XFRA:CNH CNA Financial Corp Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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CNA 2012 Q1-12


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
R QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2012
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number 1-5823
 
CNA FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
 
36-6169860
(I.R.S. Employer
Identification No.)
333 S. Wabash
Chicago, Illinois
(Address of principal executive offices)
 
60604
(Zip Code)
(312) 822-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes R 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 R No £
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.
Large accelerated filer R
 
Accelerated filer £
 
Non-accelerated filer £ (Do not check if a smaller reporting company)
 
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 R
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class
 
Outstanding at April 27, 2012
Common Stock, Par value $2.50
 
269,359,109



Item Number
PART I. Financial Information
Page
Number
1.
 





 
2.
3.
4.
 
PART II. Other Information
 
1.
4.
6.


2


Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements
CNA Financial Corporation
Condensed Consolidated Statements of Operations (Unaudited)
Three months ended March 31
 
 
 
(In millions, except per share data)
2012
 
2011
Revenues
 
 
 
Net earned premiums
$
1,649

 
$
1,615

Net investment income
648

 
620

Net realized investment gains (losses), net of participating policyholders’ interests:
 

 
 

Other-than-temporary impairment losses
(15
)
 
(20
)
Portion of other-than-temporary impairments recognized in Other comprehensive income
(12
)
 
(21
)
Net other-than-temporary impairment losses recognized in earnings
(27
)
 
(41
)
Other net realized investment gains
63

 
54

Net realized investment gains, net of participating policyholders’ interests
36

 
13

Other revenues
68

 
67

Total revenues
2,401

 
2,315

Claims, Benefits and Expenses
 
 
 
Insurance claims and policyholders’ benefits
1,381

 
1,364

Amortization of deferred acquisition costs
295

 
297

Other operating expenses
319

 
277

Interest
42

 
46

Total claims, benefits and expenses
2,037

 
1,984

Income from continuing operations before income tax
364

 
331

Income tax expense
(114
)
 
(101
)
Income from continuing operations
250

 
230

Loss from discontinued operations, net of income tax benefit of - and $0

 
(1
)
Net income
250

 
229

Net (income) loss attributable to noncontrolling interests

 
(9
)
Net income attributable to CNA
$
250

 
$
220

 
 
 
 
Income Attributable to CNA Common Stockholders
 
 
 
Income from continuing operations attributable to CNA common stockholders
$
250

 
$
221

Income (loss) from discontinued operations attributable to CNA common stockholders

 
(1
)
Income attributable to CNA common stockholders
$
250

 
$
220

 
 
 
 
Basic and Diluted Earnings Per Share Attributable to CNA Common Stockholders
 
 
 
Income from continuing operations attributable to CNA common stockholders
$
0.93

 
$
0.82

Loss from discontinued operations attributable to CNA common stockholders

 

Basic and diluted earnings per share attributable to CNA common stockholders
$
0.93

 
$
0.82

 
 
 
 
Dividends per share
$
0.15

 
$
0.10

 
 
 
 
Weighted Average Outstanding Common Stock and Common Stock Equivalents
 
 
 
Basic
269.3

 
269.2

Diluted
269.7

 
269.5

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

3


CNA Financial Corporation
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
Three months ended March 31
 
 
 
(In millions)
2012
 
2011
Other Comprehensive Income, Net of Tax
 
 
 
Changes in:
 
 
 
Net unrealized gains on investments with other-than-temporary impairments
$
40

 
$
38

Net unrealized gains on other investments
218

 
22

Net unrealized gains on investments
258

 
60

Foreign currency translation adjustment
21

 
25

Pension and postretirement benefits
6

 
1

Net unrealized gains on discontinued operations and other

 
1

Allocation to participating policyholders
(1
)
 

Other comprehensive income, net of tax
284

 
87

Net income
250

 
229

Comprehensive income
534

 
316

Change in:
 
 
 
Net unrealized (gains) losses on investments attributable to noncontrolling interests

 
2

Other comprehensive (income) loss attributable to noncontrolling interests

 
2

Net (income) loss attributable to noncontrolling interests

 
(9
)
Comprehensive (income) loss attributable to noncontrolling interests

 
(7
)
Total comprehensive income attributable to CNA
$
534

 
$
309

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

4


CNA Financial Corporation
Condensed Consolidated Balance Sheets (Unaudited)
 
March 31,
2012
 
December 31,
2011
(In millions, except share data)
 
Assets
 
 
 
Investments:
 
 
 
Fixed maturity securities at fair value (amortized cost of $37,810 and $37,345)
$
40,837

 
$
39,937

Equity securities at fair value (cost of $278 and $288)
298

 
304

Limited partnership investments
2,400

 
2,245

Other invested assets
11

 
12

Mortgage loans
281

 
234

Short term investments
1,638

 
1,641

Total investments
45,465

 
44,373

Cash
59

 
75

Reinsurance receivables (less allowance for uncollectible receivables of $91 and $91)
5,898

 
6,001

Insurance receivables (less allowance for uncollectible receivables of $113 and $112)
1,664

 
1,614

Accrued investment income
478

 
436

Deferred acquisition costs
576

 
552

Deferred income taxes
201

 
415

Property and equipment at cost (less accumulated depreciation of $425 and $420)
307

 
309

Goodwill and other intangible assets
139

 
139

Other assets (includes $12 and $130 due from Loews Corporation)
818

 
779

Separate account business
402

 
417

Total assets
$
56,007

 
$
55,110

Liabilities and Equity
 

 
 

Liabilities:
 

 
 

Insurance reserves:
 

 
 

Claim and claim adjustment expenses
$
24,203

 
$
24,303

Unearned premiums
3,383

 
3,250

Future policy benefits
9,959

 
9,810

Policyholders’ funds
169

 
191

Participating policyholders’ funds
68

 
68

Short term debt
83

 
83

Long term debt
2,526

 
2,525

Other liabilities
3,233

 
2,975

Separate account business
402

 
417

Total liabilities
44,026

 
43,622

Commitments and contingencies (Notes C, G and I)


 


Equity:
 

 
 

Common stock ($2.50 par value; 500,000,000 shares authorized; 273,040,243 shares issued; 269,356,268 and 269,274,900 shares outstanding)
683

 
683

Additional paid-in capital
2,140

 
2,141

Retained earnings
8,517

 
8,308

Accumulated other comprehensive income
764

 
480

Treasury stock (3,683,975 and 3,765,343 shares), at cost
(100
)
 
(102
)
Notes receivable for the issuance of common stock
(23
)
 
(22
)
Total CNA stockholders’ equity
11,981

 
11,488

Total liabilities and equity
$
56,007

 
$
55,110

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

5


CNA Financial Corporation
Condensed Consolidated Statements of Cash Flows (Unaudited)
Three months ended March 31
 
 
 
(In millions)
2012
 
2011
Cash Flows from Operating Activities
 
 
 
Net income
$
250

 
$
229

Adjustments to reconcile net income to net cash flows provided by operating activities:
 
 
 
Loss from discontinued operations

 
1

Loss on disposal of property and equipment
1

 
9

Deferred income tax expense
73

 
89

Trading portfolio activity
(6
)
 
6

Net realized investment gains, net of participating policyholders’ interests
(36
)
 
(13
)
Equity method investees
(69
)
 
(104
)
Amortization of investments
(23
)
 
(21
)
Depreciation
20

 
19

Changes in:
 
 
 
Receivables, net
53

 
71

Accrued investment income
(42
)
 
(44
)
Deferred acquisition costs
(15
)
 
(15
)
Insurance reserves
99

 
45

Other assets
73

 
(4
)
Other liabilities
(67
)
 
(155
)
Other, net
1

 
1

Total adjustments
62

 
(115
)
Net cash flows provided by operating activities-continuing operations
$
312

 
$
114

Net cash flows used by operating activities-discontinued operations
$

 
$
(2
)
Net cash flows provided by operating activities-total
$
312

 
$
112

Cash Flows from Investing Activities
 

 
 

Purchases of fixed maturity securities
$
(2,842
)
 
$
(3,480
)
Proceeds from fixed maturity securities:
 
 
 
Sales
1,929

 
1,881

Maturities, calls and redemptions
683

 
965

Purchases of equity securities
(12
)
 
(34
)
Proceeds from sales of equity securities
19

 
128

Origination of mortgage loans
(48
)
 
(31
)
Change in short term investments
(8
)
 
548

Change in other investments
10

 
(43
)
Purchases of property and equipment
(22
)
 
(11
)
Other, net
4

 
1

Net cash flows used by investing activities-continuing operations
$
(287
)
 
$
(76
)
Net cash flows provided by investing activities-discontinued operations
$

 
$
2

Net cash flows used by investing activities-total
$
(287
)
 
$
(74
)
The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).

6


Three months ended March 31
 
 
 
(In millions)
2012
 
2011
Cash Flows from Financing Activities
 
 
 
Dividends paid to common stockholders
$
(41
)
 
$
(27
)
Proceeds from the issuance of debt

 
396

Repayment of debt

 
(409
)
Stock options exercised

 
6

Other, net
(1
)
 
(2
)
Net cash flows used by financing activities-continuing operations
$
(42
)
 
$
(36
)
Net cash flows provided (used) by financing activities-discontinued operations
$

 
$

Net cash flows used by financing activities-total
$
(42
)
 
$
(36
)
Effect of foreign exchange rate changes on cash
$
1

 
$
2

Net change in cash
$
(16
)
 
$
4

Cash, beginning of year
75

 
77

Cash, end of period
$
59

 
$
81

 
 
 
 
Cash-continuing operations
$
59

 
$
81

Cash-discontinued operations

 

Cash-total
$
59

 
$
81

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

7


CNA Financial Corporation
Condensed Consolidated Statements of Equity (Unaudited)
Three months ended March 31
 
 
 
(In millions)
2012
 
2011
Common Stock
 
 
 
Balance, beginning of period
$
683

 
$
683

Balance, end of period
683

 
683

Additional Paid-in Capital
 
 
 
Balance, beginning of period, as previously reported
2,146

 
2,200

Cumulative effect adjustment from accounting change for deferred acquisition costs, net of tax
(5
)
 

Balance, beginning of period, as adjusted
2,141

 
2,200

Stock-based compensation
(1
)
 
(1
)
Other

 
(1
)
Balance, end of period
2,140

 
2,198

Retained Earnings
 
 
 
Balance, beginning of period, as previously reported
8,382

 
7,876

Cumulative effect adjustment from accounting change for deferred acquisition costs, net of tax
(74
)
 
(72
)
Balance, beginning of period, as adjusted
8,308

 
7,804

Dividends paid to common stockholders
(41
)
 
(27
)
Net income attributable to CNA
250

 
220

Balance, end of period
8,517

 
7,997

Accumulated Other Comprehensive Income
 
 
 
Balance, beginning of period, as previously reported
470

 
326

Cumulative effect adjustment from accounting change for deferred acquisition costs, net of tax
10

 

Balance, beginning of period, as adjusted
480

 
326

Other comprehensive income attributable to CNA
284

 
89

Balance, end of period
764

 
415

Treasury Stock
 
 
 
Balance, beginning of period
(102
)
 
(105
)
Stock-based compensation
2

 
4

Balance, end of period
(100
)
 
(101
)
Notes Receivable for the Issuance of Common Stock
 
 
 
Balance, beginning of period
(22
)
 
(26
)
(Increase) decrease in notes receivable for the issuance of common stock
(1
)
 
1

Balance, end of period
(23
)
 
(25
)
Total CNA Stockholders’ Equity
11,981

 
11,167

Noncontrolling Interests
 
 
 
Balance, beginning of period, as previously reported

 
570

Cumulative effect adjustment from accounting change for deferred acquisition costs, net of tax

 
(7
)
Balance, beginning of period, as adjusted

 
563

Net income

 
9

Other comprehensive income (loss)

 
(2
)
Other

 
3

Balance, end of period

 
573

Total Equity
$
11,981

 
$
11,740

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

8


Notes to Condensed Consolidated Financial Statements (Unaudited)
Note A. General
Basis of Presentation
The Condensed Consolidated Financial Statements (Unaudited) include the accounts of CNA Financial Corporation (CNAF) and its controlled subsidiaries. Collectively, CNAF and its controlled subsidiaries are referred to as CNA or the Company. CNA’s property and casualty and remaining life and group insurance operations are primarily conducted by Continental Casualty Company (CCC), The Continental Insurance Company, Western Surety Company and Continental Assurance Corporation. Loews Corporation (Loews) owned approximately 90% of the outstanding common stock of CNAF as of March 31, 2012.
The accompanying Condensed Consolidated Financial Statements have been prepared in conformity with accounting principles generally accepted in the United States of America (GAAP). Certain financial information that is normally included in annual financial statements, including certain financial statement notes, prepared in accordance with GAAP, is not required for interim reporting purposes and has been condensed or omitted. These statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in CNAF's Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) for the year ended December 31, 2011, including the summary of significant accounting policies in Note A. The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the Condensed Consolidated Financial Statements and the reported amounts of revenues and expenses during the reporting periods. Actual results may differ from those estimates.
The interim financial data as of March 31, 2012 and for the three months ended March 31, 2012 and 2011 is unaudited. However, in the opinion of management, the interim data includes all adjustments, consisting of normal recurring accruals, necessary for a fair statement of the Company's results for the interim periods. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. Intercompany amounts have been eliminated.
Hardy Underwriting Bermuda Limited (Hardy)
On March 21, 2012, CNA announced an agreement to acquire Hardy, a specialized Lloyd’s underwriter, in a cash acquisition for approximately $227 million. Hardy underwrote approximately $430 million in gross written premium in 2011. Subject to regulatory approvals and other conditions, the acquisition is expected to be completed during the second quarter of 2012. As of March 31, 2012, $230 million of the Company's short-term investments were held in escrow in British pounds to fund the acquisition.
Noncontrolling Interests
Net income attributable to noncontrolling interests for the three months ended March 31, 2011 represented the noncontrolling interests in CNA Surety Corporation (Surety) and First Insurance Company of Hawaii (FICOH). On June 10, 2011, CNA completed the acquisition of the noncontrolling interest of Surety and on November 29, 2011, CNA completed the sale of its 50% ownership interest in FICOH.

9


Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts
In October 2010, the Financial Accounting Standards Board issued updated accounting guidance which limits the capitalization of costs incurred to acquire or renew insurance contracts to those that are incremental direct costs of successful contract acquisitions. The previous guidance allowed the capitalization of acquisition costs that vary with and are primarily related to the acquisition of new and renewal insurance contracts, whether the costs related to successful or unsuccessful efforts.
As of January 1, 2012, the Company adopted the updated accounting guidance prospectively as of January 1, 2004, the earliest date practicable. Due to the lack of available historical data related to certain accident and health contracts issued prior to January 1, 2004, a full retrospective application of the change in accounting guidance was impracticable. Acquisition costs capitalized prior to January 1, 2004 will continue to be accounted for under the previous accounting guidance and will be amortized over the premium-paying period of the related policies using assumptions consistent with those used for computing future policy benefit reserves for such contracts.
For the three month period ended March 31, 2012, the adoption of the new accounting guidance resulted in an approximate $2 million decrease in Net income attributable to CNA and a $0.01 decrease in Basic and diluted earnings per share attributable to CNA common stockholders.
The Company has adjusted its previously reported financial information included herein to reflect the change in accounting guidance for deferred acquisition costs. The impacts of adopting the new accounting standard on the Company's Condensed Consolidated Balance Sheet as of December 31, 2011 were a $106 million decrease in Deferred acquisition costs and a $37 million increase in Deferred income taxes. The impacts to Accumulated other comprehensive income (AOCI) and Additional paid-in capital (APIC) were the result of the indirect effects of the Company's adoption of this guidance on Shadow Adjustments, as further discussed in Note C, and the Company's acquisition of the noncontrolling interest of Surety as discussed above.
The impacts on the Company's Condensed Consolidated Statement of Operations for the three month period ended March 31, 2011 were a $48 million decrease in Amortization of deferred acquisition costs, a $52 million increase in Other operating expenses, and a $1 million decrease in Income tax expense, resulting in a $3 million decrease in Net income attributable to CNA, and a $0.01 decrease in Basic and diluted earnings per share attributable to CNA common stockholders. There were no changes to net cash flows from operating, investing or financing activities for the comparative period presented as a result of the adoption of the new accounting standard.


10


Note B. Earnings Per Share
Earnings per share attributable to the Company's common stockholders is based on the weighted average number of outstanding common shares. Basic earnings (loss) per share excludes the impact of dilutive securities and is computed by dividing net income (loss) attributable to CNA by the weighted average number of common shares outstanding for the period. Diluted earnings (loss) 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.
For the three months ended March 31, 2012 and 2011, approximately 339 thousand and 272 thousand potential shares attributable to exercises under stock-based employee compensation plans were included in the calculation of diluted earnings per share. For those same periods, approximately 668 thousand and 1.0 million potential shares attributable to exercises under stock-based employee compensation plans were not included in the calculation of diluted earnings per share because the effect would have been antidilutive.

11


Note C. Investments
The significant components of net investment income are presented in the following table.
Net Investment Income
Three months ended March 31
 
 
 
(In millions)
2012

2011
Fixed maturity securities
$
516

 
$
506

Short term investments
1

 
2

Limited partnership investments
130

 
114

Equity securities
4

 
6

Mortgage loans
3

 
2

Trading portfolio (a)
7

 
3

Other
1

 
2

Gross investment income
662

 
635

Investment expense
(14
)
 
(15
)
Net investment income
$
648

 
$
620

___________________
(a)
There were no net unrealized gains (losses) related to changes in fair value of trading securities still held included in net investment income for the three months ended March 31, 2012 or 2011.
Net realized investment gains (losses) are presented in the following table.
Net Realized Investment Gains (Losses)
Three months ended March 31
 
 
 
(In millions)
2012
 
2011
Net realized investment gains (losses):
 
 
 
Fixed maturity securities:
 
 
 
Gross realized gains
$
69

 
$
88

Gross realized losses
(39
)
 
(68
)
Net realized investment gains (losses) on fixed maturity securities
30

 
20

Equity securities:
 
 
 

Gross realized gains
3

 
5

Gross realized losses
(2
)
 
(5
)
Net realized investment gains (losses) on equity securities
1

 

Derivatives
(1
)
 
(1
)
Short term investments and other (a) (b)
6

 
(6
)
Net realized investment gains (losses), net of participating policyholders’ interests
$
36

 
$
13

____________________
(a)
There were no net unrealized gains (losses) included in the three months ended March 31, 2012 and $1 million of net unrealized gains included in the three months ended March 31, 2011 related to changes in fair value of securities for which the fair value option has been elected.
(b)
The three months ended March 31, 2011 includes a $9 million loss related to the early extinguishment of $400 million of senior notes originally due August 15, 2011.

12


The components of net other-than-temporary impairment (OTTI) losses recognized in earnings by asset type are summarized in the following table.
Three months ended March 31
 
 
 
(In millions)
2012
 
2011
Fixed maturity securities available-for-sale:
 
 
 
Corporate and other bonds
$
10

 
$
9

Asset-backed:
 
 
 
Residential mortgage-backed
14

 
28

Total asset-backed
14

 
28

U.S. Treasury and obligation of government-sponsored enterprises
1

 

Total fixed maturity securities available-for-sale
25

 
37

Equity securities available-for-sale:
 
 
 
Common stock
2

 
3

Preferred stock

 
1

Total equity securities available-for-sale
2

 
4

Net OTTI losses recognized in earnings
$
27

 
$
41

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. The Company follows a consistent and systematic process for determining and recording an OTTI loss. The Company 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 the Company’s Chief Financial Officer. The Impairment Committee is responsible for evaluating all 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 the Company 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. The factors considered by the Impairment Committee include (a) the financial condition and near term prospects of the issuer, (b) whether the debtor is current on interest and principal payments, (c) credit ratings of the securities and (d) general market conditions and industry or sector specific outlook. The Company 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 OTTI in Other comprehensive income. In subsequent reporting periods, a change in intent to sell or further credit impairment on a security whose fair value has not deteriorated will cause the non-credit component originally recorded as OTTI in Other comprehensive income to be recognized as an OTTI loss in earnings.
The Company 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, and credit support from lower level tranches.

13


The Company 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: (a) the length of time and the extent to which the fair value has been less than amortized cost, (b) the financial condition and near term prospects of the issuer, (c) the intent and ability of the Company to retain its investment for a period of time sufficient to allow for an anticipated recovery in value and (d) general market conditions and industry or sector specific outlook.
The following tables provide a summary of fixed maturity and equity securities.
Summary of Fixed Maturity and Equity Securities
March 31, 2012
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
Unrealized
OTTI
Losses (Gains)
(In millions)
 
 
 
 
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
19,324

 
$
2,013

 
$
61

 
$
21,276

 
$

States, municipalities and political subdivisions
9,234

 
1,042

 
93

 
10,183

 

Asset-backed:
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
5,958

 
175

 
139

 
5,994

 
37

Commercial mortgage-backed
1,297

 
68

 
36

 
1,329

 
(2
)
Other asset-backed
1,022

 
18

 
1

 
1,039

 

Total asset-backed
8,277

 
261

 
176

 
8,362

 
35

U.S. Treasury and obligations of government-sponsored enterprises
224

 
12

 

 
236

 

Foreign government
634

 
21

 

 
655

 

Redeemable preferred stock
105

 
8

 

 
113

 

Total fixed maturity securities available-for-sale
37,798

 
3,357

 
330

 
40,825

 
$
35

Total fixed maturity securities trading
12

 

 

 
12

 
 
Equity securities available-for-sale:
 
 
 
 
 
 
 
 
 
Common stock
32

 
17

 
1

 
48

 
 
Preferred stock
246

 
4

 

 
250

 
 
Total equity securities available-for-sale
278

 
21

 
1

 
298

 
 
Total
$
38,088

 
$
3,378

 
$
331

 
$
41,135

 
 


14


December 31, 2011
Cost or
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
Unrealized
OTTI
Losses (Gains)
(In millions)
 
 
 
 
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
19,086

 
$
1,946

 
$
154

 
$
20,878

 
$

States, municipalities and political subdivisions
9,018

 
900

 
136

 
9,782

 

Asset-backed:
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
5,786

 
172

 
183

 
5,775

 
99

Commercial mortgage-backed
1,365

 
48

 
59

 
1,354

 
(2
)
Other asset-backed
946

 
13

 
4

 
955

 

Total asset-backed
8,097

 
233

 
246

 
8,084

 
97

U.S. Treasury and obligations of government-sponsored enterprises
479

 
14

 

 
493

 

Foreign government
608

 
28

 

 
636

 

Redeemable preferred stock
51

 
7

 

 
58

 

Total fixed maturity securities available-for-sale
37,339

 
3,128

 
536

 
39,931

 
$
97

Total fixed maturity securities trading
6

 

 

 
6

 
 
Equity securities available-for-sale:
 
 
 
 
 
 
 
 
 
Common stock
30

 
17

 

 
47

 
 
Preferred stock
258

 
4

 
5

 
257

 
 
Total equity securities available-for-sale
288

 
21

 
5

 
304

 
 
Total
$
37,633

 
$
3,149

 
$
541

 
$
40,241

 
 
The net unrealized gains on investments included in the tables above are recorded as a component of AOCI. When presented in AOCI, these amounts are net of tax and any required Shadow Adjustments. At March 31, 2012 and December 31, 2011, the net unrealized gains on investments included in AOCI were net of Shadow Adjustments of $751 million and $723 million. To the extent that unrealized gains on fixed income securities supporting certain products within the Life & Group Non-Core segment would result in a premium deficiency if realized, a related decrease in Deferred acquisition costs and/or increase in Insurance reserves are recorded, net of tax, as a reduction through Other comprehensive income (Shadow Adjustments).

15


The following tables summarize the estimated fair value and gross unrealized losses of available-for-sale fixed maturity and equity securities in a gross unrealized loss position by the length of time in which the securities have continuously been in that position.
Securities in a Gross Unrealized Loss Position
 
Less than 12 Months
 
12 Months or Longer
 
Total
March 31, 2012
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
(In millions)
 
 
 
 
 
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
1,635

 
$
43

 
$
124

 
$
18

 
$
1,759

 
$
61

States, municipalities and political subdivisions
385

 
8

 
460

 
85

 
845

 
93

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
882

 
39

 
1,026

 
100

 
1,908

 
139

Commercial mortgage-backed
219

 
18

 
122

 
18

 
341

 
36

Other asset-backed
297

 
1

 

 

 
297

 
1

Total asset-backed
1,398

 
58

 
1,148

 
118

 
2,546

 
176

Total fixed maturity securities available-for-sale
3,418

 
109

 
1,732

 
221

 
5,150

 
330

Equity securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
Common stock
4

 
1

 

 

 
4

 
1

Total equity securities available-for-sale
4

 
1

 

 

 
4

 
1

Total
$
3,422

 
$
110

 
$
1,732

 
$
221

 
$
5,154

 
$
331


 
Less than 12 Months
 
12 Months or Longer
 
Total
December 31, 2011
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
(In millions)
 
 
 
 
 
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
2,552

 
$
126

 
$
159

 
$
28

 
$
2,711

 
$
154

States, municipalities and political subdivisions
67

 
1

 
721

 
135

 
788

 
136

Asset-backed:
 
 
 
 
 
 
 
 
 

 
 

Residential mortgage-backed
719

 
36

 
874

 
147

 
1,593

 
183

Commercial mortgage-backed
431

 
39

 
169

 
20

 
600

 
59

Other asset-backed
389

 
4

 

 

 
389

 
4

Total asset-backed
1,539

 
79

 
1,043

 
167

 
2,582

 
246

Total fixed maturity securities available-for-sale
4,158

 
206

 
1,923

 
330

 
6,081

 
536

Equity securities available-for-sale:
 
 
 
 
 
 
 
 
 
 
 
Preferred stock
117

 
5

 

 

 
117

 
5

Total equity securities available-for-sale
117

 
5

 

 

 
117

 
5

Total
$
4,275

 
$
211

 
$
1,923

 
$
330

 
$
6,198

 
$
541

The amount of pretax net realized gains on available-for-sale securities reclassified out of AOCI into earnings was $32 million and $21 million for the three months ended March 31, 2012 and 2011.

16


The following table summarizes the activity for the three months ended March 31, 2012 and 2011 related to the pretax credit loss component reflected in Retained earnings on fixed maturity securities still held at March 31, 2012 and 2011 for which a portion of an OTTI loss was recognized in Other comprehensive income (loss).
(In millions)
2012
 
2011
Beginning balance of credit losses on fixed maturity securities
$
92

 
$
141

Additional credit losses for securities for which an OTTI loss was previously recognized
11

 
10

Credit losses for securities for which an OTTI loss was not previously recognized
1

 
1

Reductions for securities sold during the period
(4
)
 
(25
)
Reductions for securities the Company intends to sell or more likely than not will be required to sell

 
(14
)
Ending balance of credit losses on fixed maturity securities
$
100

 
$
113

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 March 31, 2012 Securities in a Gross Unrealized Loss Position 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 two major providers, Standard & Poor's and Moody's Investor Services, Inc. in that order of preference. If a security is not rated by these providers, the Company formulates an internal rating.
States, Municipalities and Political Subdivisions
The unrealized losses on the Company's investments in this category are primarily due to market conditions for zero coupon bonds, particularly for those with maturity dates that exceed 20 years. Yields for these securities continue to be higher than historical norms relative to after-tax returns on similar fixed income securities. Securities that comprise 88% of the gross unrealized losses in this category are rated AA or higher.
The largest exposures at March 31, 2012 as measured by gross unrealized losses were several separate issues of Puerto Rico sales tax revenue bonds with gross unrealized losses of $63 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 March 31, 2012.
Asset-Backed Securities
The fair value of total asset-backed holdings at March 31, 2012 was $8,362 million which was comprised of 2,027 different securities. The fair value of these securities tends to be influenced by the characteristics and projected cash flows of the underlying collateral rather than the credit of the issuer. 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, 104 had underlying collateral that was either considered sub-prime or Alt-A in nature. The exposure to sub-prime residential mortgage (sub-prime) collateral and Alternative A residential mortgages that have lower than normal standards of loan documentation (Alt-A) collateral is measured by the original deal structure.
The gross unrealized losses on residential mortgage-backed securities included $42 million related to securities guaranteed by a U.S. government agency or sponsored enterprise and $97 million related to non-agency structured securities. Non-agency structured securities included 112 securities that had at least one trade lot in a gross unrealized loss position and the aggregate severity of the gross unrealized loss was approximately 8% of amortized cost.

17


Commercial mortgage-backed securities included 43 securities that had at least one trade lot in a gross unrealized loss position. The aggregate severity of the gross unrealized loss was approximately 10% of amortized cost.
The following table summarizes asset-backed securities in a gross unrealized loss position by ratings distribution at March 31, 2012.
Gross Unrealized Losses by Ratings Distribution
March 31, 2012
Amortized
Cost
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
(In millions)
 
 
U.S. Government, Government Agencies, and Government-Sponsored Enterprises
$
852

 
$
810

 
$
42

AAA
246

 
239

 
7

AA
226

 
215

 
11

A
294

 
286

 
8

BBB
209

 
193

 
16

Non-investment grade
895

 
803

 
92

Total
$
2,722

 
$
2,546

 
$
176

The Company believes the unrealized losses are primarily attributable to broader economic conditions, changes in interest rates, wider than historical bid/ask spreads, and uncertainty with regard to the timing and amount of ultimate collateral realization, but are not indicative of the ultimate collectibility of the current carrying values of the securities. 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; accordingly, the Company has determined that there are no additional OTTI losses to be recorded at March 31, 2012.
Contractual Maturity
The following table summarizes available-for-sale fixed maturity securities by contractual maturity at March 31, 2012 and December 31, 2011. 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.
Contractual Maturity
 
March 31, 2012
 
December 31, 2011
(In millions)
Cost or
Amortized
Cost
 
Estimated
Fair
Value
 
Cost or
Amortized
Cost
 
Estimated
Fair
Value
Due in one year or less
$
1,842

 
$
1,855

 
$
1,802

 
$
1,812

Due after one year through five years
13,003

 
13,573

 
13,110

 
13,537

Due after five years through ten years
8,713

 
9,326

 
8,410

 
8,890

Due after ten years
14,240

 
16,071

 
14,017

 
15,692

Total
$
37,798

 
$
40,825

 
$
37,339

 
$
39,931


18


Investment Commitments
As of March 31, 2012, the Company had committed approximately $122 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, sales and funding. 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 March 31, 2012, the Company had commitments to purchase $151 million and sell $127 million of such investments. The Company has an obligation to fund additional amounts under the terms of current loan participations that may not be recorded until a draw is made. As of March 31, 2012, the Company had obligations on unfunded bank loan participations in the amount of $5 million.
As of March 31, 2012, the Company had mortgage loan commitments of $28 million representing signed loan applications received and accepted. The mortgage loans are recorded once funded.

19


Note D. Derivative Financial Instruments
A summary of the recognized gains (losses) related to derivative financial instruments follows.
Recognized Gains (Losses)
Three months ended March 31
 
 
 
(In millions)
2012
 
2011
Without hedge designation
 
 
 
Currency forwards
$
(1
)
 
$
(1
)
Total without hedge designation
(1
)
 
(1
)
Trading activities
 
 
 
Futures sold, not yet purchased
1

 

Total
$

 
$
(1
)
A summary of the aggregate contractual or notional amounts and gross estimated fair values related to derivative financial instruments reported as Other invested assets or Other liabilities on the Condensed Consolidated Balance Sheets follows. 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.
Derivative Financial Instruments
March 31, 2012
Contractual/
Notional
Amount
 
Estimated Fair Value
(In millions)
 
Asset
 
(Liability)
Without hedge designation
 
 
 
 
 
Credit default swaps - purchased protection
$
20

 
$

 
$
(1
)
Currency forwards
33

 

 
(1
)
Equity warrants
4

 

 

Total
$
57

 
$

 
$
(2
)

December 31, 2011
Contractual/
Notional
Amount
 
Estimated Fair Value
(In millions)
 
Asset
 
(Liability)
Without hedge designation
 
 
 
 
 
Credit default swaps - purchased protection
$
20

 
$

 
$
(1
)
Currency forwards
22

 
1

 

Equity warrants
4

 

 

Total
$
46

 
$
1

 
$
(1
)
During the three months ended March 31, 2012, new derivative transactions entered into totaled $332 million in notional value while derivative termination activity totaled $321 million. During the three months ended March 31, 2011, new derivative transactions entered into totaled approximately $341 million in notional value while derivative termination activity totaled approximately $349 million. This activity was primarily attributable to interest rate futures and foreign currency forwards for both periods.

20


Note E. 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.
Prices may fall within Level 1, 2 or 3 depending upon the methodologies and inputs used to estimate fair value for each specific security. Prices are determined by a dedicated group within the Investments and Treasury organization, who ultimately report to the Company's Chief Financial Officer. This group is responsible for valuation policies and procedures. In general the Company seeks to price securities using third-party pricing services. Securities not priced by pricing services are submitted to independent brokers for valuation and, if those are not available, internally developed pricing models are used to value assets using methodologies and inputs the Company believes market participants would use to value the assets.
The Company performs control procedures over information obtained from pricing services and brokers to ensure prices received represent a reasonable estimate of fair value and to confirm representations regarding whether inputs are observable or unobservable. Procedures include i) the review of pricing service or broker pricing methodologies, ii) back-testing, where past fair value estimates are compared to actual transactions executed in the market on similar dates, iii) exception reporting, where changes in price, period-over-period, are reviewed and challenged with the pricing service or broker based on exception criteria, iv) deep dives, where the Company independently validates detailed information regarding inputs and assumptions for individual securities and v) pricing validation, where prices received are compared to prices independently estimated by the Company.

21


Assets and Liabilities Measured at Fair Value
Assets and liabilities measured at fair value on a recurring basis are summarized below.
March 31, 2012
 
 
 
 
 
 
Total
Assets/(Liabilities)
at Fair Value
(In millions)
Level 1
 
Level 2
 
Level 3
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Corporate and other bonds
$

 
$
20,802

 
$
486

 
$
21,288

States, municipalities and political subdivisions

 
10,010

 
173

 
10,183

Asset-backed:
 
 
 
 
 
 
 
Residential mortgage-backed

 
5,547

 
447

 
5,994

Commercial mortgage-backed

 
1,224

 
105

 
1,329

Other asset-backed

 
655

 
384

 
1,039

Total asset-backed

 
7,426

 
936

 
8,362

U.S. Treasury and obligations of government-sponsored enterprises
194

 
42

 

 
236

Foreign government
124

 
531

 

 
655

Redeemable preferred stock
5

 
55

 
53

 
113

Total fixed maturity securities
323

 
38,866

 
1,648

 
40,837

Equity securities
115

 
109

 
74

 
298

Derivative and other financial instruments, included in Other invested assets

 

 
11

 
11

Short term investments
797

 
583

 

 
1,380

Life settlement contracts, included in Other assets

 

 
115

 
115

Separate account business
5

 
393

 
4

 
402

Total assets
$
1,240

 
$
39,951

 
$
1,852

 
$
43,043

Liabilities


 
 
 


 


Derivative financial instruments, included in Other liabilities
$

 
$
(1
)
 
$
(1
)
 
$
(2
)
Total liabilities
$

 
$
(1
)
 
$
(1
)
 
$
(2
)

22


December 31, 2011
 
 
 
 
 
 
Total
Assets/(Liabilities)
at Fair Value
(In millions)
Level 1
 
Level 2
 
Level 3
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Corporate and other bonds
$

 
$
20,402

 
$
482

 
$
20,884

States, municipalities and political subdivisions

 
9,611

 
171

 
9,782

Asset-backed:
 
 
 
 
 
 
 
Residential mortgage-backed

 
5,323

 
452

 
5,775

Commercial mortgage-backed

 
1,295

 
59

 
1,354

Other asset-backed

 
612

 
343

 
955

Total asset-backed

 
7,230

 
854

 
8,084

U.S. Treasury and obligations of government-sponsored enterprises
451

 
42

 

 
493

Foreign government
92

 
544

 

 
636

Redeemable preferred stock
5

 
53

 

 
58

Total fixed maturity securities
548

 
37,882

 
1,507

 
39,937

Equity securities
124

 
113

 
67

 
304

Derivative and other financial instruments, included in Other invested assets

 
1

 
11

 
12

Short term investments
1,106

 
508

 
27

 
1,641

Life settlement contracts, included in Other assets

 

 
117

 
117

Separate account business
21

 
373

 
23

 
417

Total assets
$
1,799

 
$
38,877

 
$
1,752

 
$
42,428

Liabilities
 
 
 
 
 
 
 
Derivative financial instruments, included in Other liabilities
$

 
$

 
$
(1
)
 
$
(1
)
Total liabilities
$

 
$

 
$
(1
)
 
$
(1
)

23


The tables below present a reconciliation for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended March 31, 2012 and 2011.
Level 3
(In millions)
Balance at
January 1,
2012
 
Net realized investment gains (losses) and net change in unrealized appreciation (depreciation) included in net income (loss)*
 
Net change in unrealized appreciation (depreciation) included in other comprehensive income (loss)
 
Purchases
 
Sales
 
Settlements
 
Transfers into
Level 3
 
Transfers out
of Level 3
 
Balance at
March 31,
2012
 
Unrealized gains (losses) on Level 3 assets and liabilities held at March 31, 2012 recognized in net income (loss)*
Fixed maturity securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Corporate and other bonds
$
482

 
$
3

 
$
4

 
$
79

 
$
(86
)
 
$
(19
)
 
$
33

 
$
(10
)
 
$
486

 
$

States, municipalities and political subdivisions
171

 

 
2

 

 

 

 

 

 
173

 

Asset-backed:


 


 


 


 
 
 
 
 


 


 


 


Residential mortgage-backed
452

 
1

 
(4
)
 
38

 

 
(7
)
 

 
(33
)
 
447

 

Commercial mortgage-backed
59

 

 
4

 
42

 

 

 

 

 
105

 

Other asset-backed
343

 
4

 
4

 
176

 
(77
)
 
(25
)
 

 
(41
)
 
384

 

Total asset-backed
854

 
5

 
4

 
256

 
(77
)
 
(32
)
 

 
(74
)
 
936

 

Redeemable preferred stock

 

 

 
53

 

 

 

 

 
53

 

Total fixed maturity securities
1,507

 
8

 
10

 
388

 
(163
)
 
(51
)
 
33

 
(84
)
 
1,648

 

Equity securities
67

 

 
(3
)
 
11

 
(1
)
 

 

 

 
74

 
(2
)
Derivative and other financial instruments, net
10

 

 

 

 

 

 

 

 
10

 

Short term investments
27

 

 

 
12

 

 
(39
)
 

 

 

 

Life settlement contracts
117

 
3

 

 

 

 
(5
)
 

 

 
115

 
(1
)
Separate account business