CNA 2012 Q3


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 September 30, 2012
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 1-5823
 
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 [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 [x] 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 [x]
 
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 [x]
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 October 26, 2012
Common Stock, Par value $2.50
 
269,397,139


Item Number
PART I. Financial Information
Page
Number
1.
 





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


2
Table of Contents

Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements
CNA Financial Corporation
Condensed Consolidated Statements of Operations (Unaudited)
Periods ended September 30
Three Months
 
Nine Months
(In millions, except per share data)
2012
 
2011
 
2012
 
2011
Revenues
 
 
 
 
 
 
 
Net earned premiums
$
1,781

 
$
1,732

 
$
5,098

 
$
4,942

Net investment income
601

 
394

 
1,719

 
1,531

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

 
 
 
 
Other-than-temporary impairment losses
(62
)
 
(75
)
 
(89
)
 
(136
)
Portion of other-than-temporary impairments recognized in Other comprehensive income
(2
)
 
(2
)
 
(25
)
 
(44
)
Net other-than-temporary impairment losses recognized in earnings
(64
)
 
(77
)
 
(114
)
 
(180
)
Other net realized investment gains
72

 
50

 
180

 
181

Net realized investment gains (losses), net of participating policyholders’ interests
8

 
(27
)
 
66

 
1

Other revenues
76

 
76

 
230

 
214

Total revenues
2,466

 
2,175

 
7,113

 
6,688

Claims, Benefits and Expenses
 
 
 
 
 
 
 
Insurance claims and policyholders’ benefits
1,435

 
1,400

 
4,164

 
4,131

Amortization of deferred acquisition costs
333

 
297

 
937

 
880

Other operating expenses
341

 
311

 
976

 
914

Interest
43

 
43

 
128

 
132

Total claims, benefits and expenses
2,152

 
2,051

 
6,205

 
6,057

Income from continuing operations before income tax
314

 
124

 
908

 
631

Income tax expense
(93
)
 
(48
)
 
(271
)
 
(196
)
Income from continuing operations
221

 
76

 
637

 
435

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

 
—

 
—

 
(1
)
Net income
221

 
76

 
637

 
434

Net (income) loss attributable to noncontrolling interests
—

 
(1
)
 
—

 
(15
)
Net income attributable to CNA
$
221

 
$
75

 
$
637

 
$
419


 
 
 
 
 
 
 
Income Attributable to CNA Common Stockholders
 
 
 
 
 
 
 
Income from continuing operations attributable to CNA common stockholders
$
221

 
$
75

 
$
637

 
$
420

Loss from discontinued operations attributable to CNA common stockholders
—

 
—

 
—

 
(1
)
Income attributable to CNA common stockholders
$
221

 
$
75

 
$
637

 
$
419

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


3
Table of Contents

Periods ended September 30
Three Months
 
Nine Months
(In millions, except per share data)
2012
 
2011
 
2012
 
2011
Basic Earnings Per Share Attributable to CNA Common Stockholders
 
 
 
 
 
 
 
Income from continuing operations attributable to CNA common stockholders
$
0.82

 
$
0.28

 
$
2.37

 
$
1.56

Loss from discontinued operations attributable to CNA common stockholders
—

 
—

 
—

 
—

Income attributable to CNA common stockholders
$
0.82

 
$
0.28

 
$
2.37

 
$
1.56

 
 
 
 
 
 
 
 
Diluted Earnings Per Share Attributable to CNA Common Stockholders
 
 
 
 
 
 
 
Income from continuing operations attributable to CNA common stockholders
$
0.82

 
$
0.28

 
$
2.36

 
$
1.56

Loss from discontinued operations attributable to CNA common stockholders
—

 
—

 
—

 
—

Income attributable to CNA common stockholders
$
0.82

 
$
0.28

 
$
2.36

 
$
1.56

 
 
 
 
 
 
 
 
Dividends per share
$
0.15

 
$
0.10

 
$
0.45

 
$
0.30

 
 
 
 
 
 
 
 
Weighted Average Outstanding Common Stock and Common Stock Equivalents
 
 
 
 
 
 
 
Basic
269.4

 
269.3

 
269.4

 
269.3

Diluted
269.8

 
269.6

 
269.8

 
269.6

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


4
Table of Contents

CNA Financial Corporation
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2012
 
2011
 
2012
 
2011
Other Comprehensive Income, Net of Tax
 
 
 
 
 
 
 
Changes in:
 
 
 
 
 
 
 
Net unrealized gains (losses) on investments with other-than-temporary impairments
$
36

 
$
(14
)
 
$
73

 
$
25

Net unrealized gains on other investments
191

 
236

 
530

 
558

Net unrealized gains on investments
227

 
222

 
603

 
583

Foreign currency translation adjustment
33

 
(52
)
 
37

 
(22
)
Pension and postretirement benefits
3

 
1

 
12

 
3

Net unrealized gains on discontinued operations and other
—

 
—

 
—

 
1

Allocation to participating policyholders
—

 
(6
)
 
(2
)
 
(7
)
Other comprehensive income, net of tax
263

 
165

 
650

 
558

Net income
221

 
76

 
637

 
434

Comprehensive income
484

 
241

 
1,287

 
992

Other comprehensive (income) loss attributable to noncontrolling interests related to changes in net unrealized (gains) losses on investments
—

 
—

 
—

 
(8
)
Net (income) loss attributable to noncontrolling interests
—

 
(1
)
 
—

 
(15
)
Comprehensive (income) loss attributable to noncontrolling interests
—

 
(1
)
 
—

 
(23
)
Total comprehensive income attributable to CNA
$
484

 
$
240

 
$
1,287

 
$
969

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

5
Table of Contents

CNA Financial Corporation
Condensed Consolidated Balance Sheets (Unaudited)
 
September 30,
2012
 
December 31,
2011
(In millions, except share data)
 
Assets
 
 
 
Investments:
 
 
 
Fixed maturity securities at fair value (amortized cost of $37,945 and $37,345)
$
42,305

 
$
39,937

Equity securities at fair value (cost of $228 and $288)
260

 
304

Limited partnership investments
2,370

 
2,245

Other invested assets
11

 
12

Mortgage loans
358

 
234

Short term investments
2,484

 
1,641

Total investments
47,788

 
44,373

Cash
129

 
75

Reinsurance receivables (less allowance for uncollectible receivables of $74 and $91)
5,840

 
6,001

Insurance receivables (less allowance for uncollectible receivables of $102 and $112)
1,902

 
1,614

Accrued investment income
484

 
436

Deferred acquisition costs
603

 
552

Deferred income taxes
8

 
415

Property and equipment at cost (less accumulated depreciation of $408 and $420)
317

 
309

Goodwill and other intangible assets
285

 
139

Other assets (includes $0 and $130 due from Loews Corporation)
911

 
779

Separate account business
345

 
417

Total assets
$
58,612

 
$
55,110

Liabilities and Equity
 

 
 

Liabilities:
 

 
 

Insurance reserves:
 

 
 

Claim and claim adjustment expenses
$
24,331

 
$
24,303

Unearned premiums
3,681

 
3,250

Future policy benefits
10,974

 
9,810

Policyholders’ funds
165

 
191

Participating policyholders’ funds
71

 
68

Short term debt
13

 
83

Long term debt
2,557

 
2,525

Other liabilities (includes $87 and $0 due to Loews Corporation)
3,815

 
2,975

Separate account business
345

 
417

Total liabilities
45,952

 
43,622

Commitments and contingencies (Notes D, H and J)


 


Equity:
 

 
 

Common stock ($2.50 par value; 500,000,000 shares authorized; 273,040,243 shares issued; 269,397,139 and 269,274,900 shares outstanding)
683

 
683

Additional paid-in capital
2,144

 
2,141

Retained earnings
8,823

 
8,308

Accumulated other comprehensive income
1,130

 
480

Treasury stock (3,643,104 and 3,765,343 shares), at cost
(99
)
 
(102
)
Notes receivable for the issuance of common stock
(21
)
 
(22
)
Total CNA stockholders’ equity
12,660

 
11,488

Total liabilities and equity
$
58,612

 
$
55,110

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

6
Table of Contents

CNA Financial Corporation
Condensed Consolidated Statements of Cash Flows (Unaudited)
Nine months ended September 30
 
 
 
(In millions)
2012
 
2011
Cash Flows from Operating Activities
 
 
 
Net income
$
637

 
$
434

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

 
8

Deferred income tax expense
95

 
151

Trading portfolio activity
(13
)
 
(8
)
Net realized investment gains, net of participating policyholders’ interests
(66
)
 
(1
)
Equity method investees
(68
)
 
80

Amortization of investments
(43
)
 
(47
)
Depreciation and amortization
83

 
59

Changes in:
 
 
 
Receivables, net
348

 
267

Accrued investment income
(46
)
 
(42
)
Deferred acquisition costs
(27
)
 
(21
)
Insurance reserves
(53
)
 
(5
)
Other assets
90

 
110

Other liabilities
47

 
(181
)
Other, net
8

 
10

Total adjustments
356

 
381

Net cash flows provided by operating activities-continuing operations
$
993

 
$
815

Net cash flows provided (used) by operating activities-discontinued operations
$
—

 
$
(2
)
Net cash flows provided by operating activities-total
$
993

 
$
813

Cash Flows from Investing Activities
 

 
 

Purchases of fixed maturity securities
$
(7,369
)
 
$
(8,854
)
Proceeds from fixed maturity securities:
 
 
 
Sales
4,761

 
5,900

Maturities, calls and redemptions
2,655

 
2,434

Purchases of equity securities
(30
)
 
(51
)
Proceeds from sales of equity securities
72

 
171

Origination of mortgage loans
(129
)
 
(118
)
Change in short term investments
(505
)
 
499

Change in other investments
35

 
(137
)
Purchase of Hardy
(197
)
 
—

Purchases of property and equipment
(60
)
 
(67
)
Other, net
20

 
4

Net cash flows used by investing activities-continuing operations
$
(747
)
 
$
(219
)
Net cash flows provided (used) by investing activities-discontinued operations
$
—

 
$
2

Net cash flows used by investing activities-total
$
(747
)
 
$
(217
)
The accompanying Notes are an integral part of these Condensed Consolidated Financial Statements (Unaudited).

7
Table of Contents

Nine months ended September 30
 
 
 
(In millions)
2012
 
2011
Cash Flows from Financing Activities
 
 
 
Acquisition of CNA Surety noncontrolling interest
$
—

 
$
(475
)
Dividends paid to common stockholders
(122
)
 
(81
)
Proceeds from the issuance of debt
—

 
396

Repayment of debt
(70
)
 
(420
)
Stock options exercised
1

 
2

Other, net
(4
)
 
(10
)
Net cash flows used by financing activities-continuing operations
$
(195
)
 
$
(588
)
Net cash flows provided (used) by financing activities-discontinued operations
$
—

 
$
—

Net cash flows used by financing activities-total
$
(195
)
 
$
(588
)
Effect of foreign exchange rate changes on cash
$
3

 
$
(1
)
Net change in cash
$
54

 
$
7

Cash, beginning of year
75

 
77

Cash, end of period
$
129

 
$
84

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

8
Table of Contents

CNA Financial Corporation
Condensed Consolidated Statements of Equity (Unaudited)
Nine months ended September 30
 
 
 
(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
3

 
3

Acquisition of CNA Surety noncontrolling interest
—

 
(65
)
Other
—

 
1

Balance, end of period
2,144

 
2,139

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
(122
)
 
(81
)
Net income attributable to CNA
637

 
419

Balance, end of period
8,823

 
8,142

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
650

 
550

Acquisition of CNA Surety noncontrolling interest
—

 
19

Balance, end of period
1,130

 
895

Treasury Stock
 
 
 
Balance, beginning of period
(102
)
 
(105
)
Stock-based compensation
3

 
3

Balance, end of period
(99
)
 
(102
)
Notes Receivable for the Issuance of Common Stock
 
 
 
Balance, beginning of period
(22
)
 
(26
)
Decrease in notes receivable for the issuance of common stock
1

 
4

Balance, end of period
(21
)
 
(22
)
Total CNA Stockholders’ Equity
12,660

 
11,735

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
—

 
15

Other comprehensive income
—

 
8

Acquisition of CNA Surety noncontrolling interest
—

 
(429
)
Other
—

 
(12
)
Balance, end of period
—

 
145

Total Equity
$
12,660

 
$
11,880

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

9
Table of Contents

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 September 30, 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 September 30, 2012 and for the three and nine months ended September 30, 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.
Noncontrolling Interests
Net income attributable to noncontrolling interests for the three and nine months ended September 30, 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.
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 and nine months ended September 30, 2012, the adoption of the new accounting guidance resulted in no impact and a $3 million decrease in Net income attributable to CNA and no impact 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

10
Table of Contents

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 were the result of the indirect effects of the Company's adoption of this guidance on Shadow Adjustments, as further discussed in Note D, and the Company's acquisition of the noncontrolling interest of Surety as discussed above.
The impacts on the Company's Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2011 were a $59 million and $171 million decrease in Amortization of deferred acquisition costs, a $59 million and $178 million increase in Other operating expenses, a $1 million and $2 million decrease in Income tax expense, and a $1 million increase and no impact in Net income attributable to noncontrolling interests, resulting in no impact and a $5 million decrease in Net income attributable to CNA, and no impact and a $0.02 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 periods presented as a result of the adoption of the new accounting standard.


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Note B. Hardy
On July 2, 2012, the Company completed the previously announced acquisition of all outstanding shares of Hardy Underwriting Bermuda Limited and its subsidiaries (Hardy), a specialized Lloyd's of London (Lloyd's) underwriter. Through Lloyd's Syndicate 382, Hardy underwrites primarily short-tail exposures in marine and aviation, non-marine property, specialty lines and property treaty reinsurance. The acquisition of Hardy aligns with the Company's specialized underwriting focus and will be a key platform for expanding the Company's global business through the Lloyd's marketplace. The results of Hardy for the period from July 2, 2012 to September 30, 2012 are included in the results of our core property and casualty insurance operations as a separate segment.
For the year ended December 31, 2011, Hardy reported gross written premiums of $430 million and recorded a loss of $55 million in its group consolidated financial statements prepared in accordance with International Financial Reporting Standards.
The purchase price for Hardy was $231 million. Acquisition related expenses of $4 million were incurred during the nine months ended September 30, 2012, including investment advisory, legal and other expenses, and were recorded in the Corporate and Other Non-Core segment.
The fair value of the assets acquired and the liabilities assumed as a result of the acquisition of Hardy were as follows:
(In millions)
Acquisition Date
July 2, 2012
Investments:
 
Fixed maturity securities
$
117

Short term investments
255

Total investments
372

Cash
34

Reinsurance receivables
252

Insurance receivables
222

Accrued investment income
2

Property and equipment
4

Goodwill and other intangible assets
171

Other assets
109

Total assets acquired
$
1,166

 
 
Claim and claim adjustment expenses
$
500

Unearned premiums
249

Long term debt
30

Other liabilities
156

Total liabilities assumed
$
935



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The intangible assets acquired are presented in the following table.
(In millions)
Amount
 
Economic Useful Life
Syndicate capacity
$
55

 
Indefinite
Total indefinite-lived intangible assets
55

 
 
 
 
 
 
Value of business acquired
60

 
1 - 4 years
Trade name
8

 
8 years
Distribution channel
13

 
15 years
Total finite-lived intangible assets
81

 
 
Total intangible assets as of the acquisition date
$
136

 
 
For the three months ended September 30, 2012, amortization expense of $18 million was included in Amortization of deferred acquisition costs and $6 million was included in Other operating expenses in the Statement of Operations for the Hardy segment. Estimated future amortization expense for these intangible assets is $19 million in the fourth quarter of 2012, $21 million in 2013, $4 million in 2014, $1 million in 2015 and $2 million in both 2016 and 2017.
The acquisition resulted in goodwill of $35 million which was recorded in the Hardy segment. The recognized goodwill is based on the Company's expected growth and profitability of Hardy. The goodwill is not deductible for tax purposes.
Lloyd's requires syndicate capital providers to provide funds at Lloyd's (FAL) which is available to Lloyd's should funds in the Lloyd's premium trust fund be insufficient to cover obligations. At September 30, 2012, the Company had a deposit of $66 million of short duration U.S. Treasury securities in a Lloyd's custody account related to the FAL. Although the Company still owns these securities, these securities are controlled by Lloyd's and are therefore restricted. Additionally, cash and securities with a carrying value of approximately $71 million were deposited by Hardy under local requirements of regulatory authorities as of September 30, 2012.

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Note C. 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 and nine months ended September 30, 2012, approximately 450 thousand and 400 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 693 thousand and 740 thousand 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.
For the three and nine months ended September 30, 2011, approximately 279 thousand and 286 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 1.2 million and 1.1 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.


14
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Note D. Investments
The significant components of net investment income are presented in the following table.
Net Investment Income
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2012
 
2011
 
2012

2011
Fixed maturity securities
$
507

 
$
494

 
$
1,528

 
$
1,505

Short term investments
2

 
2

 
5

 
6

Limited partnership investments
89

 
(93
)
 
184

 
32

Equity securities
4

 
4

 
10

 
16

Mortgage loans
5

 
2

 
13

 
6

Trading portfolio (a)
7

 
(1
)
 
18

 
5

Other
—

 
1

 
3

 
6

Gross investment income
614

 
409

 
1,761

 
1,576

Investment expense
(13
)
 
(15
)
 
(42
)
 
(45
)
Net investment income
$
601

 
$
394

 
$
1,719

 
$
1,531

___________________
(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 or nine months ended September 30, 2012. Net unrealized losses related to changes in fair value on trading securities still held included in net investment income were $1 million for the three and nine months ended September 30, 2011.
Net realized investment gains (losses) are presented in the following table.
Net Realized Investment Gains (Losses)
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2012
 
2011
 
2012
 
2011
Net realized investment gains (losses):
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Gross realized gains
$
75

 
$
56

 
$
193

 
$
233

Gross realized losses
(49
)
 
(85
)
 
(120
)
 
(222
)
Net realized investment gains (losses) on fixed maturity securities
26

 
(29
)
 
73

 
11

Equity securities:
 
 
 
 
 
 
 

Gross realized gains
5

 
1

 
10

 
7

Gross realized losses
(20
)
 
(2
)
 
(24
)
 
(10
)
Net realized investment gains (losses) on equity securities
(15
)
 
(1
)
 
(14
)
 
(3
)
Derivatives
(1
)
 
1

 
(1
)
 
—

Short term investments and other (a) (b)
(2
)
 
2

 
8

 
(7
)
Net realized investment gains (losses), net of participating policyholders’ interests
$
8

 
$
(27
)
 
$
66

 
$
1

____________________
(a)
The nine months ended September 30, 2011 included a $9 million loss related to the early extinguishment of debt in 2011.
(b)
Includes net unrealized gains (losses) related to changes in the fair value of securities for which the fair value option has been elected. There were no net unrealized gains (losses) included in the three months ended September 30, 2012 or 2011 or the nine months ended September 30, 2012. There were $1 million of net unrealized gains for the nine months ended September 30, 2011.

15
Table of Contents

The components of net other-than-temporary impairment (OTTI) losses recognized in earnings by asset type are summarized in the following table.
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2012
 
2011
 
2012
 
2011
Fixed maturity securities available-for-sale:
 
 
 
 
 
 
 
Corporate and other bonds
$
7

 
$
49

 
$
23

 
$
73

States, municipalities and political subdivisions
17

 
—

 
17

 
—

Asset-backed:
 
 
 
 
 
 
 
Residential mortgage-backed
20

 
21

 
49

 
95

Other asset-backed
—

 
4

 
—

 
4

Total asset-backed
20

 
25

 
49

 
99

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

 
—

 
1

 
—

Total fixed maturity securities available-for-sale
44

 
74

 
90

 
172

Equity securities available-for-sale:
 
 
 
 
 
 
 
Common stock
1

 
3

 
5

 
7

Preferred stock
19

 
—

 
19

 
1

Total equity securities available-for-sale
20

 
3

 
24

 
8

Net OTTI losses recognized in earnings
$
64

 
$
77

 
$
114

 
$
180

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 (CFO). 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.

16
Table of Contents

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.
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
September 30, 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
$
19,209

 
$
2,634

 
$
32

 
$
21,811

 
$
—

States, municipalities and political subdivisions
9,415

 
1,450

 
53

 
10,812

 
—

Asset-backed:
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
5,907

 
264

 
81

 
6,090

 
(12
)
Commercial mortgage-backed
1,582

 
123

 
17

 
1,688

 
(3
)
Other asset-backed
944

 
23

 
1

 
966

 
—

Total asset-backed
8,433

 
410

 
99

 
8,744

 
(15
)
U.S. Treasury and obligations of government-sponsored enterprises
182

 
11

 
1

 
192

 
—

Foreign government
588

 
26

 
—

 
614

 
—

Redeemable preferred stock
101

 
14

 
—

 
115

 
—

Total fixed maturity securities available-for-sale
37,928

 
4,545

 
185

 
42,288

 
$
(15
)
Total fixed maturity securities trading
17

 
—

 
—

 
17

 
 
Equity securities available-for-sale:
 
 
 
 
 
 
 
 
 
Common stock
22

 
24

 
—

 
46

 
 
Preferred stock
206

 
8

 
—

 
214

 
 
Total equity securities available-for-sale
228

 
32

 
—

 
260

 
 
Total
$
38,173

 
$
4,577

 
$
185

 
$
42,565

 
 

17
Table of Contents

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 September 30, 2012 and December 31, 2011, the net unrealized gains on investments included in AOCI were net of after-tax Shadow Adjustments of $1,277 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 is recorded, net of tax, as a reduction through Other comprehensive income (Shadow Adjustments).
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
September 30, 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
$
600

 
$
18

 
$
210

 
$
14

 
$
810

 
$
32

States, municipalities and political subdivisions
84

 
1

 
227

 
52

 
311

 
53

Asset-backed:
 
 
 
 
 
 
 
 
 
 
 
Residential mortgage-backed
327

 
3

 
580

 
78

 
907

 
81

Commercial mortgage-backed
142

 
2

 
132

 
15

 
274

 
17

Other asset-backed
66

 
1

 
—

 
—

 
66

 
1

Total asset-backed
535

 
6

 
712

 
93

 
1,247

 
99

U.S. Treasury and obligations of government-sponsored enterprises
22

 
1

 
—

 
—

 
22

 
1

Total
$
1,241

 
$
26

 
$
1,149

 
$
159

 
$
2,390

 
$
185


18
Table of Contents

 
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
$
4,275

 
$
211

 
$
1,923

 
$
330

 
$
6,198

 
$
541

Based on current facts and circumstances, the Company believes the unrealized losses presented in the September 30, 2012 Securities in a Gross Unrealized Loss Position table above, are primarily attributable to broader economic conditions, changes in interest rates and credit spreads, market illiquidity and other market factors, but are not indicative of the ultimate collectibility of the current amortized cost 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 September 30, 2012.
The amount of pretax net realized gains (losses) on available-for-sale securities reclassified out of AOCI into earnings was $12 million and $59 million for the three and nine months ended September 30, 2012 and $(29) million and $12 million for the three and nine months ended September 30, 2011.
The following table summarizes the activity for the three and nine months ended September 30, 2012 and 2011 related to the pretax credit loss component reflected in Retained earnings on fixed maturity securities still held at September 30, 2012 and 2011 for which a portion of an OTTI loss was recognized in Other comprehensive income (loss).
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2012
 
2011
 
2012
 
2011
Beginning balance of credit losses on fixed maturity securities
$
99

 
$
82

 
$
92

 
$
141

Additional credit losses for securities for which an OTTI loss was previously recognized
2

 
11

 
23

 
29

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

 
10

 
2

 
11

Reductions for securities sold during the period
(3
)
 
(4
)
 
(11
)
 
(50
)
Reductions for securities the Company intends to sell or more likely than not will be required to sell
—

 
—

 
(8
)
 
(32
)
Ending balance of credit losses on fixed maturity securities
$
98

 
$
99

 
$
98

 
$
99



19
Table of Contents

Contractual Maturity
The following table summarizes available-for-sale fixed maturity securities by contractual maturity at September 30, 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
 
September 30, 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
$
1,861

 
$
1,876

 
$
1,802

 
$
1,812

Due after one year through five years
13,382

 
14,176

 
13,110

 
13,537

Due after five years through ten years
8,490

 
9,337

 
8,410

 
8,890

Due after ten years
14,195

 
16,899

 
14,017

 
15,692

Total
$
37,928

 
$
42,288

 
$
37,339

 
$
39,931

Investment Commitments
As of September 30, 2012, the Company had committed approximately $114 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 September 30, 2012, the Company had commitments to purchase $159 million and sell $154 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 September 30, 2012, the Company had obligations on unfunded bank loan participations in the amount of $6 million.

20
Table of Contents

Note E. Derivative Financial Instruments
A summary of the recognized gains (losses) related to derivative financial instruments follows.
Recognized Gains (Losses)
Periods ended September 30
Three Months
 
Nine Months
(In millions)
2012
 
2011
 
2012
 
2011
Without hedge designation
 
 
 
 
 
 
 
Currency forwards
$
(1
)
 
$
—

 
$
(1
)
 
$
(1
)
Forward commitments for mortgage-backed securities
—

 
1

 
—

 
1

Total without hedge designation
(1
)
 
1

 
(1
)
 
—

Trading activities
 
 
 
 
 
 
 
Futures sold, not yet purchased
(1
)
 
—

 
—

 
—

Total
$
(2
)
 
$
1

 
$
(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
September 30, 2012
Contractual/
Notional
Amount
 
Estimated Fair Value
(In millions)
 
Asset
 
(Liability)
Without hedge designation
 
 
 
 
 
Credit default swaps - purchased protection
$
20

 
$
—

 
$
(1
)
Currency forwards
72

 
—

 
(2
)
Equity warrants
5

 
—

 
—

Total
$
97

 
$
—

 
$
(3
)

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 and nine months ended September 30, 2012, new derivative transactions entered into totaled $472 million and $1,251 million in notional value while derivative termination activity totaled $488 million and $1,200 million. This activity was primarily attributable to interest rate futures, forward commitments for mortgage-backed securities and foreign currency forwards. During the three and nine months ended September 30, 2011, new derivative transactions entered into totaled approximately $229 million and $728 million in notional value while derivative termination activity totaled approximately $166 million and $673 million. This activity was primarily attributable to interest rate futures, forward commitments for mortgage-backed securities and foreign currency forwards.

21
Table of Contents

Note F. 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 who ultimately report to the Company's CFO. 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.

22
Table of Contents

Assets and Liabilities Measured at Fair Value
Assets and liabilities measured at fair value on a recurring basis are summarized below.
September 30, 2012
 
 
 
 
 
 
Total
Assets/(Liabilities)
at Fair Value
(In millions)
Level 1
 
Level 2
 
Level 3
 
Assets
 
 
 
 
 
 
 
Fixed maturity securities:
 
 
 
 
 
 
 
Corporate and other bonds
$
—

 
$
21,569

 
$
259

 
$
21,828

States, municipalities and political subdivisions
—

 
10,723

 
89

 
10,812

Asset-backed:
 
 
 
 
 
 
 
Residential mortgage-backed
—

 
5,653

 
437

 
6,090

Commercial mortgage-backed
—

 
1,571

 
117

 
1,688

Other asset-backed
—

 
595

 
371

 
966

Total asset-backed
—

 
7,819

 
925

 
8,744

U.S. Treasury and obligations of government-sponsored enterprises
168

 
24

 
—

 
192

Foreign government
139

 
475

 
—

 
614

Redeemable preferred stock
29

 
60

 
26

 
115

Total fixed maturity securities
336

 
40,670

 
1,299

 
42,305

Equity securities
98

 
112

 
50

 
260

Derivative and other financial instruments, included in Other invested assets
—

 
—

 
11

 
11

Short term investments
1,209

 
1,223

 
8

 
2,440

Life settlement contracts, included in Other assets
—

 
—

 
113

 
113

Separate account business
4

 
338

 
3

 
345

Total assets
$
1,647

 
$
42,343

 
$
1,484

 
$
45,474

Liabilities


 
 
 


 


Derivative financial instruments, included in Other liabilities
$
—

 
$
(2
)
 
$
(1
)
 
$
(3
)
Total liabilities
$
—

 
$
(2
)
 
$
(1
)
 
$
(3
)

23
Table of Contents

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