5. Claim and Claim Adjustment Expense Reserves

CNA’s property and casualty insurance claim and claim adjustment expense reserves represent the estimated amounts necessary to resolve all outstanding claims, including incurred but not reported (“IBNR”) claims as of the reporting date. CNA’s reserve projections are based primarily on detailed analysis of the facts in each case, CNA’s experience with similar cases and various historical development patterns. Consideration is given to such historical patterns as claim reserving trends and settlement practices, loss payments, pending levels of unpaid claims and product mix, as well as court decisions, economic conditions including inflation and public attitudes. All of these factors can affect the estimation of claim and claim adjustment expense reserves.

Establishing claim and claim adjustment expense reserves, including claim and claim adjustment expense reserves for catastrophic events that have occurred, is an estimation process. Many factors can ultimately affect the final settlement of a claim and, therefore, the necessary reserve. Changes in the law, results of litigation, medical costs, the cost of repair materials and labor rates can affect ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably estimable than long-tail claims, such as workers’ compensation, general liability and professional liability claims. Adjustments to prior year reserve estimates, if necessary, are reflected in the results of operations in the period that the need for such adjustments is determined. There can be no assurance that CNA’s ultimate cost for insurance losses will not exceed current estimates.

Catastrophes are an inherent risk of the property and casualty insurance business and have contributed to material period-to-period fluctuations in CNA’s results of operations and/or equity. CNA reported catastrophe losses, net of reinsurance, of $26 million and $39 million for the three months ended June 30, 2018 and 2017 and $60 million and $73 million for the six months ended June 30, 2018 and 2017. Net catastrophe losses in 2018 and 2017 related primarily to U.S. weather-related events.

Liability for Unpaid Claim and Claim Adjustment Expenses Rollforward

The following table presents a reconciliation between beginning and ending claim and claim adjustment expense reserves, including claim and claim adjustment expense reserves of Other Insurance Operations.


Six Months Ended June 30	2018			2017
(In millions)

Reserves, beginning of year:
Gross	$	22,004		$	22,343
Ceded		3,934			4,094
Net reserves, beginning of year		18,070			18,249

Net incurred claim and claim adjustment expenses:
Provision for insured events of current year		2,552			2,443
Decrease in provision for insured events of prior years		(112	)		(159	)
Amortization of discount		92			93
Total net incurred (a)		2,532			2,377

Net payments attributable to:
Current year events		(312	)		(266	)
Prior year events		(2,387	)		(2,331	)
Total net payments		(2,699	)		(2,597	)

Foreign currency translation adjustment and other		(70	)		70

Net reserves, end of period		17,833			18,099
Ceded reserves, end of period		4,157			4,080
Gross reserves, end of period	$	21,990		$	22,179

(a)

Total net incurred above does not agree to Insurance claims and policyholders’ benefits as reflected in the Consolidated Condensed Statements of Income due to amounts related to retroactive reinsurance deferred gain accounting, uncollectible reinsurance and loss deductible receivables and benefit expenses related to future policy benefits, which are not reflected in the table above.

Net Prior Year Development

Changes in estimates of claim and claim adjustment expense reserves net of reinsurance, for prior years are defined as net prior year loss reserve development. These changes can be favorable or unfavorable.

Favorable net prior year development of $59 million and $55 million for the three months ended June 30, 2018 and 2017 and $98 million and $112 million for the six months ended June 30, 2018 and 2017 was recorded for CNA’s commercial property and casualty operations (“Property & Casualty Operations”).

The following table and discussion present details of the net prior year claim and claim adjustment expense reserve development in CNA’s Property & Casualty Operations:


	Three Months Ended								Six Months Ended
	June 30,								June 30,
	2018				2017				2018				2017
(In millions)

Medical professional liability		$	3			$	2			$	23			$	22
Other professional liability and management liability			(34	)			(37	)			(68	)			(69	)
Surety			(15	)							(30	)
Commercial auto							1				(1	)			(25	)
General liability			26				1				18				(17	)
Workers’ compensation			(6	)			(47	)			(12	)			(47	)
Other			(33	)			25				(28	)			24
Total pretax (favorable) unfavorable development		$	(59	)		$	(55	)		$	(98	)		$	(112	)

Three Months

2018

Favorable development in other professional liability and management liability was primarily in professional liability errors and omissions (“E&O”) reflecting lower than expected claim frequency in accident years 2014 through 2016 and favorable severity for accident years 2012 and prior.

Favorable development in surety was driven by continued lower than expected loss emergence on accident years 2015 and prior.

Unfavorable development in general liability was driven by higher than expected claim severity in umbrella in accident years 2013 through 2015.

Favorable development for other coverages was primarily due to lower than expected claim severity from catastrophes in accident year 2017 for property and other and lower than expected frequency in accident years 2015 and prior related to healthcare in Europe in healthcare and technology. This favorable development was partially offset by unfavorable development in property driven by higher than expected severity in Canada and higher than expected frequency in Hardy, both in accident year 2017 and increased severity in accident year 2017 related to professional indemnity in specialty.

2017

Favorable development in other professional liability and management liability was primarily due to lower than expected claim frequency in accident years 2013 through 2015 and lower than expected severity in accident years 2014 through 2016 for professional liability.

Favorable development for workers’ compensation was primarily related to decreases in frequency and severity in recent accident years, partially attributable to California reforms related to decreases in medical costs.

Unfavorable development for other coverages was primarily due to higher than expected severity in accident year 2016 for property and other, higher than expected severity in accident year 2015 arising from the management liability business and adverse large claims experience in the Hardy political risks portfolio, relating largely to accident year 2016. This unfavorable development was partially offset by favorable development in accident years 2014 and prior for the management liability business and better than expected frequency in accident years 2014 through 2016, for property.

Six Months

2018

Unfavorable development for medical professional liability was primarily due to higher than expected severity in accident years 2014 and 2017 in CNA’s hospitals business.

Favorable development in other professional liability and management liability was primarily due to lower than expected claim frequency for accident years 2013 through 2017 related to financial institutions. Additional favorable development was in professional liability E&O reflecting lower than expected claims frequency in accident years 2014 through 2016 and favorable severity for accident years 2012 and prior.

Favorable development for surety was due to continued lower than expected loss emergence for accident years 2015 and prior.

Unfavorable development in general liability was driven by higher than expected claim severity in umbrella in accident years 2013 through 2015.

The drivers of development for other coverages were consistent with the three month summary above.

2017

Unfavorable development in medical professional liability was primarily due to continued higher than expected frequency in aging services.

Favorable development in other professional liability and management liability was primarily due to favorable settlements on closed claims and a lower than expected frequency of large losses for accident years 2011 through 2016 for professional and management liability, lower than expected claim frequency in accident years 2013 through 2015 for professional liability and lower than expected severity in accident years 2014 through 2016 for professional liability.

Favorable development for commercial auto was primarily due to lower than expected severity in accident years 2013 through 2015.

Favorable development for general liability was due to lower than expected severity in life sciences.

The drivers of development for other coverages were generally consistent with the three month summary above.

Asbestos and Environmental Pollution (“A&EP”) Reserves

In 2010, Continental Casualty Company (“CCC”) together with several of CNA’s other insurance subsidiaries completed a transaction with National Indemnity Company (“NICO”), a subsidiary of Berkshire Hathaway Inc., under which substantially all of CNA’s legacy A&EP liabilities were ceded to NICO through a loss portfolio transfer (“loss portfolio transfer” or “LPT”). At the effective date of the transaction, CNA ceded approximately $1.6 billion of net A&EP claim and allocated claim adjustment expense reserves to NICO under a retroactive reinsurance agreement with an aggregate limit of $4.0 billion. The $1.6 billion of claim and allocated claim adjustment expense reserves ceded to NICO was net of $1.2 billion of ceded claim and allocated claim adjustment expense reserves under existing third party reinsurance contracts. The NICO LPT aggregate reinsurance limit also covers credit risk on the existing third party reinsurance related to these liabilities. CNA paid NICO a reinsurance premium of $2.0 billion and transferred to NICO billed third party reinsurance receivables related to A&EP claims with a net book value of $215 million, resulting in total consideration of $2.2 billion.

In years subsequent to the effective date of the LPT, CNA recognized adverse prior year development on its A&EP reserves resulting in additional amounts ceded under the LPT. As a result, the cumulative amounts ceded under the LPT exceeded the $2.2 billion consideration paid, resulting in the NICO LPT moving into a gain position, requiring retroactive reinsurance accounting. Under retroactive reinsurance accounting, this gain is deferred and only recognized in earnings in proportion to actual paid recoveries under the LPT. Over the life of the contract, there is no economic impact as long as any additional losses incurred are within the limit of the LPT. In a period in which CNA recognizes a change in the estimate of A&EP reserves that increases or decreases the amounts ceded under the LPT, the proportion of actual paid recoveries to total ceded losses is affected and the change in the deferred gain is recognized in earnings as if the revised estimate of ceded losses was available at the effective date of the LPT. The effect of the deferred retroactive reinsurance benefit is recorded in Insurance claims and policyholders’ benefits in the Consolidated Condensed Statements of Income.

The following table presents the impact of the loss portfolio transfer on the Consolidated Condensed Statements of Income.


	Three Months Ended								Six Months Ended
	June 30,								June 30,
	2018				2017				2018				2017
(In millions)

Additional amounts ceded under LPT:
Net A&EP adverse development before consideration of LPT		$	-			$	-			$	113			$	60
Provision for uncollectible third-party reinsurance on A&EP											(16	)
Total additional amounts ceded under LPT			-				-				97				60
Retroactive reinsurance benefit recognized			(15	)			(3	)			(72	)			(43	)
Pretax impact of deferred retroactive reinsurance		$	(15	)		$	(3	)		$	25			$	17

Based upon CNA’s annual A&EP reserve review, net unfavorable prior year development of $113 million and $60 million was recognized before consideration of cessions to the LPT for the six months ended June 30, 2018 and 2017. Additionally, in 2018, CNA released a portion of its provision for uncollectible third party reinsurance. The 2018 unfavorable development was driven by higher than anticipated defense costs on direct asbestos environmental accounts and paid losses on assumed reinsurance exposures. The 2017 unfavorable development was driven by modestly higher anticipated payouts on claims from known sources of asbestos exposure. While the unfavorable development was ceded to NICO under the LPT, CNA’s reported earnings in the six month periods were negatively affected due to the application of retroactive reinsurance accounting.

As of June 30, 2018 and December 31, 2017, the cumulative amounts ceded under the LPT were $3.0 billion and $2.9 billion. The unrecognized deferred retroactive reinsurance benefit was $351 million and $326 million as of June 30, 2018 and December 31, 2017.

NICO established a collateral trust account as security for its obligations to CNA. The fair value of the collateral trust account was $3.0 billion and $3.1 billion as of June 30, 2018 and December 31, 2017. In addition, Berkshire Hathaway Inc. guaranteed the payment obligations of NICO up to the aggregate reinsurance limit as well as certain of NICO’s performance obligations under the trust agreement. NICO is responsible for claims handling and billing and collection from third-party reinsurers related to CNA’s A&EP claims.