CNA

CNA Financial Corp. 10-Q Summary (Period Ended Sept 30, 2005)

Business Context and Reporting Period

This is a Quarterly Report (Form 10-Q) for CNA Financial Corporation (CNAF) for the period ended September 30, 2005. CNAF is a commercial insurance company, primarily operating through its property and casualty subsidiaries (Continental Casualty Company, The Continental Insurance Company, and Continental Assurance Company). Loews Corporation owns approximately 91% of CNAF's outstanding common stock. The financial statements have been restated for prior periods to correct accounting for certain reinsurance contracts and equity interests in Accord Re Ltd.

Key Financial Metrics

Material Changes vs. Prior Period

• Net Income: Increased significantly to $469 million for the nine months ended Sept 30, 2005, compared to $142 million in the same period of 2004. This improvement is primarily driven by a $622 million pretax loss on the sale of the individual life insurance business recorded in 2004, which is absent in the current period.
• Catastrophe Losses: Net catastrophe losses were $443 million for the nine months ended Sept 30, 2005, compared to $271 million in 2004. The 2005 losses were driven by Hurricanes Katrina, Dennis, Ophelia, and Rita. Gross commercial catastrophe losses were $803 million in 2005 vs. $293 million in 2004.
• Prior Year Development: Unfavorable net prior year development increased to $227 million (pretax) for the nine months ended Sept 30, 2005, compared to $123 million in 2004. This was driven by increased severity in workers' compensation and liability coverages.
• Premiums: Net earned premiums decreased by $537 million year-over-year, largely due to the sale of the individual life business in 2004 and the specialty medical business in early 2005.
• Investment Results: Realized investment gains improved to $74 million in 2005 from a loss of $415 million in 2004, excluding the one-time life business sale loss in the prior year.

Guidance, Outlook, Risks, and Unusual Items

• Catastrophe Exposure: Management notes significant judgment in estimating ultimate costs for 2005 hurricanes due to limited access to affected areas and legal uncertainties. Hurricane Wilma (Oct 2005) impact is not yet estimated.
• Asbestos and Mass Tort (APMT): CNA carries $1,579 million in net asbestos reserves and $402 million in net environmental pollution/mass tort reserves. Management states that ultimate liability for these claims is subject to high uncertainty and could materially exceed recorded reserves.
• Loans to National Contractor: CNA Surety provided loans totaling $126 million to a national contractor. The company recorded impairment charges totaling $90 million pretax in 2004 and 2005. If the contractor fails to restructure, CNA estimates additional surety losses of approximately $160 million pretax.
• Reinsurance Disputes: CNA received arbitration notices from Hannover Reinsurance Group regarding aggregate reinsurance treaties. If Hannover's position is sustained, CNA estimates additional ceded premium and interest charges of $50 million to $70 million after-tax.
• Regulatory Matters: The company is subject to ongoing state regulatory examinations regarding finite reinsurance contracts and accounting practices. Further restatements are possible.
• Terrorism Risk: The Terrorism Risk Insurance Act expires Dec 31, 2005. If not reauthorized, CNA faces increased exposure, though it is utilizing conditional exclusions where permitted.

Key Facts for Investor Verification

• Catastrophe Reserve Adequacy: Verify the sufficiency of reserves for Hurricanes Katrina, Rita, Dennis, and Ophelia, given the preliminary nature of the $443 million net loss estimate.
• APMT Reserve Development: Monitor future developments in asbestos and environmental pollution claims, as management acknowledges high uncertainty and potential for material reserve increases.
• National Contractor Exposure: Track the restructuring progress of the national contractor and potential additional impairment or surety loss charges beyond the estimated $160 million.
• Reinsurance Arbitration: Follow the outcome of the arbitration with Hannover Reinsurance Group regarding the aggregate reinsurance treaties.
• Regulatory Examinations: Watch for results of state regulatory examinations concerning finite reinsurance accounting, which could lead to further financial restatements.
• Debt Covenants: Confirm continued compliance with debt covenants, particularly the leverage ratio and fixed charge coverage ratio for CNA Surety.