CNA

CNA Financial Corp. 10-Q Summary (Period Ended June 30, 2006)

Business Context and Reporting Period

This is a Quarterly Report (Form 10-Q) for CNA Financial Corporation (CNAF) for the period ended June 30, 2006. CNAF is a holding company for property and casualty and life insurance subsidiaries, primarily Continental Casualty Company (CCC). The company is a large accelerated filer. As of June 30, 2006, Loews Corporation owned approximately 91% of CNAF's outstanding common stock and 100% of its Series H preferred stock. The financial statements are unaudited but include all normal recurring adjustments.

Key Financial Metrics

Material Changes vs. Prior Period

• Net Income: Decreased $7 million (1.5%) year-over-year, primarily due to a shift from net realized investment gains in 2005 to net realized investment losses in 2006, partially offset by a $75 million increase in Net Operating Income.
• Investment Results: Net realized investment losses were $89 million for the six months ended June 30, 2006, compared to gains of $7 million in the prior year. This was driven by sales of fixed maturity securities at a loss due to rising interest rates and increased other-than-temporary impairment (OTTI) losses ($27 million in 2006 vs. $35 million in 2005).
• Investment Income: Net investment income increased $277 million (32.8%) due to higher interest rates, an increased asset base, and reduced interest expense on funds withheld following the commutation of finite reinsurance contracts in 2005.
• Premiums: Net earned premiums decreased $50 million (1.3%), driven by a $48 million decrease in the Life and Group Non-Core segment and a $71 million decrease in Standard Lines, partially offset by a $58 million increase in Specialty Lines.
• Reserves: Total claim and claim adjustment expense reserves decreased to $30,177 million from $30,938 million. Net prior year development was unfavorable by $2 million in 2006, a significant improvement from the $160 million unfavorable development recorded in 2005.

Guidance, Outlook, Risks, and Unusual Items

• Restatements: The company restated prior period financial results (2005) to correct accounting for discontinued operations and cash flow classifications. The 2006 results reflect these corrections.
• Legal Proceedings: Significant ongoing litigation includes the Insurance Brokerage Antitrust Litigation, Global Crossing Limited Litigation, and the IGI Contingency involving John Hancock. Management believes unfavorable outcomes will not materially affect equity but could impact results of operations.
• Asbestos, Environmental, and Mass Tort (APMT): CNA carries net reserves of $1,505 million for asbestos and $374 million for environmental pollution/mass tort. Management notes high uncertainty in estimating ultimate costs for these claims due to legal and judicial factors.
• Related Party Transactions: CNA Surety has exposure to a large national contractor. While loans were fully impaired in prior years, CNA Surety established $110 million in surety loss reserves. The company estimates potential additional surety losses of approximately $90 million pretax if the contractor fails to restructure.
• Controls and Procedures: Management concluded that disclosure controls and procedures were not effective as of June 30, 2006, due to material weaknesses in internal control over financial reporting related to discontinued operations and intercompany eliminations, which are being remediated.
• Dividends: The company plans to retire the Series H preferred stock held by Loews, which accrues cumulative dividends. As of June 30, 2006, $235 million of dividends were undeclared but accumulated.

Key Facts for Investor Verification

• Investment Portfolio Quality: Verify the composition of the $674 million in gross unrealized losses on fixed maturity securities, specifically the 60% attributed to asset-backed securities and the company's assessment of these as "temporarily impaired."
• APMT Reserve Adequacy: Review the sensitivity analysis for Asbestos, Environmental, and Mass Tort reserves, noting that a 6-point increase in account size trend could increase net reserves by approximately $700 million.
• Contractor Exposure: Monitor the status of the large national contractor surety exposure, including the $90 million estimated potential additional loss and the $13 million in guarantees/collateral provided.
• Internal Controls: Track the progress of remediation efforts for the material weaknesses in internal controls identified in the 2006 restatement and the ongoing SEC investigation.
• Reinsurance Recoverables: Assess the $11,455 million in reinsurance receivables (net of $527 million allowance) and the company's ability to collect from reinsurers, particularly in the context of the IGI contingency.