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 presented in the following tables:

September 30, 2017

Level 1

Level 2

Level 3

Total

(In millions)

Fixed maturity securities:

Corporate and other bonds

19,465

119

19,584

States, municipalities and political subdivisions

13,955

13,956

Asset-backed:

Residential mortgage-backed

4,829

176

5,005

Commercial mortgage-backed

1,876

1,900

Other asset-backed

915

146

1,061

Total asset-backed

7,620

346

7,966

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

115

Foreign government

445

Redeemable preferred stock

Fixed maturities available-for-sale

135

41,485

466

42,086

Fixed maturities trading

407

421

Total fixed maturities

144

41,892

471

42,507

Equity securities available-for-sale

110

129

Equity securities trading

479

481

Total equity securities

589

610

Short term investments

4,019

876

4,895

Other invested assets

Payable to brokers

)


December 31, 2016	Level 1			Level 2		Level 3		Total
(In millions)

Fixed maturity securities:
Corporate and other bonds				$	18,828	$	130	$	18,958
States, municipalities and political subdivisions					13,239		1		13,240
Asset-backed:
Residential mortgage-backed					4,944		129		5,073
Commercial mortgage-backed					2,027		13		2,040
Other asset-backed					968		57		1,025
Total asset-backed					7,939		199		8,138
U.S. Treasury and obligations of government-sponsored enterprises	$	93							93
Foreign government					445				445
Redeemable preferred stock		19							19
Fixed maturities available-for-sale		112			40,451		330		40,893
Fixed maturities trading					595		6		601
Total fixed maturities	$	112		$	41,046	$	336	$	41,494


Equity securities available-for-sale	$	91				$	19	$	110
Equity securities trading		438					1		439
Total equity securities	$	529		$	-	$	20	$	549


Short term investments	$	3,833		$	853			$	4,686
Other invested assets		55			5				60
Receivables		1							1
Life settlement contracts						$	58		58
Payable to brokers		(44	)						(44	)

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 nine months ended September 30, 2017 and 2016:


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

Fixed maturity securities:
Corporate and other bonds	$	100	$	1		$	1		$	13			$	(11	)	$	15			$	119
States, municipalities and political subdivisions		1																			1
Asset-backed:
Residential mortgage-backed		123		1			1							(7	)		58				176
Commercial mortgage-backed		13					(1	)		12				(2	)		2				24
Other asset-backed		82		(1	)		1			27				(4	)		41				146
Total asset-backed		218		-			1			39	$	-		(13	)		101	$	-		346	$	-
Fixed maturities available-for-sale		319		1			2			52				(24	)		116				466
Fixed maturities trading		5																			5
Total fixed maturities	$	324	$	1		$	2		$	52	$	-	$	(24	)	$	116	$	-	$	471	$	-


Equity securities available-for-sale	$	19																		$	19
Equity securities trading		1							$	1											2
Total equity securities	$	20	$	-		$	-		$	1	$	-	$	-		$	-	$	-	$	21	$	-


Life settlement contracts	$	1									$	(1)								$	-


			Net Realized Gains (Losses) and Net Change in Unrealized Gains (Losses)														Transfers		Transfers					Unrealized Gains (Losses) Recognized in Net Income on Level 3 Assets and Liabilities
2016	Balance, July 1		Included in Net Income			Included in OCI			Purchases			Sales		Settlements			into Level 3		out of Level 3			Balance, September 30		Held at September 30
(In millions)

Fixed maturity securities:
Corporate and other bonds	$	242	$	1		$	7		$	16				$	(5	)						$	261
States, municipalities and political subdivisions		2													(1	)							1
Asset-backed:
Residential mortgage-backed		134					(1	)		5					(1	)			$	(58	)		79
Commercial mortgage-backed		11								23					(8	)				(2	)		24
Other asset-backed		45								34										(36	)		43
Total asset-backed		190		-			(1	)		62		$	-		(9	)	$	-		(96	)		146	$	-
Fixed maturities available-for-sale		434		1			6			78					(15	)				(96	)		408
Fixed maturities trading		6																					6		(1	)
Total fixed maturities	$	440	$	1		$	6		$	78		$	-	$	(15	)	$	-	$	(96	)	$	414	$	(1	)


Equity securities available-for-sale	$	19	$	(1	)	$	1															$	19	$	(2	)
Equity securities trading		2							$	(1	)												1		(1	)
Total equity securities	$	21	$	(1	)	$	1		$	(1	)	$	-	$	-		$	-	$	-		$	20	$	(3	)


Life settlement contracts	$	67																				$	67
Derivative financial instruments, net		1	$	(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
2017	Balance, January 1		Included in Net Income (Loss)			Included in OCI			Purchases		Sales		Settlements			Transfers into Level 3		Transfers out of Level 3			Balance, September 30		Liabilities Held at September 30
(In millions)

Fixed maturity securities:
Corporate and other bonds	$	130	$	1		$	2		$	18	$	(1)	$	(36	)	$	15	$	(10	)	$	119
States, municipalities and political subdivisions		1																				1
Asset-backed:
Residential mortgage-backed		129		3			4							(18	)		58					176
Commercial mortgage-backed		13					(1	)		12				(2	)		2					24
Other asset-backed		57		(2	)		1			78				(6	)		93		(75	)		146
Total asset-backed		199		1			4			90		-		(26	)		153		(75	)		346	$	-
Fixed maturities available-for-sale		330		2			6			108		(1)		(62	)		168		(85	)		466
Fixed maturities trading		6		(1	)																	5		(1	)
Total fixed maturities	$	336	$	1		$	6		$	108	$	(1)	$	(62	)	$	168	$	(85	)	$	471	$	(1	)


Equity securities available-for-sale	$	19				$	2		$	1	$	(3)									$	19
Equity securities trading		1								1												2
Total equity securities	$	20	$	-		$	2		$	2	$	(3)	$	-		$	-	$	-		$	21	$	-


Life settlement contracts	$	58	$	6							$	(59)	$	(5	)						$	-
Derivative financial instruments, net		-		1								(1)										-


			Net Realized Gains (Losses) and Net Change in Unrealized Gains (Losses)														Transfers		Transfers					Unrealized Gains (Losses) Recognized in Net Income on Level 3 Assets and Liabilities
2016	Balance, January 1		Included in Net Income			Included in OCI			Purchases		Sales			Settlements			into Level 3		out of Level 3			Balance, September 30		Held at September 30
(In millions)

Fixed maturity securities:
Corporate and other bonds	$	168	$	1		$	14		$	163	$	(36	)	$	(15	)			$	(34	)	$	261
States, municipalities and political subdivisions		2													(1	)							1
Asset-backed:
Residential mortgage-backed		134		2			(2	)		15					(10	)				(60	)		79
Commercial mortgage-backed		22								32					(17	)	$	3		(16	)		24
Other asset-backed		53					2			69		(25	)		(1	)		2		(57	)		43
Total asset-backed		209		2			-			116		(25	)		(28	)		5		(133	)		146	$	-
Fixed maturities available-for-sale		379		3			14			279		(61	)		(44	)		5		(167	)		408
Fixed maturities trading		85		5						2		(86	)										6		3
Total fixed maturities	$	464	$	8		$	14		$	281	$	(147	)	$	(44	)	$	5	$	(167	)	$	414	$	3


Equity securities available-for-sale	$	20	$	(1	)																	$	19	$	(2	)
Equity securities trading		1		1							$	(1	)										1
Total equity securities	$	21	$	-		$	-		$	-	$	(1	)	$	-		$	-	$	-		$	20	$	(2	)


Life settlement contracts	$	74	$	10										$	(17	)						$	67	$	2
Derivative financial instruments, net		3		(4	)						$	(2	)				$	3					-		(3	)

Net realized and unrealized gains and losses are reported in Net income (loss) 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 available-for-sale		Investment gains (losses)
Equity securities trading		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 Other revenues
Life settlement contracts		Other revenues

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 and nine months ended September 30, 2017 and 2016 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 equity securities include publicly traded securities valued using quoted market prices. Level 2 securities are primarily non-redeemable preferred stocks and common stocks 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 Investments

Securities that are actively traded or have quoted prices are classified as Level 1. These securities include money market funds and treasury bills. 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.

Other Invested Assets

Level 1 securities include exchange traded open-end funds valued using quoted market prices.

Life Settlement Contracts

CNA accounts for its investment in life settlement contracts using the fair value method. Historically, the fair value of life settlement contracts was determined as the present value of the anticipated death benefits less anticipated premium payments based on contract terms that are distinct for each insured, as well as CNA’s own assumptions for mortality, premium expense and the rate of return that a buyer would require on the contracts.

The entire portfolio of life settlement contracts was determined to be held for sale as of December 31, 2016 as CNA reached an agreement on terms to sell the portfolio. As such, CNA adjusted the fair value to the estimated sales proceeds less cost to sell. The definitive Purchase and Sale Agreement (“PSA”) related to the portfolio was executed on March 7, 2017 (“sale date”). In connection therewith, the life settlement contracts and related sale proceeds were placed in escrow until the buyer was recognized as the owner and beneficiary of each individual life settlement contract by the life insurance company that issued the policy. All of the contracts have been released from escrow as of September 30, 2017. CNA derecognized the released contracts and recorded the consideration, including a note receivable, which is payable over three years and is carried at amortized cost less any valuation allowance. The note receivable of $45 million is included within Other assets on the September 30, 2017 Consolidated Condensed Balance Sheet and interest income is accreted to the principal balance of the note.

The fair value of CNA’s investments in life settlement contracts were $0 million and $58 million as of September 30, 2017 and December 31, 2016, and are included in Other assets on the Consolidated Condensed Balance Sheets. Despite the sale, the contracts were classified as Level 3 as there is not an active market for life settlement contracts. The cash receipts and payments related to the life settlement contracts prior to the sale date are included in operating activities on the Consolidated Condensed Statements of Cash Flows. Cash receipts related to the sale of the life settlement contracts as well as principal payments on the note receivable are included in investing activities.

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. The valuation of life settlement contracts was based on the terms of the sale of the contracts to a third party; therefore the contracts are not included in the tables below.


September 30, 2017	Estimated Fair Value	Valuation Techniques	Unobservable Inputs	Range (Weighted Average)
	(In millions)

Fixed maturity securities	$ 139	Discounted cash flow	Credit spread		1% – 12% (3%)

December 31, 2016

Fixed maturity securities	$ 106	Discounted cash flow	Credit spread		2% – 40% (4%)

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
September 30, 2017	Amount		Level 1	Level 2		Level 3		Total
(In millions)

Assets:
Other invested assets, primarily mortgage loans	$	722				$	731	$	731

Liabilities:
Short term debt		191		$	152		41		193
Long term debt		11,222			10,316		1,216		11,532

December 31, 2016

Assets:
Other invested assets, primarily mortgage loans	$	591				$	594	$	594

Liabilities:
Short term debt		107		$	104		3		107
Long term debt		10,655			10,150		646		10,796

The following methods and assumptions were used in estimating the fair value of these financial assets and liabilities.

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.

Fair value of debt was based on observable market prices when available. When observable market prices were not available, the fair value of debt was based on observable market prices of comparable instruments adjusted for differences between the observed instruments and the instruments being valued or is estimated using discounted cash flow analyses, based on current incremental borrowing rates for similar types of borrowing arrangements.