

Separate account business

     43        342        38        423   

Payable to brokers

     (87     (135     (50     (272

Discontinued operations investments, included in Other liabilities

     19        106        16        141   

 

19


Table of Contents

The tables below present reconciliations for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended June 30, 2010 and 2009:

 

     Balance,
April 1
    Net Realized  Gains
(Losses) and Net Change
in Unrealized  Gains
(Losses)
   

Purchases,
Sales,

Issuances
and
Settlements

   

Transfers

into Level 3

  

Transfers
out of

Level 3

    Balance,
June 30
  

Unrealized
Gains (Losses)

Recognized in
Net Income on

Level 3 Assets

and Liabilities

Held at

June 30

 
2010     

Included in

Net Income

   

Included in

OCI

             
   
(In millions)                                               

Fixed maturity securities:

                  

Asset-backed securities:

                  

Residential mortgage-backed securities

   $ 679      $ 2      $ 3      $ 13         $ (38   $ 659   

Commercial mortgage- backed securities

     112          2        11           (30     95   

Other asset-backed securities

     368          1        (18        (45     306    $ (2
   

Total asset-backed securities

     1,159        2        6        6           (113     1,060      (2

States, municipalities and political subdivisions securities

     737          4        (202          539   

Corporate and other bonds

     680        7        9        57      $ 14      (49     718      (3

Redeemable preferred stock

     4        6        (2     (7          1   
   

Fixed maturities available-for-sale

     2,580        15        17        (146     14      (162     2,318      (5

Fixed maturities, trading

     216        2          (27          191      1   
   

Total fixed maturities

   $ 2,796      $ 17      $ 17      $ (173   $ 14    $ (162   $ 2,509    $ (4
   

Equity securities available-for-sale

   $ 8      $ (1     $ (1      $ (2   $ 4    $ (1

Short term investments

     1            20             21   

Life settlement contracts

     131        7          (4          134      5   

Separate account business

     40            (3          37   

Discontinued operations investments

     15                 (15       

Derivative financial instruments, net

     (27     (7   $ 28        10             4   

 

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Table of Contents
2009               Net Realized Gains
(Losses) and Net Change in
Unrealized Gains (Losses)
      

Purchases,
Sales,

Issuances
and
Settlements

      

Transfers

into Level 3

    

Transfers
out of
Level 3

      

Balance,
June 30

      

Unrealized
Gains (Losses)
Recognized in
Net Income (Loss)

on Level 3 Assets

and Liabilities

Held at

June 30

 
     Balance,
April 1
      

Included in

Net Income

(Loss)

      

Included in

OCI

                          
   
(In millions)                                                                      

Fixed maturity securities:

                                       

Asset-backed securities:

                                       

Residential mortgage-backed securities

     $ 743         $ (6      $ 35         $ (25      $ 71      $ (10      $ 808         $ (5

Commercial mortgage- backed securities

       158           (155        155           (9        26             175           (155

Other asset-backed securities

       252                10           (2             (119        141        
   

Total asset-backed securities

       1,153           (161        200           (36        97        (129        1,124           (160

States, municipalities and political subdivisions securities

       784                18           (17                  785        

Corporate and other bonds

       809                47           (137        16        (5        730           (1

Redeemable preferred stock

       19                               (18        1        
   

Fixed maturities available-for-sale

       2,765           (161        265           (190        113        (152        2,640           (161

Fixed maturities, trading

       213           6                6           4             229           4   
   

Total fixed maturities

     $ 2,978         $ (155      $ 265         $ (184      $ 117      $ (152      $ 2,869         $ (157
   

Equity securities available-for-sale

     $ 210              $ (1                     $ 209        

Life settlement contracts

       127         $ 5              $ (6                  126        

Separate account business

       38                3           (3                  38        

Discontinued operations investments

       13                1           (1                  13        

Derivative financial instruments, net

       (58        17           (2        36                     (7      $ (11

 

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Table of Contents

The tables below present reconciliations for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the six months ended June 30, 2010 and 2009:

 

2010     

Balance,

January 1

       Net Realized Gains (Losses)
and Net Change in
Unrealized Gains (Losses)
      

Purchases,
Sales,

Issuances
and
Settlements

      

Transfers
into Level 3

     Transfers
out of
Level 3
       Balance,
June 30
    

Unrealized
Gains (Losses)

Recognized in

Net Income on

Level 3 Assets

and Liabilities

Held at

June 30

 
          Included in
Net Income
      

Included in

OCI

                          
   
(In millions)                                                                    

Fixed maturity securities:

                                       

Asset-backed securities:

                                       

Residential mortgage-backed securities

     $ 629         $ (8      $ 29         $ 55              $ (46      $ 659      $ (10

Commercial mortgage- backed securities

       123           (1        (2        6         $ 7        (38        95        (1

Other asset-backed securities

       348           4           22           (23             (45        306        (2
   

Total asset-backed securities

       1,100           (5        49           38           7        (129        1,060        (13

States, municipalities and political subdivisions securities

       756                6           (223                  539     

Corporate and other bonds

       609           9           38           112           23        (73        718        (4

Redeemable preferred stock

       2           6                (7                  1     
   

Fixed maturities available-for-sale

       2,467           10           93           (80        30        (202        2,318        (17

Fixed maturities, trading

       197           8                (14                  191        7   
   

Total fixed maturities

     $ 2,664         $ 18         $ 93         $ (94      $ 30      $ (202      $ 2,509      $ (10
   

Equity securities available-for-sale

     $ 11         $ (1           $ (1      $ 2      $ (7      $ 4      $ (1

Short term investments

                           20           1             21     

Life settlement contracts

       130           17                (13                  134        7   

Separate account business

       38                     (1                  37     

Discontinued operations investments

       16              $ 1           (2             (15            

Derivative financial instruments, net

       (48        (15        42           25                     4     

 

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2009

              Net Realized Gains
(Losses) and Net Change in
Unrealized Gains (Losses)
      

Purchases,
Sales,

Issuances
and
Settlements

                                Unrealized
Gains (Losses)
Recognized in
Net Income (Loss)
on Level 3 Assets
and Liabilities
Held at
June 30
 
     Balance,
January 1
       Included in
Net Income
(Loss)
       Included in
OCI
            Transfers
into Level 3
     Transfers
out of
Level 3
       Balance,
June 30
      
   
(In millions)                                                                      

Fixed maturity securities:

                                       

Asset-backed securities:

                                       

Residential mortgage-backed securities

     $ 782         $ (23      $ 36         $ (48      $ 71      $ (10      $ 808         $ (12

Commercial mortgage- backed securities

       186           (165        142           (14        26             175           (165

Other asset-backed securities

       139           (30        40           (42        153        (119        141           (31
   

Total asset-backed securities

       1,107           (218        218           (104        250        (129        1,124           (208

States, municipalities and political subdivisions securities

       750                55           (20                  785        

Foreign government securities

       6                               (6          

Corporate and other bonds

       616           (5        46           67           18        (12        730           (7

Redeemable preferred stock

       13           (9        8           7                (18        1           (9
   

Fixed maturities available-for-sale

       2,492           (232        327           (50        268        (165        2,640           (224

Fixed maturities, trading

       218           9                (2        4             229           4   
   

Total fixed maturities

     $ 2,710         $ (223      $ 327         $ (52      $ 272      $ (165      $ 2,869         $ (220
   

Equity securities available-for-sale

     $ 210              $ (1                     $ 209        

Life settlement contracts

       129         $ 16              $ (19                  126         $ 2   

Separate account business

       38                4           (4                  38        

Discontinued operations investments

       15                     (2                  13        

Derivative financial instruments, net

       (72        35           (12        42                     (7        (15

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

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. The Company’s policy is to recognize transfers between levels at the beginning of the reporting period.

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.

 

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Fixed Maturity Securities

Level 1 securities include highly liquid government bonds within the U.S. Treasury securities category and securities issued by foreign governments for which quoted market prices are available. 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, states, municipalities and political subdivisions securities, foreign provincial and local government bonds, asset-backed securities, mortgage-backed pass-through securities and redeemable preferred stock. Level 2 securities may also include securities that have firm sale commitments and prices that are not recorded until the settlement date. 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. These securities include certain corporate bonds, asset-backed securities, states, municipalities and political subdivisions securities and redeemable preferred stock. Within corporate bonds and states, municipalities and political subdivisions securities, Level 3 securities also include tax-exempt and taxable 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 stocks 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, total return swaps, commodity 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.

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 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 determined as the present value of the anticipated death benefits less anticipated premium payments based on contract terms that are distinct for each insured, as well as CNA’s own assumptions for mortality, premium expense, and the rate of return that a buyer would require on the contracts, as no comparable market pricing data is available.

Discontinued Operations Investments

Assets relating to CNA’s discontinued operations include fixed maturity securities and short term investments. The valuation methodologies for these asset types have been described above.

 

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Table of Contents

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 Company’s financial instrument liabilities which are not measured at fair value on the Consolidated Condensed Balance Sheets are listed in the table below.

 

      June 30, 2010    December 31, 2009
      Carrying
Amount
   Estimated
Fair Value
   Carrying
Amount
   Estimated
Fair Value
(In millions)                    

Financial liabilities:

           

Premium deposits and annuity contracts

   $ 101    $ 103    $ 105    $ 106

Short term debt

     247      247      10      10

Long term debt

     8,809      9,086      9,475      9,574

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 business.

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 Company’s 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.

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 Company’s 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.

CNA’s 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

 

25


Table of Contents

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 obligor’s 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 Company’s 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 forwards. 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.

 

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Table of Contents

The tables below summarize open CDS contracts where the Company sold credit protection as of June 30, 2010 and December 31, 2009. The fair value of the contracts represents the amounts that the Company would receive at those dates to exit the derivative 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.

 

June 30, 2010    Fair Value
of Credit
Default
Swaps
   Maximum
Amount of
Future
Payments
under Credit
Default
Swaps
   Weighted
Average
Years
To Maturity
(In millions)               

B-rated

   $ 1    $ 8    2.6
 

Total

   $ 1    $ 8    2.6
 

December 31, 2009

        
 

B-rated

      $ 8    3.1
 

Total

   $ —      $ 8    3.1
 

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 $41 million at June 30, 2010 and $7 million at December 31, 2009 and primarily consisted of cash and U.S. Treasury Bills. The fair value of cash collateral received from counterparties was $1 million at June 30, 2010 and December 31, 2009.

The agreements governing HighMount’s derivative instruments contain certain covenants, including a maximum debt to capitalization ratio reviewed quarterly. 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 HighMount’s derivative instruments that are in a liability position was $99 million at June 30, 2010. HighMount was not required to post any collateral under the governing agreements. At June 30, 2010, HighMount was in compliance with all of its covenants under the derivatives agreements.

See Note 3 for information regarding the fair value of derivative instruments.

 

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Table of Contents

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. 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.

 

     June 30, 2010    December 31, 2009
 
     Contractual/              Contractual/          
   Notional    Estimated Fair Value    Notional    Estimated Fair Value
   Amount    Asset    (Liability)    Amount    Asset    (Liability)
 
(In millions)                              

With hedge designation

                 

Interest rate risk:

                 

Interest rate swaps

   $ 1,095       $ (92)    $ 1,600       $ (135)

Commodities:

                 

Forwards – short

     575    $ 91      (6)      715    $ 50      (39)

Foreign exchange:

                 

Currency forwards – short

     119         (4)      114      3   

Other

              13      2   

Without hedge designation

                 

Equity markets:

                 

Options – purchased

     164      34         242      45   

Options – written

     232         (14)      282         (9)

Equity warrants

     5               

Interest rate risk:

                 

Options on government
securities – short

     635         (13)         

Interest rate swaps

     5            9      

Credit default swaps – purchased protection

     35         (3)      116         (11)

Credit default swaps – sold protection

     8      1         8      

Futures – long

     610               

Futures – short

     2,839            132      

Commodities:

                 

Forwards – long

     11      1            

Forwards – short

     18      4            

Other

     5            2      
 

Total

   $ 6,356    $ 131    $ (132)    $ 3,233    $ 100    $ (194)
 

Derivatives without hedge designation – For derivatives not held in a trading portfolio, new derivative transactions entered into totaled approximately $610 million and $714 million in notional value while derivative termination activity totaled approximately $626 million and $775 million during the three and six months ended June 30, 2010. This activity was primarily attributable to interest rate futures and forward commitments for mortgage-backed securities. During the three and six months ended June 30, 2009, new derivative transactions entered into totaled approximately $4.4 billion and $10.5 billion in notional value while derivative termination activity totaled approximately $5.3 billion and $11.4 billion. This activity was primarily attributable to interest rate futures, interest rate options and interest rate swaps.

 

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Table of Contents

A summary of the recognized gains (losses) related to derivative financial instruments without hedge designation follows. Changes in the fair value of derivatives not held in a trading portfolio are reported in Investment gains (losses) and changes in the fair value of derivatives held for trading purposes are reported in Net investment income on the Consolidated Condensed Statements of Operations.

 

      Three Months Ended
June 30,
       Six Months Ended
June 30,
 
      2010        2009        2010        2009  
(In millions)                                  

Included in Net investment income:

                 

Equity risk:

                 

Equity options – purchased

   $ 10         $ (18      $ (3      $ (20

Equity options – written

     (1        25           5           30   

Futures – long

     (4        11           (3        11   

Futures – short

     1                (3     

Foreign exchange:

                 

Currency forwards – long

     (2        2           (2        (6

Currency forwards – short

     (1             (1        7   

Currency options – short

     (4             (2     

Interest rate risk:

                 

Credit default swaps – purchased protection

          3                12   

Credit default swaps – sold protection

          (2             (8

Options on government securities – short

          3                14   

Futures – long

     (21             (18        5   

Futures – short

     (3               

Other

     (1        (4        (2        (5
   
     (26        20           (29        40   
   

Included in Investment gains (losses):

                 

Equity options – written

          4                15   

Interest rate risk:

                 

Interest rate swaps

     (18        38           (44        59   

Credit default swaps – purchased protection

          (26             (35

Credit default swaps – sold protection

          8                2   

Futures – short

          9                23   

Commodity forwards – short

               13        
   
     (18        33           (31        64   
   

Included in Other revenues:

                 

Currency options – short

          9                9   
   

Total

   $ (44      $ 62         $ (60      $ 113   
   

Cash flow hedges – A significant portion of the Company’s 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 June 30, 2010, approximately 91.0 billion cubic feet of natural gas equivalents was hedged by qualifying cash flow hedges. The effective portion of these commodity hedges is reclassified from AOCI into earnings when the anticipated transaction affects earnings. Approximately 35% of these derivatives have settlement dates in 2010 and 50% have settlement dates in 2011. As of June 30, 2010, the estimated amount of net unrealized gains associated with commodity contracts that will be reclassified into earnings during the next twelve months was $64 million. However, these amounts are likely to vary materially as a result of changes in market conditions. Diamond Offshore uses foreign currency forward exchange contracts to reduce exposure to foreign currency losses on future foreign currency expenditures. The effective portion of these hedges is reclassified from AOCI into earnings when the hedged transaction affects earnings or it is determined that the hedged transaction will not occur. As of June 30,

 

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Table of Contents

2010, the estimated amount of net unrealized losses associated with these contracts that will be reclassified into earnings over the next twelve months was $4 million. The Company also uses 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. As of June 30, 2010, the estimated amount of net unrealized losses associated with interest rate swaps that will be reclassified into earnings during the next twelve months was $51 million. However, this is likely to vary as a result of changes in the LIBOR rate. For the three and six months ended June 30, 2010 and 2009, the net amounts recognized due to ineffectiveness were less than $1 million.

In the first quarter of 2010, HighMount determined that a portion of the expected underlying transactions related to its hedging activities were no longer probable of occurring and discontinued hedge accounting treatment for a portion of its interest rate cash flow hedges and its commodity price swaps. HighMount entered into definitive sales agreements for exploration and production assets in the Antrim Shale in Michigan in March 2010 and Black Warrior Basin in Alabama in April 2010. As a result, HighMount recognized losses of $14 million and $36 million in Investment gains (losses) in the Consolidated Condensed Statements of Operations for the three and six months ended June 30, 2010, reflecting the reclassification of net derivative losses from AOCI to earnings. These amounts are reflected in the table below.

The following table summarizes the effective portion of the net derivative gains or losses included in OCI and the amount reclassified into Income (loss) for derivatives designated as cash flow hedges and for the de-designated hedges:

 

      Three Months Ended
June 30,
    Six Months Ended
June 30,
 
      2010     2009     2010     2009  

(In millions)

        

Amount of gain (loss) recognized in OCI

        

Commodities

   $ 13      $ 11      $ 117      $ 103   

Foreign exchange

     (5     6        (5     6   

Interest rate

     (12     13        (34     4   
   

Total

   $ (4   $ 30      $ 78      $ 113   
   

Amount of gain (loss) reclassified from AOCI into income (loss)

        

Commodities

   $ 18      $ 65      $ 48      $ 139   

Foreign exchange

     (1       1     

Interest rate

     (33     (17     (79     (31
   

Total

   $ (16   $ 48      $ (30   $ 108   
   

Location of gain (loss) reclassified from AOCI into income (loss):

 

Type of cash flow hedge

   Consolidated Condensed Statements of Operations line items
 

Commodities

   Other revenues and Investment gains (losses)

Foreign exchange

   Contract drilling expenses

Interest rate

   Interest and Investment gains (losses)

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. Short sales of equity securities resulted in proceeds of $64 million and $66 million with fair value liabilities of $61 million and $78 million at June 30, 2010 and December 31, 2009. These positions are marked to market and

 

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investment gains or losses are included in Net investment income in the Consolidated Condensed Statements of Operations.

5. Claim and Claim Adjustment Expense Reserves

CNA’s 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. CNA’s reserve projections are based primarily on detailed analysis of the facts in each case, CNA’s 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.

Catastrophes are an inherent risk of the property and casualty insurance business and have contributed to material period-to-period fluctuations in the Company’s results of operations and/or equity. CNA reported catastrophe losses, net of reinsurance, of $48 million and $88 million for the three and six months ended June 30, 2010 for events occurring in those periods. Catastrophe losses in 2010 related primarily to wind, thunderstorms and winter storms. CNA reported catastrophe losses, net of reinsurance, of $43 million and $56 million for the three and six months ended June 30, 2009 for events occurring in those periods. There can be no assurance that CNA’s ultimate cost for catastrophes will not exceed current estimates.

The following provides discussion of the Company’s Asbestos and Environmental Pollution (“A&E”) reserves.

A&E Reserves

CNA’s property and casualty insurance subsidiaries have actual and potential exposures related to A&E claims.

The following table provides data related to CNA’s A&E claim and claim adjustment expense reserves managed by its centralized A&E claims group.

 

      June 30, 2010     December 31, 2009  
      Asbestos     Environmental
Pollution
    Asbestos     Environmental
Pollution
 

(In millions)

        

Gross reserves

   $ 1,937      $ 412      $ 2,046      $ 482   

Ceded reserves

     (875     (174     (909     (196
   

Net reserves

   $ 1,062      $ 238      $ 1,137      $ 286   
   

In connection with the pending transaction related to A&E reinsurance discussed in Note 11, CNA is also ceding A&E liabilities reflected by the carried reserves of certain assumed reinsurance run-off books of business not managed by the centralized A&E claims group. As of December 31, 2009 there were approximately $68 million of net A&E claim and claim adjustment expense reserves within these assumed reinsurance run-off books of business. Additionally, CNA had approximately $90 million of net undiscounted A&E reserves within its discontinued operations, which are included in Other liabilities on the Consolidated Condensed Balance Sheets on a discounted

 

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basis of $61 million. The A&E liabilities in the table above along with these A&E liabilities will be ceded under the pending A&E reinsurance transaction.

Asbestos

The table below provides a reconciliation between CNA’s beginning and ending net reserves for asbestos.

 

Six months ended June 30    2010     2009  
(In millions)             

Beginning net reserves

   $ 1,137      $ 1,202   

Paid claims, net of reinsurance recoveries

     (75     (89
   

Ending net reserves

   $ 1,062      $ 1,113   
   

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. CNA’s 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 Company’s results of operations and/or equity.

Certain asbestos claim litigation in which CNA is currently engaged is described below:

A.P. Green: In February 2003, CNA announced it had resolved asbestos-related coverage litigation and claims involving A.P. Green Industries, A.P. Green Services and Bigelow–Liptak 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 in August 2003. The debtor’s plan of reorganization includes an injunction to protect CNA from any future claims. The bankruptcy court issued an opinion in September 2007 recommending confirmation of that plan. In July 2008, the District Court affirmed the Bankruptcy Court’s ruling. Several insurers have appealed that ruling to the Third Circuit Court of Appeals; that appeal was argued in May 2009. On June 15, 2010, the Court of Appeals entered an order to list the case for rehearing. No date has been set for rehearing.

Direct Action Case - Montana: In March 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. Grace’s pending bankruptcy. In April 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 was held in two phases. The first phase was held in June 2009. The second phase concluded in January 2010 and the bankruptcy court has taken the matter under advisement. The settlement in principle with the asbestos claimants has no present impact on the stay currently imposed on the

 

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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: (a) 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; (b) the potential application of Statutes of Limitation to many of the claims which may be made depending on the nature and scope of the alleged duties; (c) the unclear nature of the required nexus between the acts of the defendants and the right of any particular claimant to recovery; (d) the diseases and damages claimed by such claimants; (e) the extent that such liability would be shared with other potentially responsible parties; and (f) 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 CNA’s business, insurer financial strength and debt ratings and the Company’s results of operations and/or equity.

Environmental Pollution

The table below provides a reconciliation between CNA’s beginning and ending net reserves for environmental pollution.

 

Six months ended June 30    2010     2009  
(In millions)             

Beginning net reserves

   $ 286      $ 262   

Paid claims, net of reinsurance recoveries

     (48     (22
   

Ending net reserves

   $ 238      $ 240   
   

Net Prior Year Development

The following tables and discussion include the net prior year development recorded for CNA Specialty, CNA Commercial and Other Insurance. Favorable net prior year development of $17 million and $26 million was recorded in the Life & Group Non-Core segment for the three and six months ended June 30, 2010. Development in 2010 included favorable reserve development of $24 million arising from a commutation of an assumed reinsurance agreement in the first quarter of 2010. For the three and six months ended June 30, 2009 for the Life & Group Non-Core segment, favorable net prior year development of $5 million and unfavorable net prior year development $6 million was recorded.

Three Month Comparison

 

Three Months Ended June 30, 2010    CNA
Specialty
    CNA
Commercial
    Other
Insurance
    Total  

(In millions)

        

Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development:

        

Core (Non-A&E)

   $ (125   $ (175   $ 1      $ (299

Pretax (favorable) unfavorable premium development

     1        35        (2     34   
   

Total pretax favorable net prior year development

   $ (124   $ (140   $ (1   $ (265
   

 

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Three Months Ended June 30, 2009    CNA
Specialty
    CNA
Commercial
    Other
Insurance
    Total  

Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development:

        

Core (Non-A&E)

   $ (35   $ (85   $ 4      $ (116

Pretax (favorable) unfavorable premium development

     2        56        (2     56   
   

Total pretax (favorable) unfavorable net prior year development

   $ (33   $ (29   $ 2      $ (60
   

2010 Net Prior Year Development

CNA Specialty

The favorable claim and allocated claim adjustment expense reserve development was primarily due to professional liability coverages as further discussed below.

Approximately $51 million of favorable claim and allocated claim adjustment expense reserve development was recorded for medical professional liability coverages due to favorable incurred emergence, primarily in accident years 2007 and prior.

Favorable claim and allocated claim adjustment expense reserve development of approximately $33 million was recorded for financial institutions and life agents coverages due to reduced frequency of large claims and favorable ceded recoveries, primarily in accident years 2007 and prior. Favorable development of $18 million was recorded in architects and engineers coverages due to favorable incurred emergence and claims closing favorable to expectations, primarily in accident years 2007 and prior.

CNA Commercial

The favorable claim and allocated claim adjustment expense reserve development was primarily due to favorable experience in property, auto and international coverages as further discussed below.

Approximately $98 million of favorable claim and allocated claim adjustment expense reserve development was recorded for property coverages. Favorable development of $53 million was recorded in catastrophe coverages due to favorable incurred loss emergence, primarily in accident years 2008 and 2009. Favorable claim and allocated claim adjustment expense reserve development of approximately $45 million was recorded for non-catastrophe related property coverages, primarily due to decreased severity in accident years 2009 and prior.

Approximately $61 million of favorable claim and allocated claim adjustment expense reserve development was primarily due to decreased frequency and severity trends in commercial auto coverages in accident years 2009 and prior.

Approximately $35 million of favorable claim and allocated claim adjustment expense reserve development was recorded in international commercial coverages. Approximately $21 million of favorable development was recorded due to decreased frequency across several lines within an affiliate, primarily in accident years 2008 and prior. The remaining favorable development was primarily due to a commutation within CNA’s European operations book of renewable energy business.

Approximately $32 million of unfavorable claim and allocated claim adjustment expense reserve development was due to increased claim frequency in a portion of our primary casualty surplus lines book in accident years 2008 and 2009.

Approximately $35 million of unfavorable premium development was recorded due to a change in ultimate premium estimates relating to retrospectively rated policies and return premium on auditable policies due to reduced exposures.

 

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2009 Net Prior Year Development

CNA Specialty

Favorable claim and allocated claim adjustment expense reserve development of approximately $25 million for medical professional liability was primarily due to better than expected frequency and severity in accident years 2005 and prior, including individual claims closing favorable to expectations.

Approximately $8 million of favorable claim and allocated claim adjustment expense reserve development was recorded for professional liability coverages due primarily to favorable experience on a number of large claims, primarily related to financial institutions in accident years 2003 and prior.

CNA Commercial

Favorable claim and allocated claim adjustment expense reserve development was primarily due to experience in property coverages. Prior year catastrophe reserves decreased approximately $33 million, driven by the favorable settlement of several claims primarily in accident years 2005 and 2007. An additional $17 million of favorable claim and allocated claim adjustment expense reserve development was due to non-catastrophe related favorable loss emergence on large property coverages, primarily in accident years 2007 and 2008.

Approximately $25 million of favorable claim and allocated claim adjustment expense reserve development was due to decreased frequency and severity trends related to construction defect exposures in accident years 2003 and prior.

Approximately $40 million of adverse premium development was related to changes in estimated ultimate premium on retrospectively rated coverages. Additional adverse premium development was due to an estimated liability for an assessment related to a reinsurance association and less premium processing on auditable policies than expected.

Six Month Comparison

 

Six Months Ended June 30, 2010    CNA
Specialty
    CNA
Commercial
    Other
Insurance
    Total  

(In millions)

        

Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development:

        

Core (Non-A&E)

   $ (150   $ (203   $ 3      $ (350

Pretax (favorable) unfavorable premium development

     (3     56        (3     50   
   

Total pretax favorable net prior year development

   $ (153   $ (147   $      $ (300
   
Six Months Ended June 30, 2009                             

Pretax (favorable) unfavorable net prior year claim and allocated claim adjustment expense reserve development:

        

Core (Non-A&E)

   $ (64   $ (127   $ 5      $ (186

Pretax (favorable) unfavorable premium development

     (3     76        (3     70   
   

Total pretax (favorable) unfavorable net prior year development

   $ (67   $ (51   $ 2      $ (116
   

2010 Net Prior Year Development

CNA Specialty

The favorable claim and allocated claim adjustment expense reserve development was primarily due to professional liability coverages as discussed below.

 

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Approximately $52 million of favorable claim and allocated claim adjustment expense reserve development was recorded for medical professional liability coverages primarily due to favorable incurred emergence, primarily in accident years 2007 and prior.

Favorable claim and allocated claim adjustment expense reserve development of approximately $68 million was recorded for financial institutions, commercial governance and life agents coverages due to reduced frequency of large claims and favorable ceded recoveries, primarily in accident years 2007 and prior. Favorable development of $28 million was recorded in architects and engineers coverages due to favorable incurred emergence and claims closing favorable to expectations, primarily in accident years 2007 and prior. This favorability was partially offset by unfavorable development of approximately $28 million in employee practices liability driven by higher unemployment, primarily in accident years 2008 and 2009.

CNA Commercial

The favorable claim and allocated claim adjustment expense reserve development was primarily due to favorable experience in property, auto and international casualty coverages as discussed below.

Approximately $116 million of favorable claim and allocated claim adjustment expense reserve development was recorded for property coverages. Favorable development of $53 million was recorded in catastrophe coverages due to favorable incurred loss emergence, primarily in accident years 2008 and 2009. Favorable claim and allocated claim adjustment expense reserve development of approximately $63 million was recorded for non-catastrophe related property coverages, primarily due to decreased severity in accident years 2009 and prior.

Approximately $61 million of favorable claim and allocated claim adjustment expense reserve development was primarily due to decreased frequency and severity trends in commercial auto coverages in accident years 2009 and prior.

Approximately $47 million of favorable claim and allocated claim adjustment expense reserve development was recorded in international commercial coverages. Approximately $25 million of favorable development was recorded due to decreased frequency across several lines within an affiliate, primarily in accident years 2008 and prior. The remaining favorable development was primarily due to a commutation within the European affiliate’s book of renewable energy business.

Approximately $32 million of unfavorable claim and allocated claim adjustment expense reserve development was due to increased claim frequency in a portion of our primary casualty surplus lines book in accident years 2008 and 2009.

Approximately $56 million of unfavorable premium development was recorded due to a change in ultimate premium estimates relating to retrospectively rated policies and return premium on auditable policies due to reduced exposures.

2009 Net Prior Year Development

CNA Specialty

Favorable claim and allocated claim adjustment expense reserve development of approximately $25 million for medical professional liability was primarily due to better than expected frequency and severity in accident years 2005 and prior, including claims closing favorable to expectations.

Approximately $28 million of favorable claim and allocated claim adjustment expense reserve development was recorded for professional liability coverages due primarily to favorable experience on a number of large claims related to financial institutions in accident years 2003 and prior and decreased frequency of large claims in accident years 2007 and prior.

An additional $4 million of favorable claim and allocated claim adjustment expense reserve development was a result of favorable outcomes on claims relating to catastrophes in accident year 2005.

CNA Commercial

Favorable claim and allocated claim adjustment expense reserve development was primarily due to experience in property coverages. Prior year catastrophe reserves decreased approximately $64 million, driven by the favorable settlement of several claims primarily in accident years 2005 and 2007, and favorable frequency and severity on

 

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claims relating to catastrophes in accident year 2008. An additional $17 million of favorable claim and allocated claim adjustment expense reserve development was due to non-catastrophe related favorable loss emergence on large property coverages, primarily in accident years 2007 and 2008.

Approximately $25 million of favorable claim and allocated claim adjustment expense reserve development was due to decreased frequency and severity trends related to construction defect exposures in accident years 2003 and prior.

Approximately $40 million of adverse premium development was related to changes in estimated ultimate premium on retrospectively rated coverages. Additional adverse premium development was due to an estimated liability for an assessment related to a reinsurance association and less premium processing on auditable policies than expected.

6. Benefit Plans

Pension Plans - The Company has several non-contributory defined benefit plans for eligible employees. Benefits for certain plans are determined annually based on a specified percentage of annual earnings (based on the participant’s age or years of service) and a specified interest rate (which is established annually for all participants) applied to accrued balances. The benefits for another plan which cover salaried employees are based on formulas which include, among others, years of service and average pay. The Company’s funding policy is to make contributions in accordance with applicable governmental regulatory requirements.

Other Postretirement Benefit Plans - The Company has several postretirement benefit plans covering eligible employees and retirees. Participants generally become eligible after reaching age 55 with required years of service. Actual requirements for coverage vary by plan. Benefits for retirees who were covered by bargaining units vary by each unit and contract. Benefits for certain retirees are in the form of a Company health care account.

Benefits for retirees reaching age 65 are generally integrated with Medicare. Other retirees, based on plan provisions, must use Medicare as their primary coverage, with the Company reimbursing a portion of the unpaid amount; or are reimbursed for the Medicare Part B premium or have no Company coverage. The benefits provided by the Company are basically health and, for certain retirees, life insurance type benefits.

The Company funds certain of these benefit plans and accrues postretirement benefits during the active service of those employees who would become eligible for such benefits when they retire.

The components of net periodic benefit cost are as follows:

 

      Pension Benefits  
     

Three Months Ended

June 30,

    Six Months Ended
June 30,
 
      2010     2009     2010     2009  

(In millions)

        

Service cost

   $ 7      $ 6      $ 13      $ 13   

Interest cost

     41        43        83        86   

Expected return on plan assets

     (44     (39     (88     (78

Amortization of unrecognized net loss

     7        7        14        14   
   

Net periodic benefit cost

   $ 11      $ 17      $ 22      $ 35   
   
      Other Postretirement Benefits  
      Three Months Ended
June 30,
    Six Months Ended
June 30,
 
      2010     2009     2010     2009  

(In millions)

        

Service cost

       $ 1      $ 1   

Interest cost

   $ 3      $ 3        6        6   

Expected return on plan assets

     (1     (1     (2     (2

Amortization of unrecognized net loss

     1          2        1   

Amortization of unrecognized prior service benefit

     (6     (6     (12     (12

Regulatory asset decrease

     2        2        3        3   
   

Net periodic benefit cost

   $ (1   $ (2   $ (2   $ (3
   

 

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7. Business Segments

The Company’s reportable segments are primarily based on its individual operating subsidiaries. Each of the principal operating subsidiaries are headed by a chief executive officer who is responsible for the operation of its business and has the duties and authority commensurate with that position. Investment gains (losses) and the related income taxes, excluding those of CNA, are included in the Corporate and other segment.

CNA’s core property and casualty commercial insurance operations are reported in two business segments: CNA Specialty and CNA Commercial. CNA Specialty provides a broad array of professional, financial and specialty property and casualty products and services, primarily through insurance brokers and managing general underwriters. CNA Commercial includes property and casualty coverages sold to small businesses and middle market entities and organizations primarily through an independent agency distribution system. CNA Commercial also includes commercial insurance and risk management products sold to large corporations primarily through insurance brokers.

CNA’s non-core operations are managed in two segments: Life & Group Non-Core and Other Insurance. Life & Group Non-Core primarily includes the results of the life and group lines of business that are in run-off. Other Insurance primarily includes certain corporate expenses, including interest on corporate debt, and the results of certain property and casualty business primarily in run-off, including CNA Re. This segment also includes the results related to the centralized adjusting and settlement of A&E.

Diamond Offshore’s business primarily consists of operating 47 offshore drilling rigs that are chartered on a contract basis for fixed terms by companies engaged in exploration and production of hydrocarbons. Offshore rigs are mobile units that can be relocated based on market demand. On June 30, 2010, Diamond Offshore’s drilling rigs were located offshore twelve countries in addition to the United States. On July 7, 2010, Diamond Offshore completed the sale of one of its high performance, premium jack-up drilling rigs, the Ocean Shield.

HighMount’s business consists primarily of natural gas exploration and production operations located in the Permian Basin in Texas, the Antrim Shale in Michigan and the Black Warrior Basin in Alabama. In the second quarter of 2010, HighMount sold its exploration and production assets located in the Antrim Shale in Michigan and the Black Warrior Basin in Alabama. The Michigan and Alabama properties represented approximately 17%, in aggregate, of HighMount’s total proved reserves.

Boardwalk Pipeline is engaged in the interstate transportation and storage of natural gas. This segment consists of three interstate natural gas pipeline systems originating in the Gulf Coast area and running north and east through Texas, Louisiana, Mississippi, Alabama, Florida, Arkansas, Tennessee, Kentucky, Indiana, Ohio, Illinois and Oklahoma.

Loews Hotels owns and/or operates 19 hotels, 17 of which are in the United States and two are in Canada. The Loews Atlanta Hotel, which is operated under a management contract, opened on April 1, 2010.

The Corporate and other segment consists primarily of corporate investment income, including investment gains (losses) from non-insurance subsidiaries, corporate interest expenses and other unallocated expenses.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note 1 of the Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. In addition, CNA does not maintain a distinct investment portfolio for each of its insurance segments, and accordingly, allocation of assets to each segment is not performed. Therefore, net investment income and investment gains (losses) are allocated based on each segment’s carried insurance reserves, as adjusted.

 

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The following tables set forth the Company’s consolidated revenues and income (loss) attributable to Loews Corporation by business segment:

 

      Three Months Ended
June 30,
    Six Months Ended
June 30,
 
      2010     2009     2010     2009  

(In millions)

        

Revenues (a):

        

CNA Financial:

        

CNA Specialty

   $ 875      $ 787      $ 1,741      $ 1,477   

CNA Commercial

     981        954        2,054        1,790   

Life and Group Non-Core

     321        329        641        453   

Other Insurance

     56        26        112        14   
   

Total CNA Financial

     2,233        2,096        4,548        3,734   

Diamond Offshore

     823        957        1,685        1,843   

HighMount

     105        147        253        322   

Boardwalk Pipeline

     256        201        557        425   

Loews Hotels

     81        73        156        146   

Corporate and other

     (12     60          87   
   

Total

   $ 3,486      $ 3,534      $ 7,199      $ 6,557   
   

Income (loss) before income tax and noncontrolling interest (a):

        

CNA Financial:

        

CNA Specialty

   $ 302      $ 147      $ 518      $ 202   

CNA Commercial

     187        55        350        (32

Life and Group Non-Core

     (45     (42     (66     (282

Other Insurance

     5        (27     7        (87
   

Total CNA Financial

     449        133        809        (199

Diamond Offshore

     320        520        725        971   

HighMount

     18        46        75        (960

Boardwalk Pipeline

     53        18        141        69   

Loews Hotels

     6        6        5        (23

Corporate and other

     (43     33        (56     30   
   

Total

   $ 803      $ 756      $ 1,699      $ (112
   

Net income (loss) - Loews (a):

        

CNA Financial:

        

CNA Specialty

   $ 170      $ 84      $ 293      $ 119   

CNA Commercial

     100        41        200        (3

Life and Group Non-Core

     (17     (15     (20     (146

Other Insurance

     6        (11     11        (41
   

Total CNA Financial

     259        99        484        (71

Diamond Offshore

     104        181        240        344   

HighMount

     5        29        37        (612

Boardwalk Pipeline

     21        8        59        30   

Loews Hotels

     4        3        3        (15

Corporate and other

     (27     20        (37     17   
   

Total

   $ 366      $ 340      $ 786      $ (307
   

 

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(a) Investment gains (losses) included in Revenues, Income (loss) before income tax and noncontrolling interest and Net income (loss) - Loews are as follows:

 

      Three Months Ended
June 30,
    Six Months Ended
June 30,
 
      2010     2009     2010     2009  

Revenues and Income (loss) before income tax and noncontrolling interest:

        

CNA Financial:

        

CNA Specialty

   $ 32      $ (83   $ 45      $ (192

CNA Commercial

     (13     (183     8        (369

Life & Group Non-Core

     (1     13        (5     (177

Other Insurance

     11        (44     15        (91
   

Total CNA Financial

     29        (297     63        (829

Corporate and other

     (18       (31     1   
   

Total

   $ 11      $ (297   $ 32      $ (828
   

Net income (loss) - Loews:

        

CNA Financial:

        

CNA Specialty

   $ 19      $ (51   $ 27      $ (114

CNA Commercial

     (12     (110       (218

Life & Group Non-Core

       8