4. 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 methodology and inputs used to estimate fair value for each specific security. 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 a methodology and inputs the Company believes market participants would use to value the assets. Prices obtained from third-party pricing services or brokers are not adjusted by the Company.

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 may include: (i) the review of pricing service methodologies or broker pricing qualifications, (ii) back-testing, where past fair value estimates are compared to actual transactions executed in the market on similar dates, (iii) exception reporting, where period-over-period changes in price are reviewed and challenged with the pricing service or broker based on exception criteria, (iv) detailed analysis, where the Company performs an independent analysis of the inputs and assumptions used to price individual securities and (v) pricing validation, where prices received are compared to prices independently estimated by the Company.

Assets and liabilities measured at fair value on a recurring basis are summarized in the following tables. Corporate bonds and other includes obligations of the U.S. Treasury, government-sponsored enterprises and foreign governments and redeemable preferred stock.


June 30, 2018	Level 1				Level 2			Level 3			Total
(In millions)

Fixed maturity securities:
Corporate bonds and other		$	166			$	18,932		$	94		$	19,192
States, municipalities and political subdivisions							12,008			1			12,009
Asset-backed							8,304			273			8,577
Fixed maturities available-for-sale			166				39,244			368			39,778
Fixed maturities trading							656			7			663
Total fixed maturities		$	166			$	39,900		$	375		$	40,441


Equity securities		$	683			$	604		$	18		$	1,305
Short term and other			3,361				1,050						4,411
Receivables							19						19
Payable to brokers			(11	)									(11	)

December 31, 2017

Fixed maturity securities:
Corporate bonds and other		$	128			$	19,145		$	98		$	19,371
States, municipalities and political subdivisions							14,026			1			14,027
Asset-backed							7,751			335			8,086
Fixed maturities available-for-sale			128				40,922			434			41,484
Fixed maturities trading			10				635			4			649
Total fixed maturities		$	138			$	41,557		$	438		$	42,133


Equity securities available-for-sale		$	91			$	584		$	20		$	695
Equity securities trading			527							2			529
Total equity securities		$	618			$	584		$	22		$	1,224



Short term and other		$	3,669			$	958					$	4,627
Receivables			1				4						5
Payable to brokers			(12	)									(12	)

The following tables present reconciliations for all assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three and six months ended June 30, 2018 and 2017:


				Net Realized Gains (Losses) and Net Change in Unrealized Gains (Losses)																													Unrealized Gains (Losses) Recognized in Net Income (Loss) on Level 3 Assets and
				Included in																			Transfers			Transfers							Liabilities
	Balance,			Net Income				Included in															into			out of				Balance,			Held at
2018	April 1			(Loss)				OCI				Purchases			Sales				Settlements				Level 3			Level 3				June 30			June 30
(In millions)

Fixed maturity securities:
Corporate bonds and other		$	100						$	(1	)		$	2		$	(5	)		$	(2	)									$	94
States, municipalities and political subdivisions			1																													1
Asset-backed			279							(1	)			41							(6	)		$	13		$	(53	)			273
Fixed maturities available-for-sale			380		$	-				(2	)			43			(5	)			(8	)			13			(53	)			368		$	-
Fixed maturities trading			7																													7
Total fixed maturities		$	387		$	-			$	(2	)		$	43			$ (5	)		$	(8	)		$	13		$	(53	)		$	375		$	-


Equity securities		$	20		$	(1	)									$	(1	)													$	18		$	(1	)


				Net Realized Gains (Losses) and Net Change in Unrealized Gains (Losses)																											Unrealized Gains (Losses) Recognized in Net Income (Loss) on Level 3 Assets and
				Included in																	Transfers			Transfers							Liabilities
	Balance,			Net Income			Included in														into			out of				Balance,			Held at
2017	April 1			(Loss)			OCI			Purchases			Sales				Settlements				Level 3			Level 3				June 30			June 30
(In millions)

Fixed maturity securities:
Corporate bonds and other		$	121															$	(11	)					$	(10	)		$	100
States, municipalities and political subdivisions			1																											1
Asset-backed			256		$	1		$	1		$	13							(7	)		$	24			(70	)			218
Fixed maturities available-for-sale			378			1			1			13							(18	)			24			(80	)			319		$	-
Fixed maturities trading			5																											5			(1	)
Total fixed maturities		$	383		$	1		$	1		$	13		$	-			$	(18	)		$	24		$	(80	)		$	324		$	(1	)


Equity securities available-for-sale		$	19					$	1					$	(1	)													$	19
Equity securities trading			1																											1
Total equity securities		$	20		$	-		$	1		$	-		$	(1	)		$	-			$	-		$	-			$	20		$	-


Life settlement contracts		$	46											$	(45	)													$	1


				Net Realized Gains (Losses) and Net Change in Unrealized Gains (Losses)																													Unrealized Gains (Losses) Recognized in Net Income (Loss) on Level 3 Assets and
				Included in																			Transfers			Transfers							Liabilities
	Balance,			Net Income				Included in															into			out of				Balance,			Held at
2018	January 1			(Loss)				OCI				Purchases			Sales				Settlements				Level 3			Level 3				June 30			June 30
(In millions)

Fixed maturity securities:
Corporate bonds and other		$	98		$	(1	)		$	(1	)		$	2		$	(5	)		$	(4	)		$	5						$	94
States, municipalities and political subdivisions			1																													1
Asset-backed			335			7				(6	)			71			(72	)			(12	)			13		$	(63	)			273
Fixed maturities available-for-sale			434			6				(7	)			73			(77	)			(16	)			18			(63	)			368		$	-
Fixed maturities trading			4			3																										7			3
Total fixed maturities		$	438		$	9			$	(7	)		$	73		$	(77	)		$	(16	)		$	18		$	(63	)		$	375		$	3


Equity securities		$	22		$	(3	)									$	(1	)													$	18		$	(3	)


				Net Realized Gains (Losses) and Net Change in Unrealized Gains (Losses)																												Unrealized Gains (Losses) Recognized in Net Income (Loss) on Level 3 Assets and
				Included in																		Transfers			Transfers							Liabilities
	Balance,			Net Income				Included in														into			out of				Balance,			Held at
2017	January 1			(Loss)				OCI			Purchases			Sales				Settlements				Level 3			Level 3				June 30			June 30
(In millions)

Fixed maturity securities:
Corporate bonds and other		$	130						$	1		$	5		$	(1	)		$	(25	)					$	(10	)		$	100
States, municipalities and political subdivisions			1																												1
Asset-backed			199		$	1				3			51							(13	)		$	52			(75	)			218
Fixed maturities available-for-sale			330			1				4			56			(1	)			(38	)			52			(85	)			319		$	-
Fixed maturities trading			6			(1	)																								5			(1	)
Total fixed maturities		$	336		$	-			$	4		$	56		$	(1	)		$	(38	)		$	52		$	(85	)		$	324		$	(1	)


Equity securities available-for-sale		$	19						$	2		$	1		$	(3	)													$	19
Equity securities trading			1																												1
Total equity securities		$	20		$	-			$	2		$	1		$	(3	)		$	-			$	-		$	-			$	20		$	-


Life settlement contracts		$	58		$	6									$	(58	)		$	(5	)									$	1
Derivative financial instruments, net			-			1										(1	)														-

Net realized and unrealized gains and losses are reported in Net income as follows:


Major Category of Assets and Liabilities		Consolidated Condensed Statements of Income Line Items

Fixed maturity securities available-for-sale		Investment gains (losses)
Fixed maturity securities trading		Net investment income
Equity securities		Investment gains (losses) and Net investment income
Other invested assets		Investment gains (losses) and Net investment income
Derivative financial instruments held in a trading portfolio		Net investment income
Derivative financial instruments, other		Investment gains (losses) and Operating revenues and other
Life settlement contracts		Operating revenues and other

Securities may be transferred in or out of levels within the fair value hierarchy based on the availability of observable market information and quoted prices used to determine the fair value of the security. The availability of observable market information and quoted prices varies based on market conditions and trading volume. During the three months ended June 30, 2018, there were no transfers between Level 1 and Level 2. During the six months ended June 30, 2018, there were $29 million of transfers from Level 2 to Level 1 and no transfers from Level 1 to Level 2. During the three and six months ended June 30, 2017 there were no transfers between Level 1 and Level 2. The Company’s policy is to recognize transfers between levels at the beginning of quarterly reporting periods.

Valuation Methodologies and Inputs

The following section describes the valuation methodologies and relevant inputs used to measure different financial instruments at fair value, including an indication of the level in the fair value hierarchy in which the instruments are generally classified.

Fixed Maturity Securities

Level 1 securities include highly liquid and exchange traded bonds and redeemable preferred stock, valued using quoted market prices. Level 2 securities include most other fixed maturity securities as the significant inputs are observable in the marketplace. All classes of Level 2 fixed maturity securities are valued using a methodology based on information generated by market transactions involving identical or comparable assets, a discounted cash flow methodology or a combination of both when necessary. Common inputs for all classes of fixed maturity securities include prices from recently executed transactions of similar securities, marketplace quotes, benchmark yields, spreads off benchmark yields, interest rates and U.S. Treasury or swap curves. Specifically for asset-backed securities, key inputs include prepayment and default projections based on past performance of the underlying collateral and current market data. Fixed maturity securities are primarily assigned to Level 3 in cases where broker/dealer quotes are significant inputs to the valuation, and there is a lack of transparency as to whether these quotes are based on information that is observable in the marketplace. Level 3 securities also include private placement debt securities whose fair value is determined using internal models with inputs that are not market observable.

Equity Securities

Level 1 securities include publicly traded securities valued using quoted market prices. Level 2 securities are primarily valued using pricing for similar securities, recently executed transactions and other pricing models utilizing market observable inputs. Level 3 securities are primarily priced using broker/dealer quotes and internal models with inputs that are not market observable.

Derivative Financial Instruments

Exchange traded derivatives are valued using quoted market prices and are classified within Level 1 of the fair value hierarchy. Level 2 derivatives primarily include currency forwards valued using observable market forward rates. Over-the-counter derivatives, principally interest rate swaps, total return swaps, commodity swaps, equity warrants and options, are valued using inputs including broker/dealer quotes and are classified within Level 2 or Level 3 of the valuation hierarchy, depending on the amount of transparency as to whether these quotes are based on information that is observable in the marketplace.

Short Term and Other Invested Assets

Securities that are actively traded or have quoted prices are classified as Level 1. These securities include money market funds, treasury bills and exchange traded open-end funds valued using quoted market prices. Level 2 primarily includes commercial paper, for which all inputs are market observable. Fixed maturity securities purchased within one year of maturity are classified consistent with fixed maturity securities discussed above. Short term investments as presented in the tables above differ from the amounts presented in the Consolidated Condensed Balance Sheets because certain short term investments, such as time deposits, are not measured at fair value.

Life Settlement Contracts

CNA sold its life settlement contracts to a third party in 2017. The valuation of the life settlement contracts was based on the terms of sale. The contracts were classified as Level 3 as there was not an active market for life settlement contracts.

Significant Unobservable Inputs

The following tables present quantitative information about the significant unobservable inputs utilized by the Company in the fair value measurement of Level 3 assets. Valuations for assets and liabilities not presented in the tables below are primarily based on broker/dealer quotes for which there is a lack of transparency as to inputs used to develop the valuations. The quantitative detail of unobservable inputs from these broker quotes is neither provided nor reasonably available to the Company.


June 30, 2018	Estimated Fair Value	Valuation Techniques	Unobservable Inputs	Range (Weighted Average)
	(In millions)

Fixed maturity securities	$ 130	Discounted cash flow	Credit spread		1	% –12% (3%)

December 31, 2017

Fixed maturity securities	$ 136	Discounted cash flow	Credit spread		1	% – 12% (3%)

For fixed maturity securities, an increase to the credit spread assumptions would result in a lower fair value measurement.

Financial Assets and Liabilities Not Measured at Fair Value

The carrying amount, estimated fair value and the level of the fair value hierarchy of the Company’s financial assets and liabilities which are not measured at fair value on the Consolidated Condensed Balance Sheets are presented in the following tables. The carrying amounts and estimated fair values of short term debt and long term debt exclude capital lease obligations. The carrying amounts reported on the Consolidated Condensed Balance Sheets for cash and short term investments not carried at fair value and certain other assets and liabilities approximate fair value due to the short term nature of these items.


	Carrying		Estimated Fair Value
June 30, 2018	Amount		Level 1	Level 2		Level 3		Total
(In millions)

Assets:
Other invested assets, primarily mortgage loans	$	865				$	850	$	850

Liabilities:
Short term debt		178		$	36		142		178
Long term debt		11,273			10,550		631		11,181

December 31, 2017

Assets:
Other invested assets, primarily mortgage loans	$	839				$	844	$	844

Liabilities:
Short term debt		278		$	156		122		278
Long term debt		11,236			10,966		525		11,491

The fair values of mortgage loans, included in Other invested assets, were based on the present value of the expected future cash flows discounted at the current interest rate for similar financial instruments, adjusted for specific loan risk.