===============================================================================
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, 1998
------------------
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 1-6541
------
LOEWS CORPORATION
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 13-2646102
- - ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
667 MADISON AVENUE, NEW YORK, N.Y. 10021-8087
----------------------------------------------------
(Address of principal executive offices) (Zip Code)
(212) 521-2000
----------------------------------------------------
(Registrant's telephone number, including area code)
NOT APPLICABLE
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
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
--------- ---------
Class Outstanding at November 6, 1998
- - -------------------------- -------------------------------
Common stock, $1 par value 113,690,800 shares
===============================================================================
Page 1
INDEX
Part I. Financial Information Page No.
--------
Item 1. Financial Statements
Consolidated Condensed Balance Sheets--
September 30, 1998 and December 31, 1997 ...................... 3
Consolidated Condensed Statements of Income--
Three and nine months ended September 30, 1998 and 1997 ....... 4
Consolidated Condensed Statements of Cash Flows--
Nine months ended September 30, 1998 and 1997 ................. 5
Notes to Consolidated Condensed Financial Statements ............ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations ........................................ 39
Item 3. Quantitative and Qualitative Disclosures about Market Risk 57
Part II. Other Information
Item 1. Legal Proceedings ......................................... 60
Item 6. Exhibits and Reports on Form 8-K .......................... 61
Page 2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
--------------------
Loews Corporation and Subsidiaries
Consolidated Condensed Balance Sheets
- - -------------------------------------------------------------------------------
(Amounts in millions) September 30, December 31,
1998 1997
-----------------------------
Assets:
Investments:
Fixed maturities, amortized cost of $28,734.7
and $30,201.6 ................................ $29,612.2 $30,723.2
Equity securities, cost of $1,716.8 and
$1,102.6 ..................................... 2,239.8 1,163.3
Other investments ............................. 1,099.3 978.4
Short-term investments ........................ 9,204.2 8,754.2
----------------------------
Total investments .......................... 42,155.5 41,619.1
Cash ............................................ 181.0 497.8
Receivables-net ................................. 14,960.3 13,616.9
Property, plant and equipment-net ............... 2,669.8 2,590.2
Deferred income taxes ........................... 661.9 944.3
Goodwill and other intangible assets-net ........ 720.2 751.4
Other assets .................................... 1,910.3 1,935.1
Deferred policy acquisition costs of insurance
subsidiaries ................................... 2,358.9 2,141.7
Separate Account business ....................... 5,381.5 5,811.6
----------------------------
Total assets ............................... $70,999.4 $69,908.1
============================
Liabilities and Shareholders' Equity:
Insurance reserves and claims ................... $40,482.5 $39,828.4
Payable to brokers .............................. 1,821.6 1,559.2
Securities sold under repurchase agreements ..... 57.9 152.7
Long-term debt, less unamortized discount ....... 5,701.3 5,752.6
Other liabilities ............................... 4,540.6 4,749.1
Separate Account business ....................... 5,381.5 5,811.6
----------------------------
Total liabilities .......................... 57,985.4 57,853.6
Minority interest ............................... 2,502.9 2,389.4
Shareholders' equity ............................ 10,511.1 9,665.1
----------------------------
Total liabilities and shareholders' equity . $70,999.4 $69,908.1
============================
See accompanying Notes to Consolidated Condensed Financial Statements.
Page 3
Loews Corporation and Subsidiaries
Consolidated Condensed Statements of Income
- - -------------------------------------------------------------------------------------------------
(Amounts in millions, except per share data) Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
---------------------------------------------------
Revenues:
Insurance premiums:
Property and casualty ................. $ 2,513.8 $2,488.8 $ 7,706.7 $ 7,488.7
Life .................................. 784.1 846.3 2,424.2 2,538.8
Investment income, net of expenses ...... 585.4 583.7 1,837.9 1,803.5
Investment gains (losses) ............... 663.0 1.5 338.0 (265.1)
Manufactured products (including excise
taxes of $134.8, $131.8, $371.5 and
$366.2) ................................ 805.2 674.8 2,126.2 1,841.4
Other ................................... 600.4 516.3 1,718.8 1,392.3
--------------------------------------------------
Total ................................ 5,951.9 5,111.4 16,151.8 14,799.6
--------------------------------------------------
Expenses:
Insurance claims and policyholders'
benefits ............................... 2,773.4 2,854.5 8,560.6 8,607.0
Amortization of deferred policy
acquisition costs ...................... 544.9 621.3 1,803.7 1,737.5
Cost of manufactured products sold ...... 272.6 272.0 769.2 770.1
Selling, operating, advertising and
administrative expenses ................ 1,207.0 859.3 3,180.8 2,401.4
Interest ................................ 89.3 88.3 282.3 239.4
--------------------------------------------------
Total ................................ 4,887.2 4,695.4 14,596.6 13,755.4
--------------------------------------------------
1,064.7 416.0 1,555.2 1,044.2
--------------------------------------------------
Income tax expense ...................... 384.9 134.3 532.0 330.4
Minority interest ....................... 62.7 84.1 242.6 213.1
--------------------------------------------------
Total ................................ 447.6 218.4 774.6 543.5
--------------------------------------------------
Net income ................................ $ 617.1 $ 197.6 $ 780.6 $ 500.7
==================================================
Net income per share ...................... $ 5.38 $ 1.72 $ 6.79 $ 4.35
==================================================
Cash dividends per share .................. $ .25 $ .25 $ .75 $ .75
==================================================
Weighted average number of shares
outstanding .............................. 114.7 115.0 114.9 115.0
==================================================
See accompanying Notes to Consolidated Condensed Financial Statements.
Page 4
Loews Corporation and Subsidiaries
Consolidated Condensed Statements of Cash Flows
- - -------------------------------------------------------------------------------
(Amounts in millions) Nine Months Ended September 30,
1998 1997
-------------------------------
Operating Activities:
Net income .................................. $ 780.6 $ 500.7
Adjustments to reconcile net income to net
cash used by operating activities-net ...... 182.6 784.2
Changes in assets and liabilities-net:
Reinsurance receivable .................... (178.3) 127.6
Other receivables ......................... (693.1) (486.5)
Deferred policy acquisition costs ......... (217.3) (369.3)
Insurance reserves and claims ............. 665.5 993.2
Other liabilities ......................... 135.1 (1,029.3)
Trading securities ........................ (673.4) (598.6)
Other-net ................................. (156.4) (172.6)
--------------------------
(154.7) (250.6)
--------------------------
Investing Activities:
Purchases of fixed maturities ............... (50,541.0) (30,956.4)
Proceeds from sales of fixed maturities ..... 49,698.1 30,131.3
Proceeds from maturities of fixed maturities 2,655.3 1,667.8
Change in securities sold under repurchase
agreements ................................. (94.8) 627.7
Purchases of equity securities .............. (793.0) (854.2)
Proceeds from sales of equity securities .... 511.7 937.5
Change in short-term investments ............ (560.7) (1,963.4)
Purchases of property, plant and equipment .. (345.2) (533.1)
Change in other investments ................. (246.2) 40.1
--------------------------
284.2 (902.7)
--------------------------
Financing Activities:
Dividends paid to shareholders .............. (86.2) (86.3)
Dividends paid to minority interests ........ (30.7)
Issuance of long-term debt .................. 1,011.7 1,634.1
Principal payments on long-term debt ........ (1,065.9) (206.4)
Purchase of treasury shares ................. (110.1)
Purchase of treasury shares by subsidiaries . (153.6)
Net change in revolving line of credit ...... (63.0)
Net change in short-term debt ............... (9.9)
Receipts credited to policyholders .......... 18.8 6.7
Withdrawals of policyholder account balances (30.3) (18.4)
---------------------------
(446.3) 1,256.8
---------------------------
Net change in cash ............................ (316.8) 103.5
Cash, beginning of period ..................... 497.8 305.7
---------------------------
Cash, end of period ........................... $ 181.0 $ 409.2
===========================
See accompanying Notes to Consolidated Condensed Financial Statements.
Page 5
Loews Corporation and Subsidiaries
Notes to Consolidated Condensed Financial Statements
- - -------------------------------------------------------------------------------
(Dollars in millions, except per share data)
1. General:
Reference is made to Notes to Consolidated Financial Statements in the 1997
Annual Report to Shareholders which should be read in conjunction with these
consolidated condensed financial statements.
Comprehensive income
Comprehensive income includes all changes to shareholders' equity, including
net income, except those resulting from investments by, and distributions
to, owners. For the three and nine months ended September 30, 1998 and 1997,
comprehensive income totaled $846.9, $462.4, $1,042.3 and $656.5,
respectively. Comprehensive income includes net income, unrealized
appreciation (depreciation) and foreign currency translation gains or
losses.
Net income per share
The Company adopted SFAS No. 128, "Earnings Per Share," which requires
presentation of basic and diluted earnings per share for entities with
complex capital structures. Basic earnings per share excludes dilution and
is computed by dividing net income by the weighted average number of common
shares outstanding for the period. Diluted earnings 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. The
Company does not have any dilutive instruments related to its common shares.
Accordingly, basic and diluted earnings per share are the same.
Reclassifications
Certain amounts applicable to prior periods have been reclassified to
conform to the classifications followed in 1998.
2. Reinsurance:
CNA assumes and cedes insurance with other insurers and reinsurers and
members of various reinsurance pools and associations. CNA utilizes
reinsurance arrangements to limit its maximum loss, to provide greater
diversification of risk and to minimize exposures on larger risks. The
reinsurance coverages are tailored to the specific risk characteristics of
each product line with CNA's retained amount varying by type of coverage.
Generally, reinsurance coverage for property risks is on an excess of loss,
per risk basis. Liability coverages are generally reinsured on a quota share
basis in excess of CNA's retained risk.
The ceding of insurance does not discharge the primary liability of the
original insurer. CNA places reinsurance with other carriers only after
careful review of the nature of the contract and a thorough assessment of
the reinsurers' credit quality and claim settlement performance. Further,
for carriers that are not authorized reinsurers in CNA's states of domicile,
CNA receives collateral, primarily in the form of bank letters of credit,
securing a large portion of the recoverables.
Page 6
The effects of reinsurance on earned premiums are as follows:
% %
Direct Assumed Ceded Net Assumed Direct Assumed Ceded Net Assumed
--------------------------------------------------------------------------------------
Nine Months Ended September 30,
--------------------------------------------------------------------------------------
---------------- 1998 -------------------- ---------------- 1997 -------------------
Property and
casualty .. $6,261.0 $1,114.0 $481.0 $ 6,894.0 16.2% $6,087.0 $1,078.0 $549.0 $ 6,616.0 16.3%
Accident and
health .... 2,620.0 153.0 202.0 2,571.0 5.9 2,803.0 73.0 115.0 2,761.0 2.6
Life ....... 742.0 112.0 188.0 666.0 16.8 649.0 92.0 90.0 651.0 14.1
--------------------------------------------------------------------------------------
Total .... $9,623.0 $1,379.0 $871.0 $10,131.0 13.6% $9,539.0 $1,243.0 $754.0 $10,028.0 12.4%
======================================================================================
In the above table, life premium revenue is principally from long duration
contracts and the property and casualty earned premium is from short
duration contracts. Approximately three quarters of accident and health
earned premiums are from short duration contracts.
Insurance claims and policyholders' benefits are net of reinsurance
recoveries of $721.0 and $618.0 for the nine months ended September 30, 1998
and 1997, respectively.
3. The Company's receivables are comprised of the following:
September 30, December 31,
1998 1997
---------------------------
Reinsurance .................................. $ 6,235.3 $ 6,057.0
Other insurance .............................. 6,956.1 6,293.9
Security sales ............................... 1,300.7 755.8
Accrued investment income .................... 428.3 422.8
Other ....................... ................ 363.2 405.4
---------------------------
Total ................................. 15,283.6 13,934.9
Less allowance for doubtful accounts and
cash discounts .............................. 323.3 318.0
---------------------------
Receivables-net ....................... $14,960.3 $13,616.9
===========================
Page 7
4. Shareholders' equity:
September 30, December 31,
1998 1997
---------------------------
Preferred stock, $.10 par value:
Authorized--100,000,000 shares
Common stock, $1 par value:
Authorized--400,000,000 shares
Issued--115,000,000 shares ................. $ 115.0 $ 115.0
Additional paid-in capital ................... 165.8 165.8
Earnings retained in the business ............ 9,589.8 8,895.4
Accumulated other comprehensive income ....... 750.6 488.9
--------------------------
Total ................................. 10,621.2 9,665.1
Less common stock (1,309,200 shares) held in
treasury at cost ............................ 110.1
--------------------------
Total ................................. $10,511.1 $9,665.1
==========================
5. Restructuring and Other Related Charges-
In the third quarter of 1998, CNA finalized and approved a plan to
restructure its operations. In connection with this plan, CNA recorded pre-
tax restructuring and other related charges totaling approximately $220.0.
The restructuring plan focused primarily on a net reduction in current
workforce, the consolidation of certain processing centers, the closing of
various facilities, and the exiting of certain businesses. CNA's plan calls
for a reduction in the current workforce of approximately 4,500 employees
resulting in a net reduction of approximately 2,400 employees upon
completion of the plans activities. The charges recorded in the third
quarter of 1998 relate to employee termination benefits ($72.0), the
writedown of certain assets to their fair values ($74.0), lease abandonment
costs ($42.0) and losses related to the exiting of businesses ($32.0).
6. Legal Proceedings and Contingent Liabilities-
INSURANCE RELATED
Fibreboard Litigation
---------------------
CNA's primary property and casualty subsidiary, Continental Casualty Company
("Casualty"), has been party to litigation with Fibreboard Corporation
("Fibreboard") involving coverage for certain asbestos-related claims and
defense costs (San Francisco Superior Court, Judicial Council Coordination
Proceeding 1072). As described below, Casualty, Fibreboard, another insurer
(Pacific Indemnity, a subsidiary of the Chubb Corporation), and a
negotiating committee of asbestos claimant attorneys (collectively referred
to as "Settling Parties") have reached a Global Settlement (the "Global
Settlement") to resolve all future asbestos-related bodily injury claims
involving Fibreboard, which is subject to court approval.
Casualty, Fibreboard and Pacific Indemnity have also reached an agreement
(the "Trilateral Agreement") on a settlement to resolve the coverage
litigation in the event the Global Settlement does not obtain final court
Page 8
approval.
On July 27, 1995, the United States District Court for the Eastern District
of Texas entered judgment approving the Global Settlement Agreement and the
Trilateral Agreement. As expected, appeals were filed as respects to both of
these decisions. On July 25, 1996, a panel of the United States Fifth
Circuit Court of Appeals in New Orleans affirmed the judgment approving the
Global Settlement Agreement by a 2 to 1 vote and affirmed the judgment
approving the Trilateral Agreement by a 3 to 0 vote. Petitions for rehearing
by the panel and Suggestions for Rehearing by the entire Fifth Circuit Court
of Appeals as respects to the decision on the Global Settlement Agreement
were denied. Two petitions for certiorari were filed in the Supreme Court as
respects the Global Settlement Agreement. On June 27, 1997, the Supreme
Court granted these petitions, vacated the Fifth Circuit's judgment as
respects to the Global Settlement Agreement, and remanded the matter to the
Fifth Circuit for reconsideration in light of the Supreme Court's decision
in Amchem Products Co. v. Windsor.
On January 27, 1998, a panel of the United States Fifth Circuit Court of
Appeals again approved the Global Settlement Agreement by a 2 to 1 vote. Two
sets of objectors filed petitions for certiorari which were docketed on
April 16 and 17, 1998, by the United States Supreme Court. On June 22, 1998,
the Supreme Court granted the petition for certiorari filed by one of the
sets of objectors. The Supreme Court has set oral argument for December 8,
1998.
No further appeal was filed with respect to the Trilateral Agreement;
therefore, court approval of the Trilateral Agreement has become final.
Settlement Agreements - On April 9, 1993, Casualty and Fibreboard entered
into an agreement pursuant to which, among other things, the parties agreed
to use their best efforts to negotiate and finalize a global class action
settlement with asbestos-related bodily injury and death claimants.
On August 27, 1993, the Settling Parties reached an agreement in principle
for an omnibus settlement to resolve all future asbestos-related bodily
injury claims involving Fibreboard. The Global Settlement Agreement was
executed on December 23, 1993. The agreement calls for contribution by
Casualty and Pacific Indemnity of an aggregate of $1,525.0 to a trust fund
for a class of all future asbestos claimants, defined generally as those
persons whose claims against Fibreboard were neither filed nor settled
before August 27, 1993. An additional $10.0 is to be contributed to the fund
by Fibreboard. As indicated above, the Global Settlement Agreement has been
approved by the Fifth Circuit a second time, but the Supreme Court has
granted a petition for certiorari filed by one of the sets of objectors to
the settlement.
On October 12, 1993, Casualty, Pacific Indemnity and Fibreboard entered into
the Trilateral Agreement to settle the coverage litigation to operate in the
event that the Global Settlement Agreement is disapproved. The Trilateral
Agreement calls for payment by Casualty and Pacific Indemnity of an
aggregate $2,000.0, of which Casualty's portion is approximately $1,460.0,
to Fibreboard to resolve all claims by Fibreboard and all future and
unsettled present asbestos claimants arising under the policy issued to
Fibreboard by Casualty.
Under either the Global Settlement Agreement or the Trilateral Agreement,
Casualty is also obligated to pay under prior settlements of present
asbestos claims. As a result of the final approval of the Trilateral
Agreement, such obligation has become final. Through September 30, 1998,
Casualty, Fibreboard and plaintiff attorneys had reached settlements with
Page 9
respect to approximately 135,200 present claims, for an estimated settlement
amount of approximately $1,630.0 plus any applicable interest. Final court
approval of the Trilateral Agreement obligates Casualty to pay under these
settlements. Approximately $1,670.0 (including interest of $184.0) was paid
through September 30, 1998. Such payments have been partially recovered from
Pacific Indemnity. Casualty may negotiate other agreements for unsettled
claims.
Final court approval of the Trilateral Agreement and its implementation
resolved Casualty's exposure with respect to the Fibreboard asbestos claims.
Casualty's management does not anticipate further material exposure with
respect to the Fibreboard matter, and subsequent adverse reserve
adjustments, if any, are not expected to materially affect the results of
operations or equity of the Company.
Tobacco Litigation
------------------
Several of CNA's property/casualty subsidiaries have been named as
defendants as part of a "direct action" lawsuit, Richard P. Ieyoub v. The
American Tobacco Company, et al., filed by the Attorney General for the
State of Louisiana, in state court, Calcasieu Parish, Louisiana. In that
suit, filed against certain tobacco manufacturers and distributors (the
"Tobacco Defendants") and over 100 insurance companies, the State of
Louisiana seeks to recover medical expenses allegedly incurred by the State
as a result of tobacco-related illnesses.
The original suit was filed on March 13, 1996, against the Tobacco
Defendants only. The insurance companies were added to the suit in March
1997 under a "direct action" procedure in Louisiana. Under the direct action
statute, the Louisiana Attorney General is pursuing liability claims against
the Tobacco Defendants and their insurers in the same suit, even though none
of the Tobacco Defendants has made a claim for insurance coverage.
In June of 1997, the United States District Court for the Western District
of Louisiana, Lake Charles Division, granted a petition to remove this
litigation to the federal district court. The district court's decision is
currently on appeal to the United States Fifth Circuit Court of Appeals.
During the pending appeal, all proceedings in state court and in the federal
district court are stayed. Because of the uncertainties inherent in
assessing the risk of liability at this very early stage of the litigation,
management is unable to make a meaningful estimate of the amount or range of
any loss that could result from an unfavorable outcome of the pending
litigation. However, management believes that the ultimate outcome of the
pending litigation should not materially affect the results of operations or
equity of CNA.
Environmental Pollution and Asbestos
------------------------------------
The CNA property and casualty insurance companies have potential exposures
related to environmental pollution and asbestos claims.
Environmental pollution clean-up is the subject of both federal and state
regulation. By some estimates, there are thousands of potential waste sites
subject to clean-up. The insurance industry is involved in extensive
litigation regarding coverage issues. Judicial interpretations in many cases
have expanded the scope of coverage and liability beyond the original intent
of the policies.
The Comprehensive Environmental Response Compensation and Liability Act of
Page 10
1980 ("Superfund") and comparable state statutes ("mini-Superfund") govern
the clean-up and restoration of abandoned toxic waste sites and formalize
the concept of legal liability for clean-up and restoration by potentially
responsible parties ("PRP's"). Superfund and the mini-Superfunds
(Environmental Clean-up Laws or "ECLs") establish mechanisms to pay for
clean-up of waste sites if PRPs fail to do so, and to assign liability to
PRPs. The extent of liability to be allocated to a PRP is dependent on a
variety of factors. Further, the number of waste sites subject to clean-up
is unknown. To date, approximately 1,300 clean-up sites have been identified
by the Environmental Protection Agency on its National Priorities List
("NPL"). The addition of new clean-up sites to the NPL has slowed in recent
years. Many clean-up sites have been designated by state authorities as
well.
Many policyholders have made claims against various CNA insurance
subsidiaries for defense costs and indemnification in connection with
environmental pollution matters. CNA and the insurance industry are
disputing coverage for many such claims. Key coverage issues include whether
clean-up costs are considered damages under the policies, trigger of
coverage, applicability of pollution exclusions and owned property
exclusions, the potential for joint and several liability and definition of
an occurrence. To date, courts have been inconsistent in their rulings on
these issues.
A number of proposals to reform Superfund have been made by various parties.
However, no reforms were enacted by Congress in 1998 and it is unclear as to
what positions the Congress or the Clinton Administration will take and what
legislation, if any, will result. If there is legislation, and in some
circumstances even if there is no legislation, the federal role in
environmental clean-up may be significantly reduced in favor of state
action. Substantial changes in the federal statute or the activity of the
EPA may cause states to reconsider their environmental clean-up statutes and
regulations. There can be no meaningful prediction of the pattern of
regulation that would result.
Due to the inherent uncertainties described above, including the
inconsistency of court decisions, the number of waste sites subject to
clean-up, and the standards for clean-up and liability, CNA's ultimate
liability for environmental pollution claims may vary substantially from the
amount currently recorded.
As of September 30, 1998 and December 31, 1997, CNA carried $646.0 and
$773.0, respectively, of claim and claim expense reserves, net of
reinsurance recoverables, for reported and unreported environmental
pollution claims. The reserves relate to claims for accident years 1988 and
prior, after which CNA adopted the Simplified Commercial General Liability
coverage form which includes an absolute pollution exclusion. Unfavorable
environmental pollution reserve development for the nine months ended
September 30, 1998 was $58.0. There was no environmental pollution reserve
development for the nine months ended September 30, 1997.
CNA's property and casualty insurance subsidiaries have exposure to asbestos
claims, including those attributable to CNA's litigation with Fibreboard
Corporation (see above). Estimation of asbestos claim reserves involves many
of the same limitations discussed above for environmental pollution claims
such as inconsistency of court decisions, specific policy provisions,
allocation of liability among insurers, missing policies and proof of
coverage. As of September 30, 1998 and December 31, 1997, CNA carried
$1,455.0 and $1,400.0, respectively, of claim and claim expense reserves,
net of reinsurance recoverables, for reported and unreported
asbestos-related claims. Unfavorable asbestos claim reserve development for
Page 11
the nine months ended September 30, 1998 and 1997 totaled $205.0 and $40.0,
respectively.
The unfavorable reserve development on environmental and asbestos reserves
in 1998 was more than offset by favorable reserve development in other
lines, primarily commercial and specialty coverages. Excluding environmental
and asbestos reserves, favorable loss and allocated loss adjustment expense
reserve development approximated $380.0 and $340.0 for the nine months ended
September 30, 1998 and 1997, respectively. Premium development for these
same periods approximated $30.0 favorable and $165.0 unfavorable,
respectively. The large unfavorable premium development in 1997 is primarily
attributable to reductions in residual market premiums.
The following table provides additional data related to CNA's environmental
pollution and asbestos-related claims activity.
September 30, 1998 December 31, 1997
----------------------------------------------------
Environmental Environmental
Pollution Asbestos Pollution Asbestos
----------------------------------------------------
Reported Claims:
Gross reserves .................... $279.0 $1,308.0 $279.0 $1,198.0
Less reinsurance recoverable ...... (52.0) (101.0) (36.0) (117.0)
------------------------------------------------
Net reported claims ............... 227.0 1,207.0 243.0 1,081.0
Net unreported claims ............... 419.0 248.0 530.0 319.0
------------------------------------------------
Net reserves ........................ $646.0 $1,455.0 $773.0 $1,400.0
================================================
The results of operations in future years may continue to be adversely
affected by environmental pollution and asbestos claims and claim expenses.
Management will continue to monitor these liabilities and make further
adjustments as warranted.
NON-INSURANCE
Tobacco Litigation -- Lawsuits continue to be filed with increasing
frequency against Lorillard and other manufacturers of tobacco products
seeking damages for cancer and other health effects claimed to have resulted
from an individual's use of cigarettes, addiction to smoking, or exposure to
environmental tobacco smoke. Tobacco litigation includes claims brought by
individual plaintiffs ("Conventional Product Liability Cases"); claims
brought as class actions on behalf of a large number of individuals for
damages allegedly caused by smoking ("Class Actions"); claims brought on
behalf of governmental entities and others, including private citizens suing
on behalf of taxpayers, labor unions, Indian Tribes and private companies,
seeking, among other alleged damages, reimbursement of health care costs
allegedly incurred as a result of smoking ("Reimbursement Cases"); and
claims for contribution and/or indemnity of asbestos claims by asbestos
manufacturers ("Claims for Contribution"). In addition, claims have been
brought against Lorillard seeking damages resulting from exposure to
asbestos fibers which had been incorporated, for a limited period of time,
ending more than forty years ago, into filter material used in one brand of
cigarettes manufactured by Lorillard ("Filter Cases").
In these actions, plaintiffs claim substantial compensatory, statutory and
punitive damages in amounts ranging into the billions of dollars. These
Page 12
claims are based on a number of legal theories including, among other
things, theories of negligence, fraud, misrepresentation, strict liability,
breach of warranty, enterprise liability, civil conspiracy, intentional
infliction of harm, violation of anti-trust laws and state consumer
protection statutes, and failure to warn of the allegedly harmful and/or
addictive nature of tobacco products.
On June 20, 1997, together with other companies in the United States tobacco
industry, Lorillard entered into a Memorandum of Understanding to support
the adoption of federal legislation and any necessary ancillary undertakings
incorporating the features described in the proposed resolution attached to
the Memorandum of Understanding (together, the "Proposed Resolution"). The
Proposed Resolution can be implemented only by federal legislation. If
enacted into law, the legislation implementing the Proposed Resolution would
resolve many of the regulatory and litigation issues affecting the United
States tobacco industry thereby reducing uncertainties facing the industry.
Certain legislation had been introduced in Congress that would significantly
modify the Proposed Resolution including provisions more stringent than
those included in the Proposed Resolution. On April 18, 1998, Lorillard and
other companies announced a withdrawal from the legislative process to enact
a comprehensive tobacco settlement. (See Item 1 - Lorillard, Inc. -
"Proposed Resolution of Certain Regulatory and Litigation Issues" in the
Company's annual report on Form 10-K for the year ended December 31, 1997.)
CONVENTIONAL PRODUCT LIABILITY CASES - There are approximately 660 cases
filed by individual plaintiffs against manufacturers of tobacco products
pending in the United States federal and state courts in which individuals
allege they or their decedents have been injured due to smoking cigarettes,
due to exposure to environmental tobacco smoke, or due to nicotine
dependence. Lorillard is a defendant in approximately 300 of these cases.
The Company is a defendant in 73 of the cases, although two have not been
served. Sixty-five of the 73 cases have been filed in West Virginia.
Plaintiffs in these cases seek unspecified amounts in compensatory and
punitive damages in many cases, and in other cases damages are stated to
amount to as much as $100.0 in compensatory damages and $600.0 in punitive
damages.
On March 19, 1998, the jury in Dunn v. RJR Nabisco Holdings Corporation, et
al. (Superior Court, Delaware County, Indiana, filed May 28, 1993) returned
a unanimous verdict in favor of the defendant cigarette manufacturers and
their parent entities, including the Company, in the trial of a suit brought
by the family of a woman who died of cancer, allegedly caused by exposure to
environmental tobacco smoke. The court denied plaintiffs' motion for new
trial. Plaintiffs did not notice an appeal.
On September 26, 1997, a jury in the case of Gordon v. R.J. Reynolds Tobacco
Company, et al. (Superior Court, Middlesex County, Massachusetts), returned
a special verdict favorable to the defendants, which included Lorillard. The
court entered judgment in favor of the defendants. Trial was held on the
limited issue of the cigarettes smoked by the decedent and the time period
in which she smoked them. Plaintiff has filed a motion for new trial, which
is pending.
During 1998, a jury in the Circuit Court of Duval County, Florida, returned
a verdict in favor of plaintiffs in a smoking and health case in which
Lorillard was not a party, Widdick v. Brown & Williamson Tobacco Corporation
(verdict returned June 10, 1998). The jury awarded plaintiffs $1.0 in actual
damages and punitive damages. The First District of the Florida Court of
Appeal reversed the trial court's order denying Brown & Williamson Tobacco
Corporation's motion to transfer venue. The Circuit Court of Duval County,
Page 13
Florida, transferred the case to the Circuit Court of Palm Beach County,
Florida. Brown & Williamson's motion for new trial is pending.
During 1997, juries returned verdicts in favor of the defendants in trials
in two smoking and health cases in which Lorillard was not a party, Connor
v. R.J. Reynolds Tobacco Company (verdict returned May 5, 1997) and
Karbiwnyk v. R.J. Reynolds Tobacco Company (verdict returned October 31,
1997) (both cases were tried in the Circuit Court of Duval County, Florida).
Appeals are not pending in either case.
The Florida Court of Appeals issued a ruling in the case of Carter v. Brown
& Williamson Tobacco Corporation, filed in the Circuit Court of Duval
County, Florida, that reversed a 1996 verdict entered in favor of plaintiffs
in which they were awarded a total of seven hundred fifty thousand dollars
in actual damages. The Court of Appeals directed that judgment be entered in
favor of Brown & Williamson Tobacco Corporation by the trial court.
Plaintiffs have asked the Court of Appeals to reconsider its decision.
Lorillard was not a party to Carter v. Brown & Williamson Tobacco
Corporation.
CLASS ACTIONS - There are approximately 70 purported class actions pending
against cigarette manufacturers and other defendants, including the Company.
Three cases have not been served. Most of the suits seek class certification
on behalf of residents of the states in which the cases have been filed,
although some suits seek class certification on behalf of residents of
multiple states. All but one of the purported class actions seek class
certification on behalf of individuals who smoked cigarettes or were exposed
to environmental tobacco smoke. One of the cases seek class certification on
behalf of individuals who have paid insurance premiums to Blue Cross and
Blue Shield organizations. Plaintiffs in a number of Reimbursement cases
also seek certification as class actions (see Reimbursement Cases, below).
Theories of liability asserted in the purported class actions include a
broad range of product liability theories, including those based on consumer
protection statutes and fraud and misrepresentation. Plaintiffs seek damages
in each case that range from unspecified amounts to the billions of dollars.
Most plaintiffs seek punitive damages and some seek treble damages.
Plaintiffs in many of the cases seek medical monitoring. Plaintiffs in
several of the purported class actions are represented by a well-funded and
coordinated consortium of over 60 law firms from throughout the United
States. Lorillard is a defendant in 59 of the approximately 70 cases seeking
class certification. The Company is a defendant in 24 of the purported class
actions, two of which have not been served. Many of the purported class
actions are in the pre-trial, discovery stage.
Broin v. Philip Morris Companies, Inc., et al. (Circuit Court, Dade County,
Florida, October 31, 1991). On October 10, 1997, the parties to this class
action brought on behalf of flight attendants claiming injury as a result of
exposure to environmental tobacco smoke executed a settlement agreement
which was approved by the trial court on February 3, 1998. The settlement
agreement requires Lorillard and three other cigarette manufacturers jointly
to pay $300.0 in three annual installments to create and endow a research
institute to study diseases associated with cigarette smoke. None of these
payments are to be made until all appeals have been exhausted and judgment
becomes final. The amount to be paid by Lorillard is based upon each of the
four settling defendants' then share of the United States market for the
sale of cigarettes. Lorillard had approximately 8.8% of the cigarette market
in the United States. Based on this calculation, Lorillard is expected to
pay approximately $26.0 of the proposed settlement amount. The plaintiff
class members are permitted to file individual suits, but these individuals
may not seek punitive damages for injuries that arose prior to January 15,
Page 14
1997 which enabled them to be members of the class. The defendants that
executed the settlement agreement will pay a total of $49.0 as fees and
expenses of the attorneys who represented plaintiffs. Certain of the absent
class members objected to the settlement agreement and have noticed an
appeal from the February 3, 1998 order.
Castano, et al. v. The American Tobacco Company, Inc. et al. (U.S. District
Court, Eastern District, Louisiana, March 29, 1994). This case was initiated
as a class action on behalf of nicotine dependent smokers in the United
States. During 1998, Lorillard Tobacco Company and certain other cigarette
manufacturer defendants agreed with the plaintiffs to dismiss this action
without prejudice and to toll the statute of limitations as to the named
plaintiffs' claims. Lorillard Tobacco Company paid $1.0 to reimburse the
costs and expenses of plaintiffs' counsel. This amount will be credited
against any award of costs and expenses incurred in connection with this
suit that plaintiffs' counsel may obtain in the future as a result of the
federal legislation implementing the Proposed Resolution, or against any
judgment or settlements that such counsel may obtain in the future in
similar actions.
Granier v. The American Tobacco Company, et al. (U.S. District Court,
Eastern District, Louisiana, filed September 26, 1994).
Engle v. R.J. Reynolds Tobacco Co., et al. (Circuit Court, Dade County,
Florida, filed May 5, 1994). Class certification has been granted as to
Florida citizens who allege they, or their survivors, have, have had or have
died from diseases and medical conditions caused by smoking cigarettes. The
Florida Supreme Court has denied defendants' appeal. Trial is underway.
Norton v. RJR Nabisco Holdings Corporation, et al. (Superior Court, Madison
County, Indiana, filed May 3, 1996). The Company is a defendant in the case.
Richardson v. Philip Morris Incorporated, et al. (Circuit Court, Baltimore
City, Maryland, filed May 24, 1996). During January of 1998, the court
granted plaintiffs' motion for class certification on behalf of Maryland
residents who had, presently have, or died from diseases, medical conditions
or injuries caused by smoking cigarettes or using smokeless tobacco
products; nicotine dependent persons in Maryland who have purchased and used
cigarettes and smokeless tobacco products manufactured by the defendants;
and Maryland residents who require medical monitoring. Defendants have filed
a petition for writ of mandamus or prohibition from the class certification
order with the Maryland Court of Special Appeals.
Scott v. The American Tobacco Company, et al. (U.S. District Court, Eastern
District, Louisiana, filed May 24, 1996). The Company is a defendant in the
case. Class certification has been granted on behalf of Louisiana citizens
who require medical monitoring. The class certification order was affirmed
on appeal by the Louisiana Court of Appeals.
Small v. Lorillard Tobacco Company, Inc., et al., Hoskins v. R.J. Reynolds
Tobacco Company, et al., Frosina v. Philip Morris Incorporated, et al.,
Hoberman v. Brown & Williamson Tobacco Corporation, et al., and Zito v.
American Tobacco Company, et al. (Supreme Court, New York County, New York,
filed June 19, 1996). Small is the only one of these cases to name Lorillard
as a defendant. Small formerly was known as Mroczowski. Plaintiffs' motions
for class certification on behalf of New York residents who are nicotine
dependent was granted. On appeal, the Appellate Division of the New York
Supreme Court reversed the trial court's class certification order and
directed the trial court to enter judgment in favor of the defendants. The
New York Court of Appeals has agreed to review the Appellate Division's
ruling.
Page 15
Reed v. Philip Morris Incorporated, et al. (Superior Court, District of
Columbia, filed June 21, 1996). The court has denied plaintiff's motion for
class certification.
Barnes v. The American Tobacco Company, et al. (U.S. District Court, Eastern
District, Pennsylvania, filed August 8, 1996). The District Court has
vacated its prior order that granted class certification on behalf of
Pennsylvania smokers who require medical monitoring. The court also granted
defendants' motion for summary judgment. The Third Circuit Court of Appeals
has affirmed the trial court's class certification ruling and the order
granting the summary judgment motion.
Blaylock v. The American Tobacco Company, et al. (Circuit Court, Montgomery
County, Alabama, filed August 8, 1996). The Company is a defendant in the
case. This matter formerly was known as Holmes.
Lyons v. The American Tobacco Company, et al. (U.S. District Court, Southern
District, Alabama, filed August 8, 1996).
Chamberlain v. The American Tobacco Company, et al. (U.S. District Court,
Northern District, Ohio, filed August 14, 1996). The Company is a defendant
in the case.
Thompson v. American Tobacco Company, Inc., et al. (U.S. District Court,
Minnesota, filed September 4, 1996). The Company is a defendant in the case.
Perry v. The American Tobacco Company, et al. (Circuit Court, Coffee County,
Tennessee, filed September 30, 1996). Plaintiffs seek class certification on
behalf of individuals who have paid medical insurance premiums to a Blue
Cross and Blue Shield organization.
Connor v. The American Tobacco Company, et al. (Second Judicial District
Court, Bernalillo County, New Mexico, filed October 10, 1996).
Ruiz v. The American Tobacco Company, et al. (U.S. District Court, Puerto
Rico, filed October 23, 1996). The court denied plaintiffs' motion for class
certification.
Hansen v. The American Tobacco Company, et al. (U.S. District Court, Eastern
District, Arkansas, filed November 4, 1996). The Company is a defendant in
the case.
McCune v. American Tobacco Company, et al. (Circuit Court, Kanawha County,
West Virginia, filed January 31, 1997). The Company is a defendant in the
case.
Muncy v. Philip Morris Incorporated, et al. (Circuit Court, McDowell County,
West Virginia, filed February 4, 1997). This matter formerly was known as
Woods.
Emig v. American Tobacco Company, et al. (U.S. District Court, Kansas, filed
February 6, 1997). The Company is a defendant in the case. The court has
heard argument on plaintiffs' motion for class certification.
Peterson v. American Tobacco Company, et al. (U.S. District Court, Hawaii,
filed February 6, 1997). The Company is a defendant in the case.
Walls v. The American Tobacco Company, et al. (U.S. District Court, Northern
District, Oklahoma, filed February 6, 1997). The court has heard argument on
plaintiffs' motion for class certification. The court has indicated that it
will certify certain question of Oklahoma law to the Oklahoma Supreme Court.
Page 16
Selcer v. R.J. Reynolds Tobacco Company, et al. (U.S. District Court,
Nevada, filed March 3, 1997). The Company is a defendant in the case.
Insolia v. Philip Morris Incorporated, et al. (U.S. District Court, Western
District, Wisconsin, filed April 21, 1997). Briefing of plaintiffs' motion
for class certification has been completed. The court has not scheduled the
case for oral argument and has indicated that it may decide the motion based
on the briefs that have been submitted.
Geiger v. The American Tobacco Company, et al. (Supreme Court, Queens
County, New York, filed April 30, 1997). The trial court granted on an
interim basis plaintiffs' motion for class certification on behalf of New
York residents who allege lung cancer or throat cancer as a result of
smoking cigarettes. The Appellate Division of the New York Supreme Court
reversed the class certification order and directed the trial court to allow
the parties to conduct additional proceedings on the class certification
motion.
Cole v. The Tobacco Institute, Inc., et al. (U.S. District Court, Eastern
District, Texas, Texarkana Division, filed May 5, 1997).
Clay v. The American Tobacco Company, Inc., et al. (U.S. District Court,
Southern District, Illinois, Benton Division, filed May 22, 1997).
Anderson v. The American Tobacco Company, Inc., et al. (U.S. District Court,
Eastern District, Tennessee, filed May 23, 1997). The Company is a defendant
in the case.
Taylor v. The American Tobacco Company, Inc., et al. (Circuit Court, Wayne
County, Michigan, filed May 23, 1997).
Lyons v. Brown & Williamson Tobacco Corporation, et al. (U.S. District
Court, Northern District, Georgia, filed May 27, 1997). The Company is a
defendant in the case.
Cosentino v. Philip Morris Incorporated, et al. (Superior Court, Middlesex
County, New Jersey, filed May 28, 1997). The court has denied plaintiffs'
motion for class certification.
Kirstein v. American Tobacco Company, Inc., et al. (Superior Court, Camden
County, New Jersey, filed May 28, 1997). The court has denied plaintiffs'
motion for class certification.
Tepper v. Philip Morris Incorporated, et al. (Superior Court, Bergen County,
New Jersey, filed May 28, 1997). The court has denied plaintiffs' motion for
class certification.
Brown v. The American Tobacco Company, Inc., et al. (Superior Court, San
Diego County, California, filed June 10, 1997).
Lippincott v. American Tobacco Company, Inc., et al. (Superior Court, Camden
County, New Jersey, filed June 13, 1997). The court has denied plaintiffs'
motion for class certification.
Brammer v. R.J. Reynolds Tobacco Company, et al. (U.S. District Court,
Southern District, Iowa, filed June 20, 1997). The Company is a defendant in
the case.
Knowles v. The American Tobacco Company, et al. (U.S. District Court,
Eastern District, Louisiana, filed June 30, 1997). The Company is a
defendant in the case.
Page 17
Daley v. American Brands, Inc., et al. (U.S. District Court, Northern
District, Illinois, filed July 7, 1997).
Piscitello v. Philip Morris, Incorporated, et al. (Superior Court, Middlesex
County, New Jersey, filed July 28, 1997). The Company is a defendant in the
case. The court has denied plaintiffs' motion for class certification.
Azorsky v. R.J. Reynolds Tobacco Company, et al. (U.S. District Court,
Western District, Pennsylvania, filed August 15, 1997). The court granted
defendants' motion to dismiss. Plaintiffs have attempted to notice appeals
to the United States Court of Appeals for the Third Circuit.
Bush v. Philip Morris Incorporated, et al. (U.S. District Court, Eastern
District, Texas, filed September 10, 1997).
Nwanze v. Philip Morris Companies Inc., et al. (U.S. District Court,
Southern District, New York, filed September 29, 1997). The Company is a
defendant in the case. The court denied plaintiffs' motion for class
certification.
Badillo v. American Tobacco Company, et al. (U.S. District Court, Nevada,
filed October 8, 1997). The Company is a defendant in the case.
Newborn v. Brown & Williamson Tobacco Corporation, et al. (U.S. District
Court, Western District, Tennessee, filed October 9, 1997).
Young v. The American Tobacco Company, et al. (Civil District Court, Orleans
Parish, Louisiana, filed November 12, 1997). The Company is a defendant in
the case.
Aksamit v. Brown & Williamson Tobacco Corporation, et al. (U.S. District
Court, South Carolina, filed November 20, 1997). The Company is a defendant
in the case.
DiEnno v. Liggett Group, Inc., et al. (U.S. District Court, Nevada, filed
December 22, 1997).
Jackson v. Philip Morris Incorporated, et al. (U.S. District Court, Central
District, Utah, filed on or about February 13, 1998). The Company is a
defendant in the case.
Parsons v. AC&S, et al. (Circuit Court, Kanawha County, West Virginia, filed
February 27, 1998). The Company is a defendant in the case.
Basik v. Lorillard Tobacco Company, et al. (Circuit Court, Cook County,
Illinois, filed March 17, 1998).
Daniels v. Philip Morris Companies, Inc., et al. (Superior Court, San Diego
County, California, filed April 2, 1998). The Company is a defendant in the
case.
Christensen v. Philip Morris Companies, Inc., et al. (U.S. District Court,
Nevada, filed April 3, 1998). The Company is a defendant in the case. To
date, none of the defendants have received service of process.
Avallone v. The American Tobacco Company, Inc., et al. (Superior Court,
Middlesex County, New Jersey, filed April 23, 1998). The Company is a
defendant in the case. The court has heard argument on plaintiffs' motion
for class certification.
Collier v. Philip Morris Incorporated, et al. (U.S. District Court, Southern
Page 18
District, Mississippi, filed May 27, 1998).
Cleary v. Philip Morris Incorporated, et al. (Circuit Court, Cook County,
Illinois, filed June 5, 1998).
Vaughan v. Philip Morris Incorporated, et al. (U.S. District Court, Western
District, Virginia, filed June 30, 1998). To date, none of the defendants
have received service of process.
Creekmore v. Brown & Williamson Tobacco Corporation, et al. (Superior Court,
Buncombe County, North Carolina, filed July 31, 1998). To date, none of the
defendants have received service of process.
Jiminez v. Brown & Williamson Tobacco Corporation, et al. (Second Judicial
District Court, Bernalillo County, New Mexico, filed August 20, 1998).
Smokers for Fairness v. British American Tobacco Company, et al. (Superior
Court, Los Angeles County, California, filed September 25, 1998). To date,
none of the defendants have received service of process.
Brown v. Philip Morris, Inc., et al. (U.S. District Court, Eastern District,
Pennsylvania, filed October 16, 1998).
REIMBURSEMENT CASES - Approximately 140 actions are pending in which
governmental entities, private citizens, or other organizations, including
labor unions, insurers and Indian Tribes, seek recovery of funds expended by
them to provide health care to individuals with injuries or other health
effects allegedly caused by use of tobacco products or exposure to cigarette
smoke. These cases are based on, among other things, equitable claims,
including indemnity, restitution, unjust enrichment and public nuisance, and
claims based on antitrust laws and state consumer protection acts.
Plaintiffs in a number of these actions seek certification as class actions.
Plaintiffs seek damages in each case that range from unspecified amounts to
the billions of dollars. Most plaintiffs seek punitive damages and some seek
treble damages. Plaintiffs in many of the cases seek medical monitoring.
Lorillard is named as a defendant in all such actions except for one filed
in a U.S. court by a nation in which Lorillard does not conduct business
(The Republic of Guatemala). The Company is named as a defendant in 17 of
them.
State or Local Governmental Reimbursement Cases - To date, suits filed by 42
states, the Commonwealth of Puerto Rico, and the Republic of The Marshall
Islands are pending. In addition, cities, counties or other local
governmental entities have filed eight such suits. The Company is a
defendant in 13 cases filed by state or local governmental entities. Since
January 1, 1997, cases brought by Florida, Minnesota, Mississippi, Texas and
Blue Cross and Blue Shield of Minnesota have been settled (see "Settlements
of Reimbursement Cases"). Many of the pending Reimbursement Cases are in the
pre-trial, discovery stage.
Moore v. The American Tobacco Company, et al. (Chancery Court, Jackson
County, Mississippi, filed May 23, 1994). On July 2, 1997, Lorillard and
other defendants entered into a Memorandum of Understanding with the State
of Mississippi which settled the State's claims for monetary damages. See
"Settlements of Reimbursement Cases" below.
State of Minnesota, et al. v. Philip Morris Incorporated, et al., (District
Court, Ramsey County, Minnesota, filed August 17, 1994). Blue Cross and Blue
Shield of Minnesota ("Blue Cross") also is plaintiff in the case. On May 8,
1998, the parties reached an agreement to settle the matter. See
"Settlements of Reimbursement Cases" below.
Page 19
McGraw v. The American Tobacco Company, et al. (Circuit Court, Kanawha
County, West Virginia, filed September 20, 1994 by the West Virginia
Attorney General and state agencies). The Company is a defendant in the
case.
The State of Florida, et al. v. The American Tobacco Company, et al.
(Circuit Court, Palm Beach County, Florida, filed February 21, 1995). The
trial court granted the Company's motion to dismiss. The Florida Court of
Appeal affirmed the order dismissing the Company. On August 25, 1997,
Lorillard Tobacco Company and other defendants entered into a Memorandum of
Understanding with the State of Florida which settled the State's claims for
monetary damages. See "Settlements of Reimbursement Cases" below. The
remaining claims have now been dismissed.
Commonwealth of Massachusetts v. Philip Morris Inc., et al. (Superior Court,
Middlesex County, Massachusetts, filed December 19, 1995). The court has
scheduled trial in this matter to begin on February 1, 1999.
Ieyoub v. The American Tobacco Company, et al. (U.S. District Court, Western
District, Louisiana, filed March 13, 1996 by the Louisiana Attorney
General). The Company is a defendant in the case.
The State of Texas v. The American Tobacco Company, et al. (U.S. District
Court, Eastern District, Texas, filed March 28, 1996). On January 16, 1998,
Lorillard Tobacco Company and other defendants entered into a Memorandum of
Understanding with the State of Texas which settled the State's claims for
monetary damages. See "Settlements of Reimbursement Cases" below.
State of Maryland v. Philip Morris Incorporated, et al. (Circuit Court,
Baltimore City, Maryland, filed May 1, 1996).
State of Washington v. The American Tobacco Company, et al. (Superior Court,
King County, Washington, filed June 5, 1996). Trial is underway.
City and County of San Francisco, et al. v. Philip Morris Incorporated, et
al. (U.S. District Court, Northern District, California, filed June 6, 1996
by various California cities and counties).
State of Connecticut v. Philip Morris Incorporated, et al. (Superior Court,
Litchfield District, Connecticut, filed July 18, 1996).
County of Los Angeles v. R.J. Reynolds Tobacco Company, et al. (Superior
Court, San Diego County, filed August 5, 1996). The court has scheduled a
bench trial to begin on February 5, 1999 in this matter and in two other
cases that assert allegations that defendants violated certain provisions of
the California Business and Professions Code. Immediately after the
completion of the bench trial, the court will convene a jury as to the
remainder of the plaintiff's claims in County of Los Angeles.
State of Arizona v. The American Tobacco Company, et al. (Superior Court,
Maricopa County, Arizona, filed August 20, 1996). The court has scheduled
the case for trial on April 14, 1999.
State of Kansas v. R.J. Reynolds Tobacco Company, et al. (District Court,
Shawnee County, Kansas, filed August 20, 1996).
Kelley v. Philip Morris Incorporated, et al. (Circuit Court, Ingham County,
Michigan, filed August 21, 1996 by the Attorney General of Michigan).
State of Oklahoma, et al. v. R.J. Reynolds Tobacco Company, et al. (District
Court, Cleveland County, Oklahoma, filed August 22, 1996). The Company is a
Page 20
defendant in the case. The court has scheduled the case for trial on January
25, 1999.
People of the State of California v. Philip Morris Incorporated, et al.
(Superior Court, San Francisco County, California, filed September 5, 1996
by various California counties and cities and local chapters of various
medical societies and associations). The court has scheduled the case for
trial on March 1, 1999.
State of New Jersey v. R.J. Reynolds Tobacco Company, et al. (Superior
Court, Middlesex County, New Jersey, filed September 10, 1996).
State of Utah v. R.J. Reynolds Tobacco Company, et al. (U.S. District Court,
Central Division, Utah, filed September 30, 1996). The Company is a
defendant in the case.
City of New York, et al. v. The Tobacco Institute, et al. (Supreme Court,
New York County, filed October 17, 1996).
People of the State of Illinois v. Philip Morris, Inc., et al. (Circuit
Court, Cook County, Illinois, filed November 12, 1996).
State of Iowa v. R.J. Reynolds Tobacco Company, et al. (District Court,
Fifth Judicial District, Polk County, Iowa, filed November 27, 1996). The
Company is a defendant in the case. The Supreme Court of Iowa has affirmed
the trial court's order dismissing plaintiff's claims of deception,
voluntary assumption of a special duty and indemnity. Plaintiff did not
attempt to appeal the dismissal of its claim of unjust
enrichment/restitution.
County of Erie v. The Tobacco Institute, Inc., et al. (Supreme Court, Erie
County, New York, filed January 14, 1997).
State of New York v. The American Tobacco Company, et al. (Supreme Court,
New York County, New York, filed January 21, 1997). The Company is a
defendant in the case.
State of Hawaii v. Brown & Williamson Tobacco Corporation, et al. (Circuit
Court, First Circuit, Hawaii, filed January 31, 1997).
State of Wisconsin v. Philip Morris Incorporated, et al. (Circuit Court,
Dane County, Wisconsin, filed February 5, 1997).
State of Indiana v. Philip Morris Incorporated, et al. (Superior Court,
Marion County, Indiana, filed February 19, 1997). The court has granted
defendants' motion to dismiss all counts of the complaint. Plaintiff has
noticed an appeal to the Indiana Court of Appeals.
State of Alaska v. Philip Morris, Incorporated, et al. (Superior Court,
First Judicial District, Alaska, filed April 14, 1997).
County of Cook v. Philip Morris, Incorporated, et al. (Circuit Court, Cook
County, Illinois, filed April 18, 1997).
Commonwealth of Pennsylvania v. Philip Morris, Inc., et al. (Court of Common
Pleas, Philadelphia County, Pennsylvania, filed April 23, 1997).
State of Arkansas v. The American Tobacco Company, et al. (Sixth Division,
Chancery Court, Pulaski County, Arkansas, filed May 5, 1997).
State of Montana v. Philip Morris, Incorporated, et al. (First Judicial
Page 21
Court, Lewis and Clark County, Montana, filed May 5, 1997).
State of Ohio v. Philip Morris, Incorporated, et al. (Court of Common Pleas,
Franklin County, Ohio, filed on May 8, 1997).
State of Missouri v. American Tobacco Company, Inc., et al. (Circuit Court,
City of St. Louis, Missouri, filed May 12, 1997). The Company is a defendant
in the case. Several hospitals or owners of hospitals have filed a motion to
intervene in the suit.
State of South Carolina v. Brown & Williamson Tobacco Corporation, et al.
(Court of Common Pleas, Richland County, South Carolina, filed May 12,
1997). The Company is a defendant in the case.
State of Nevada v. Philip Morris, Incorporated, et al. (Second Judicial
District, Washoe County, Nevada, filed May 21, 1997).
University of South Alabama v. The American Tobacco Company, et al. (U.S.
District Court, Southern District, Alabama, filed May 23, 1997). The Company
is a defendant in the case. Plaintiff noticed an appeal to the U.S. Court of
Appeals for the Fifth Circuit from the trial court's order that dismissed
the action.
State of New Mexico v. The American Tobacco Company, et al. (First Judicial
District Court, Santa Fe County, New Mexico, filed May 27, 1997).
City of Birmingham, Alabama, and The Greene County Racing Commission v. The
American Tobacco Company, et al. (U.S. District Court, Northern District,
Alabama, filed May 28, 1997). The Company is a defendant in the case. The
court granted defendants' motion to strike the complaint. Plaintiffs have
noticed an appeal to the United States Court of Appeals for the Eleventh
Circuit.
State of Vermont v. Philip Morris, Incorporated, et al. (Superior Court,
Chittenden County, Vermont, filed May 29, 1997).
State of New Hampshire v. R.J. Reynolds Tobacco Company, et al. (Superior
Court, Merrimack County, New Hampshire, filed June 4, 1997).
State of Colorado v. R.J. Reynolds Tobacco Co., et al. (District Court, City
and County of Denver, Colorado, filed June 5, 1997).
State of Idaho v. Philip Morris, Inc., et al. (District Court, Fourth
Judicial District, Ada County, Idaho, filed June 9, 1997). The court has
granted defendants' motion to dismiss and has entered final judgment in
their favor. Plaintiff has noticed an appeal to the Idaho Court of Appeals.
State of Oregon v. The American Tobacco Company, et al. (Circuit Court,
Multnomah County, Oregon, filed June 9, 1997).
People of the State of California v. Philip Morris, Inc., et al. (Superior
Court, Sacramento County, California, filed June 12, 1997).
State of Maine v. Philip Morris, Incorporated, et al. (Superior Court,
Kennebec County, Maine, filed June 17, 1997).
Rossello, et al. v. Brown & Williamson Tobacco Corporation, et al. (U.S.
District Court, Puerto Rico, filed June 17, 1997). The Company is a
defendant in the case.
State of Rhode Island v. American Tobacco Company, Inc., et al. (Superior
Page 22
Court, Providence, Rhode Island, filed June 17, 1997). The Company is a
defendant in the case.
State of Georgia v. Philip Morris, Inc., et al. (Superior Court, Fulton
County, Georgia, filed August 29, 1997).
Republic of the Marshall Islands v. The American Tobacco Company, et al.
(High Court, Republic of the Marshall Islands, filed October 20, 1997). The
court granted motions to dismiss filed by Lorillard Tobacco Company,
Lorillard, Inc., and Loews Corporation.
State of South Dakota and South Dakota Department of Social Services v.
Philip Morris, Inc., et al. (Circuit Court, Sixth Judicial Circuit, Hughes
County, South Dakota filed February 23, 1998).
The Republic of Guatemala v. The Tobacco Institute, Inc., et al. (U.S.
District Court, District of Columbia, filed May 11, 1998). Neither Lorillard
nor the Company are named as defendants in the matter.
State of Vermont v. Philip Morris, Incorporated, et al. (Superior Court,
Chittenden County, Vermont, filed July 7, 1998). Plaintiff asserts different
claims in this suit than in the one filed on May 29, 1997, that is listed
above.
State of Nebraska v. R.J. Reynolds Tobacco Company, et al. (District Court,
Lancaster County, Nebraska, filed August 21, 1998).
Republic of Panama v. The American Tobacco Company, et al. (District Court,
Orleans Parish, Louisiana, filed October 16, 1998). The Company is a
defendant in the case.
Private Citizens' Reimbursement Cases - There are five suits pending in
which plaintiffs are private citizens. Four of the suits have been filed by
private citizens on behalf of taxpayers of their respective states, although
governmental entities have filed a reimbursement suit in one of the four
states. The Company is a defendant in two of the five pending private
citizen Reimbursement Cases. Lorillard is a defendant in each of the cases.
Each of these cases is in the pre-trial discovery stage.
Coyne v. The American Tobacco Company, et al. (U.S. District Court, Northern
District, Ohio, filed September 17, 1996). The Company is a defendant in the
case. The suit is on behalf of taxpayers of Ohio. The court has granted
defendants' motion to dismiss. The plaintiffs have noticed an appeal from
the court's order granting a motion to dismiss.
Beckom v. The American Tobacco Company, et al. (U.S. District Court, Eastern
District, Tennessee, filed May 8, 1997). The Company is a defendant in the
case. The suit is on behalf of taxpayers of Tennessee. The court has granted
defendants' motion to dismiss. The time for plaintiffs to notice an appeal
from the ruling has not expired.
Mason v. The American Tobacco Company, et al. (U.S. District Court, Northern
District, Texas, filed December 23, 1997). The suit is on behalf of
taxpayers of the U.S. as to funds expended by the Medicaid program.
The State of North Carolina, et al. v. The American Tobacco Company, et al.
(U.S. District Court, Middle District, North Carolina, filed February 13,
1998).
Wynn v. Philip Morris, Inc., et al. (U.S. District Court, Northern District,
Alabama, filed May 27, 1998). The suit is on behalf of taxpayers of Alabama.
Page 23
Reimbursement Cases By Indian Tribes - Indian Tribes have filed eight
reimbursement suits in their tribal courts, two of which have been
dismissed. Lorillard is a defendant in each of the cases. The Company is not
named as a defendant in any of the seven tribal suits filed to date. Each of
the pending cases is in the pre-trial, discovery stage.
The Lower Brule Sioux Tribe v. The American Tobacco Company, et al. (Tribal
Court, Lower Brule Sioux Tribe, filed on an unknown date, first amended
complaint filed May 28, 1997).
Muscogee Creek Nation v. The American Tobacco Company, et al. (District
Court, Muscogee Creek Nation, Okmulgee District, filed June 20, 1997).
Crow Creek Sioux Tribe v. The American Tobacco Company, et al. (Tribal
Court, Crow Creek Sioux Tribe, filed September 14, 1997).
The Standing Rock Sioux Tribe v. The American Tobacco Company, et al.
(Tribal Court, Standing Rock Sioux Tribe, filed May 8, 1998).
The Sisseton-Wahpeton Sioux Tribe v. The American Tobacco Company, et al.
(Tribal Court, Sisseton-Wahpeton Sioux Tribe, filed May 12, 1998).
Pechanga Band of Luiseno Mission Indians, et al. v. Philip Morris, Inc., et
al. (Superior Court, San Diego County, California, filed October 30, 1998).
Reimbursement Cases By Labor Unions - Labor unions have filed approximately
70 reimbursement suits in various states in federal or state courts. In 23
of these cases, plaintiffs seek class certification. Lorillard is named as a
defendant in each of the suits filed to date by unions. The Company is a
defendant in two of the pending suits. Each of these cases is in the pre-
trial, discovery stage.
Stationary Engineers Local 39 Health and Welfare Trust Fund v. Philip
Morris, Inc., et al. (U.S. District Court, Northern District, California,
filed April 25, 1997).
Iron Workers Local Union No. 17 Insurance Fund, et al. v. Philip Morris,
Inc., et al. (U.S. District Court, Northern District, Ohio, Eastern
Division, filed May 20, 1997). The court has granted plaintiffs' motion for
class certification on behalf of funds in Ohio established under the Taft-
Hartley Act. The court has scheduled trial in this matter to begin on
February 22, 1999.
Northwest Laborers-Employers Health and Security Trust Fund, et al. v.
Philip Morris, Inc., et al. (U.S. District Court, Western District,
Washington, filed May 21, 1997). The court has granted plaintiffs' motion
for class certification on behalf of "all existing jointly-administered and
collectively bargained-for health and welfare trusts in [the State of]
Washington, and/or the trustees of such entities, that have provided or paid
for health care and/or addiction treatment costs or services for employees
or other beneficiaries." The United States Court of Appeals for the Ninth
Circuit has declined to review the ruling at this time.
Massachusetts Laborers Health and Welfare Fund v. Philip Morris Inc., et al.
(U.S. District Court, Massachusetts, filed June 2, 1997).
Central Laborers Welfare Fund, et al. v. Philip Morris, Inc., et al. (U.S.
District Court, Southern District, Illinois, filed on or about June 9,
1997).
Hawaii Health and Welfare Trust Fund for Operating Engineers v. Philip
Page 24
Morris, Inc., et al. (U.S. District Court, Hawaii, filed June 13, 1997).
Laborers Local 17 Health and Benefit Fund and The Transport Workers Union
New York City Private Bus Lines Health Benefit Trust v. Philip Morris, Inc.,
et al. (U.S. District Court, Southern District, New York, filed June 19,
1997).
Ark-La-Miss Laborers Welfare Fund v. Philip Morris, Inc., et al. (U.S.
District Court, Eastern District, Louisiana, filed June 20, 1997).
Kentucky Laborers District Council Health and Welfare Trust Fund v. Hill &
Knowlton, Inc., et al. (U.S. District Court, Western District, Kentucky,
Louisville Division, filed June 20, 1997).
Oregon Laborers -- Employers Health and Welfare Trust Fund, et al. v. Philip
Morris, Inc., et al. (U.S. District Court, Oregon, filed June 20, 1997). The
court granted defendants' motion for judgment on the pleadings, which
dismissed the case. Plaintiffs have noticed an appeal to the United States
Court of Appeals for the Ninth Circuit.
United Federation of Teachers Welfare Fund, et al. v. Philip Morris, Inc.,
et al. (U.S. District Court, Southern District, New York, filed June 25,
1997).
Laborers and Operating Engineers Utility Agreement Health and Welfare Trust
Fund for Arizona v. Philip Morris Incorporated, et al. (U.S. District Court,
Arizona, filed July 7, 1997).
West Virginia Laborers Pension Fund v. Philip Morris, Inc., et al. (U.S.
District Court, Southern District, West Virginia, Huntington Division, filed
July 11, 1997).
Rhode Island Laborers Health and Welfare Fund v. Philip Morris Incorporated,
et al. (U.S. District Court, Rhode Island, filed July 20, 1997).
Eastern States Health and Welfare Fund, et al. v. Philip Morris, Inc., et
al. (Supreme Court, New York County, New York, filed July 28, 1997).
Asbestos Workers Local 53 Health and Welfare Fund, et al. v. Philip Morris,
Inc., et al. (U.S. District Court, Eastern District, Louisiana, filed August
15, 1997). This action has been consolidated with the case of Ark-La-Miss
Laborers Welfare Fund.
Steamfitters Local Union No. 420 Welfare Fund, et al. v. Philip Morris,
Inc., et al. (U.S. District Court, Eastern District, Pennsylvania, filed
August 21, 1997). The court granted defendants' motion to dismiss the case.
Plaintiffs have noticed an appeal to the United States Court of Appeals for
the Third Circuit.
Construction Laborers of Greater St. Louis Welfare Fund, et al. v. Philip
Morris, Inc., et al. (U.S. District Court, Eastern District, Missouri, filed
September 2, 1997).
Arkansas Carpenters Health & Welfare Fund v. Philip Morris, Inc., et al.
(U.S. District Court, Eastern District, Arkansas, filed September 4, 1997).
West Virginia--Ohio Valley Area International Brotherhood of Electrical
Workers Welfare Fund v. The American Tobacco Company, et al. (U.S. District
Court, West Virginia, filed September 11, 1997).
Teamsters Union No. 142, Health and Welfare Trust Fund and Sheet Metal
Page 25
Workers Local Union No. 20 Welfare and Benefit Fund v. Philip Morris
Incorporated, et al. (Circuit Court, St. Joseph County, Indiana, filed
September 12, 1997).
Operating Engineers Local 12 Health and Welfare Trust v. American Tobacco
Company, et al. (Superior Court, Los Angeles County, California, filed
September 16, 1997).
Puerto Rican ILGWU Health & Welfare Fund v. Philip Morris Inc., et al.
(Supreme Court, New York County, New York, filed September 17, 1997).
New Jersey Carpenters Health Fund, et al. v. Philip Morris, Inc., et al.
(U.S. District Court, New Jersey, filed September 25, 1997).
New Mexico and West Texas Multi-Craft Health and Welfare Trust Fund, et al.
v. Philip Morris, Inc., et al. (Second Judicial District Court, Bernalillo
County, New Mexico, filed October 10, 1997).
Central States Joint Board v. Philip Morris, Inc., et al. (U.S. District
Court, Northern District, Illinois, filed October 20, 1997).
International Brotherhood of Teamsters Local 734 v. Philip Morris, Inc., et
al. (U.S. District Court, Northern District, Illinois, filed October 20,
1997).
Texas Carpenters Health Benefit Fund, et al. v. Philip Morris, Inc., et al.
(U.S. District Court, Eastern District, Texas, Beaumont Division, filed
October 31, 1997). The court granted defendants' motion to dismiss.
Plaintiff has noticed an appeal to the United States Court of Appeals for
the Fifth Circuit.
United Food and Commercial Workers Unions and Employers Health and Welfare
Fund, et al. v. Philip Morris, Inc., et al. (U.S. District Court, Northern
District, Alabama, filed November 13, 1997).
B.A.C. Local 32 Insurance Trust Fund, et al. v. Philip Morris, Incorporated,
et al. (U.S. District Court, Eastern District, Michigan, filed November 14,
1997). Plaintiffs have filed a motion to voluntarily dismiss the case
without prejudice. Defendants have filed a motion to strike plaintiffs'
voluntary dismissal and have asked the court to enter a dismissal with
prejudice. The court has not ruled on the motion to date.
Screen Actors Guild-Producers Health Plan, et al. v. Philip Morris, Inc., et
al. (Superior Court, Los Angeles County, California, filed November 20,
1997).
IBEW Local 25 Health and Benefit Fund v. Philip Morris, Inc. et al. (Supreme
Court, New York County, New York, filed November 25, 1997).
IBEW Local 363 Welfare Fund v. Philip Morris, Inc., et al. (Supreme Court,
New York County, New York, filed November 25, 1997).
Local 138, 138A and 138B International Union of Operating Engineers Welfare
Fund v. Philip Morris, Inc., et al. (Supreme Court, New York County, New
York, filed November 25, 1997).
Local 840, International Brotherhood of Teamsters Health and Insurance Fund
v. Philip Morris, Inc., et al. (Supreme Court, New York County, New York,
filed November 25, 1997).
Long Island Council of Regional Carpenters Welfare Fund v. Philip Morris,
Page 26
Inc., et al. (Supreme Court, New York County, New York, filed November 25,
1997).
Day Care Council - Local 205 D.C. 1707 Welfare Fund v. Philip Morris, Inc.,
et al. (Supreme Court, New York County, New York, filed December 8, 1997).
Local 1199 Home Care Industry Benefit Fund v. Philip Morris, Inc., et al.
(Supreme Court, New York County, New York, filed December 8, 1997).
Local 1199 National Benefit Fund for Health and Human Services Employees v.
Philip Morris, Inc., et al. (Supreme Court, New York County, New York, filed
December 8, 1997).
Operating Engineers Local 324 Health Care Fund, et al. v. Philip Morris,
Inc., et al. (Circuit Court, Wayne County, Michigan, filed December 30,
1997).
Carpenters & Joiners Welfare Fund, et al. v. Philip Morris Incorporated, et
al. (U.S. District Court, Minnesota, filed December 31, 1997).
Steamfitters Local Union No. 614 Health & Welfare Fund, et al. v. Philip
Morris, Inc., et al. (Circuit Court, Thirteenth Judicial District,
Tennessee, filed January 7, 1998).
National Asbestos Workers, et al. v. Philip Morris Incorporated, et al.
(U.S. District Court, Eastern District, New York, filed February 27, 1998).
The Company is a defendant in the case.
Milwaukee Carpenters, et al. v. Philip Morris, Incorporated, et al. (Circuit
Court, Milwaukee County, Wisconsin, filed March 4, 1998). To date, none of
the defendants have received service of process.
Service Employees International Union Health & Welfare Fund, et al. v.
Philip Morris, Inc., et al. (U.S. District Court, District of Columbia,
filed March 19, 1998).
Milwaukee Carpenters, et al. v. Philip Morris, Incorporated, et al. (Circuit
Court, Milwaukee County, Wisconsin, filed March 30, 1998).
United Association of Plumbing and Pipefitters Industry Local 467, et al. v.
Philip Morris Incorporated, et al. (Superior Court, San Mateo County,
California, filed March 31, 1998).
Newspaper Periodical Drivers Local 921 San Francisco Newspaper Agency Health
& Welfare Fund v. Philip Morris, Inc., et al. (Superior Court, San Mateo
County, California, filed April 15, 1998).
Teamsters Benefit Trust v. Philip Morris, Inc., et al. (Superior Court,
Alameda County, California, filed April 15, 1998).
United Association Local 159 Health and Welfare Trust Fund v. Philip Morris,
Inc., et al. (Superior Court, Alameda County, California, filed April 15,
1998).
Bay Area Automotive Group Welfare Fund v. Philip Morris, Inc., et al.
(Superior Court, San Francisco County, California, filed April 16, 1998).
Bay Area Delivery Drivers Security Fund v. Philip Morris, Inc., et al.
(Superior Court, Alameda County, California, filed April 16, 1998).
Pipe Trades District Council No. 36 Health & Welfare Trust Fund v. Philip
Page 27
Morris, Inc., et al. (Superior Court, Alameda County, California, filed
April 16, 1998).
Sign, Pictorial and Display Industry Welfare Fund v. Philip Morris, Inc., et
al. (Superior Court, San Francisco County, California, filed April 16,
1998).
United Association Local No. 343 Health and Welfare Trust Fund v. Philip
Morris, Inc., et al. (Superior Court, Alameda County, California, filed
April 16, 1998).
San Francisco Newspaper Publishers and Northern California Newspaper Guild
Health & Welfare Trust v. Philip Morris, Inc., et al. (Superior Court, San
Francisco County, California, filed April 17, 1998).
North Coast Trust Fund v. Philip Morris, Inc., et al. (Superior Court, San
Francisco County, California, filed April 24, 1998).
Northern California Bakery Drivers Security Fund v. Philip Morris, Inc., et
al. (Superior Court, Alameda County, California, filed April 24, 1998).
Northern California Plasterers Health & Welfare Trust Fund v. Philip Morris,
Inc., et al. (Superior Court, San Francisco County, California, filed May
21, 1998).
U.A. Local No. 393 Health and Welfare Trust Fund v. Philip Morris, Inc., et
al. (Superior Court, Alameda County, California, filed May 21, 1998).
Northern California General Teamsters Security Fund v. Philip Morris, Inc.,
et al. (Superior Court, Alameda County, California, filed May 22, 1998).
Utah Laborers Health & Welfare Trust Fund, et al. v. Philip Morris
Incorporated, et al. (U.S. District Court, Utah, Central Division, filed
June 4, 1998). The Company is a defendant in the case.
Joint Benefit Trust v. Philip Morris, Inc., et al. (Superior Court, Alameda
County, California, filed June 15, 1998).
Northern California Pipe Trades Health and Welfare Trust v. Philip Morris,
Inc., et al. (Superior Court, Alameda County, California, filed June 18,
1998).
S.E.I.U. v. Philip Morris, Inc., et al. (U.S. District Court, District of
Columbia, filed June 22, 1998). To date, none of the defendants have
received service of process.
Plastering Industry Welfare Trust Fund v. Philip Morris, Inc. et al.
(Superior Court, San Francisco County, California, filed July 1, 1998).
Central Valley Painting & Decorating Health & Welfare Trust Fund v. Philip
Morris, Inc., et al. (Superior Court, San Francisco County, California,
filed July 6, 1998).
Holland, et al., Trustees of United Mine Workers v. Philip Morris
Incorporated, et al. (U.S. District Court, District of Columbia, filed July
9, 1998).
Northern California Tile Industry Health & Welfare Trust Fund v. Philip
Morris, Inc., et al. (Superior Court, San Francisco County, California,
filed July 29, 1998).
Page 28
San Francisco Culinary, Bartenders and Service Employees Welfare Fund v.
Philip Morris, Inc., et al. (Superior Court, San Francisco County,
California, filed July 30, 1998).
IBEW Local 595 Health and Welfare Trust Fund v. Philip Morris, Inc., et al.
(Superior Court, Alameda County, California, filed July 30, 1998).
Shop Ironworkers Local 790 Welfare Plan v. Philip Morris, Inc., et al.
(Superior Court, Alameda County, California, filed July 31, 1998).
Contractors, Laborers, Teamsters & Engineers Health & Welfare Plan v. Philip
Morris, Inc., et al. (U.S. District Court, Nebraska, filed August 11, 1998).
Reimbursement Cases By Private Companies - Private companies have filed six
Reimbursement Cases to date. Lorillard is named as a defendant in each of
the cases filed by private companies. The Company is not a defendant in the
cases filed by private companies.
Group Health Plan, Inc., et al. v. Philip Morris Incorporated, et al. (U.S.
District Court, Minnesota, filed March 11, 1998).
Williams and Drake Company v. The American Tobacco Company, et al. (U.S.
District Court, Western District, Pennsylvania, filed March 23, 1998).
Conwed Corporation, et al. v. R.J. Reynolds Tobacco Company, et al. (U.S.
District Court, Minnesota, filed April 10, 1998).
Arkansas Blue Cross and Blue Shield, et al. v. Philip Morris, Incorporated,
et al. (U.S. District Court, Northern District, Illinois, filed April 29,
1998).
Blue Cross and Blue Shield of New Jersey, Inc., et al. v. Philip Morris,
Incorporated, et al. (U.S. District Court, Eastern District, New York, filed
April 29, 1998).
Regence Blueshield, et al. v. Philip Morris, Incorporated, et al. (U.S.
District Court, Western District, Washington, filed April 29, 1998).
CONTRIBUTION CLAIMS - In addition to the foregoing cases, nine cases are
pending in which private companies seek recovery of funds expended by them
to individuals whose asbestos disease or illness was alleged to have been
caused in whole or in part by smoking-related illnesses. One of the cases
has not been served. Lorillard is named as a defendant in each action. The
Company is named as a defendant in four of the cases but has not received
service of process in one of them. Each of these cases is in the pre-trial,
discovery stage.
Raymark Industries v. R.J. Reynolds Tobacco Company, et al. (Circuit Court,
Duval County, Florida, filed September 15, 1997). The Company is a defendant
in the case but has not received service of process to date.
Raymark Industries v. Brown & Williamson Tobacco Corporation, et al. (U.S.
District Court, Northern District, Georgia, filed September 15, 1997). The
Company is a defendant in the case.
Fibreboard Corporation and Owens-Corning v. The American Tobacco Company, et
al. (Superior Court, Alameda County, California, filed December 11, 1997).
Keene Creditors Trust v. Brown & Williamson Tobacco Corporation, et al.
(Supreme Court, New York County, New York, filed December 19, 1997). The
Company is a defendant in the case.
Page 29
Falise, et al., as Trustees of the Manville Personal Injury Settlement Trust
v. The American Tobacco Company, et al. (U.S. District Court, Eastern
District, New York, filed December 31, 1997).
H.K. Porter Company v. B.A.T. Industries, PLC, et al. (U.S. District Court,
Southern District, New York, filed December 31, 1997).
Raymark Industries v. R.J. Reynolds Tobacco Co., et al. (Circuit Court,
Duval County, Florida, filed December 31, 1997). To date, none of the
defendants have received service of process.
Raymark Industries v. The American Tobacco Company, et al. (U.S. District
Court, Eastern District, New York, filed January 30, 1998).
Thomas v. R.J. Reynolds Tobacco Company, et al., (Circuit Court of Jefferson
County, Mississippi, filed August 21, 1998). The complaint asserts
contribution claims on behalf of Owens Corning as well as conventional
product liability claims on behalf of an individual. The Company is a
defendant in the case.
FILTER CASES - A number of cases have been filed against Lorillard seeking
damages for cancer and other health effects claimed to have resulted from
exposure to asbestos fibers which were incorporated, for a limited period of
time, ending more than forty years ago, into the filter material used in one
of the brands of cigarettes manufactured by Lorillard. Nineteen such cases,
including one that also includes allegations that plaintiff also was injured
as a result of smoking cigarettes, are pending in federal and state courts.
Allegations of liability include negligence, strict liability, fraud,
misrepresentation and breach of warranty. Plaintiffs seek unspecified
amounts in compensatory and punitive damages in many cases, and in other
cases damages are stated to amount to as much as $15.0 in compensatory
damages and $100.0 in punitive damages. No such cases have been tried during
1998. In the one case of this type that has been tried during 1997, the jury
returned a verdict in favor of Lorillard. Trials were held in three cases of
this type during 1996. In two of the cases, the juries returned verdicts in
favor of Lorillard. In the third case, the jury returned a verdict in favor
of plaintiffs. The verdict required Lorillard to pay the amount of one
hundred forty thousand dollars, although the award subsequently was reduced
to seventy thousand dollars. Lorillard's appeals from the verdict have been
rejected.
Trials were held in three cases of this type during 1995. In two of the
cases, the juries returned verdicts in favor of Lorillard. In the third
case, the jury returned a verdict in favor of plaintiffs, which was upheld
on appeal. The Company has paid the compensatory judgment award, trial costs
and interest thereon in the amount of $1.6 on December 30, 1997. The United
States Supreme Court denied the Company's petition for writ of certiorari as
to the punitive damages award. The Company has paid the punitive damages
award.
In addition to the foregoing litigation, one pending case, Cordova v.
Liggett Group, Inc., et al. (Superior Court, San Diego County, California,
filed May 12, 1992), alleges that Lorillard and other named defendants,
including other manufacturers of tobacco products, engaged in unfair and
fraudulent business practices in connection with activities relating to the
Council for Tobacco Research-USA, Inc., of which Lorillard is a sponsor, in
violation of a California state consumer protection law by misrepresenting
to or concealing from the public information concerning the health aspects
of smoking. The court has scheduled trial to begin no earlier than February
5, 1999 in this matter and in four other cases that assert allegations that
defendants violated certain provisions of the California Business and
Page 30
Professions Code.
In addition, two California cities, Los Angeles and San Jose, suing on
behalf of The People of the State of California, have filed suits alleging
cigarette manufacturers, including Lorillard, have violated a California
statute, commonly known as "Proposition 65," that requires California
residents to be informed if they are exposed to substances that are alleged
to cause cancer or birth defects. Plaintiffs in both suits allege that non-
smokers have not been warned by cigarette manufacturers that exposure to
environmental tobacco smoke may cause illness. Plaintiffs in both suits
further allege defendants violated certain provisions of the California
Business and Professions Code (The People of the State of California, and
American Environmental Safety Institute v. Philip Morris Incorporated, et
al. (Superior Court, Los Angeles County, California, filed July 14, 1998)
and The People of the State of California, the City of San Jose and Paul
Dowhall v. Brown & Williamson Tobacco Corporation, et al. (Superior Court,
San Francisco County, California, filed July 28, 1998)).
DOCUMENT DISCOVERY ISSUES - Plaintiffs in a number of the cases pending
against the tobacco industry, including cases against Lorillard and the
Company, have challenged the claims made by Lorillard and other companies in
the tobacco industry that certain documents sought by plaintiffs are
protected from disclosure by the attorney-client privilege, joint defense
privilege and work product doctrine. These challenges include, among other
things, allegations that such documents do not contain legal advice or were
not prepared for litigation purposes and, thus, are not privileged or
protected as attorney work product. Certain plaintiffs in these cases have
also alleged that defendants' privileged documents should be discoverable
pursuant to the so-called crime/fraud exception which negates the privilege
as to documents found to have been related to and prepared in furtherance of
an alleged crime or fraud. In addition, several plaintiffs have argued, and
certain courts have found, that defendants have "waived" their privilege as
to a number of documents. Such arguments by plaintiffs generally pertain to
certain industry documents which were subpoenaed by the House Commerce
Committee (see discussion below).
Various courts have addressed these issues and have arrived at differing
conclusions as to whether the privilege for some of defendants' documents
should be maintained. Some of these rulings are final and, as a result,
certain documents as to which defendants have claimed a privilege have been
released to plaintiffs.
On December 5, 1997, certain documents as to which defendants had claimed
privilege were provided to the Chairman of the House Commerce Committee in
response to a subpoena. These documents were subsequently made available on
the Internet.
On February 19, 1998, the Committee subpoenaed approximately 37,000
additional documents which Lorillard and other companies in the tobacco
industry have asserted to be privileged. These documents were the subject of
a March 7, 1998 ruling in the Reimbursement Case brought by the State of
Minnesota, in which the judge ordered that the documents should be released
on the basis of the crime/fraud exception. Defendants exhausted their
remedies through the state's judicial system as well as the U.S. Supreme
Court. On April 6, 1998, the U.S. Supreme Court denied defendants'
application for a Stay and, in accordance with the March 7, 1998 ruling of
the district court, such documents were released to plaintiffs in Minnesota.
Also on April 6, 1998 and pursuant to the February 19, 1998 subpoena,
documents were submitted to the Committee. The Committee subsequently made
available on the Internet the vast majority of those documents.
Page 31
Under the Proposed Resolution, Lorillard and the other companies in the
tobacco industry agreed to establish an industry-funded document depository
to allow public viewing of certain industry documents. In recent
Congressional testimony, representatives of the tobacco companies offered to
make tens of millions of pages of documents public prior to the enactment of
any comprehensive legislation to demonstrate their commitment to the
principles set forth in the Proposed Resolution. On February 27, 1998,
Lorillard and other companies in the tobacco industry posted on the Internet
the first installment of these documents for public access. In addition, the
court in the Reimbursement Case brought by the State of Minnesota has
granted defendants' request to allow public access to the document
depository established in that case. The publicly available materials will
not include documents containing trade secret information, certain personnel
and third party information, or documents for which attorney-client
privilege or work product doctrine claims have been asserted.
Tobacco industry documents have generated extensive media coverage recently
and have become a focal point in the litigation. The Company cannot predict
the effect disclosure of these documents may have on pending litigation or
Congressional consideration of the Proposed Resolution.
SETTLEMENTS OF REIMBURSEMENT CASES - During 1997 and 1998, Lorillard and
other companies in the United States tobacco industry (the "settling
defendants") settled health care cost recovery actions brought by the States
of Mississippi, Florida, Texas and Minnesota. Claims of Blue Cross and Blue
Shield of Minnesota asserted against the settling defendants together with
Minnesota's claims were separately settled as well. These settlements are
described in Note 5 of the Notes to Consolidated Condensed Financial
Statements of the Company's Quarterly Report on Form 10-Q for the quarter
ended March 31, 1998. Recently, as detailed below, the Mississippi, Texas
and Florida settlement agreements have been amended pursuant to their "most
favored nation" clauses to reflect terms of the Minnesota settlement. The
Florida, Texas and Minnesota health care cost recovery settlements and
certain ancillary agreements are filed as Exhibits to various reports of the
Company filed with the Securities and Exchange Commission, and the
amendments to the Mississippi and Texas settlements and certain ancillary
agreements are filed as Exhibits to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1998. The amendments to the Florida
settlement and certain ancillary agreements are filed as Exhibits to this
Form 10-Q. The discussion herein is qualified by reference thereto.
Following the settlement with Minnesota, Lorillard was contacted by counsel
for the States of Texas, Florida and Mississippi seeking to discuss the
issue of what effect, if any, the settlement of the Minnesota action has
upon the terms of the prior settlements with those states pursuant to the
"most favored nation" ("MFN") provision of those prior state settlements.
That provision provides that, in the event the settling defendants enter
into a subsequent pre-verdict settlement with a non-federal governmental
entity on terms more favorable to such entity than the terms of the prior
state settlements (after due consideration of relevant differences in
population or other appropriate factors), the terms of the prior state
settlements will be revised to provide treatment at least as relatively
favorable. As discussed below, the Mississippi, Texas and Florida settlement
agreements were recently amended pursuant to this provision.
On July 6, July 24 and September 11, 1998 respectively, Lorillard and the
other settling defendants reached agreements with the States of Mississippi,
Texas and Florida to amend those States' settlements pursuant to the MFN
provision. The MFN amendments call for the settling defendants to make
additional settlement payments to Mississippi, Texas and Florida aggregating
$550.0, $2,275.0 and $1,750.0, respectively. These amounts are payable in
Page 32
January of the year indicated:
1999 2000 2001 2002 2003 Total
---------------------------------------------------------
Mississippi $ 41.7 $ 145.2 $ 145.2 $ 145.2 $ 72.7 $ 550.0
Texas 156.5 605.1 605.1 605.1 303.2 2,275.0
Florida 123.5 464.6 464.6 464.6 232.7 1,750.0
---------------------------------------------------------
$321.7 $1,214.9 $1,214.9 $1,214.9 $608.6 $4,575.0
=========================================================
These payments, which in the case of payments after 1999 will be adjusted
for inflation, changes in domestic sales volume, and, under specified
circumstances, increases in net operating profits from domestic sales, will
be allocated among the settling defendants in accordance with their relative
unit volume of domestic cigarette sales.
In the event a settling defendant defaults on its obligation to make timely
payment of the above amounts, the remaining settling defendants may, in
their absolute discretion, pay the missing payment. If they elect not to
make up the missing payment, each settling defendant can be required by the
state to pay its share of the remaining payments scheduled above within 30
days of the default, subject to inflation and volume adjustments. The
obligations of the settling defendants under the amended settlement
agreements are several and not joint; the amended settlement agreements do
not obligate any settling defendant to pay the share of another settling
defendant.
The nominal amounts of the ongoing annual payments, (the "Ongoing Annual
Payments") contemplated by the original Mississippi, Texas and Florida
settlement agreements are unchanged by the MFN amendments.
The MFN amendments modify the provisions of the original settlement
agreements that address the impact enactment of federal tobacco legislation
before November 30, 2000 would have on such settlements. Under the MFN
amendments, the settling defendants will be entitled to receive a dollar-for-
dollar offset against their Ongoing Annual Payments for amounts that
Mississippi, Texas and Florida, as the case may be, could elect to receive
pursuant to such federal tobacco legislation ("Federal Settlement Funds"),
except to the extent that: (i) such Federal Settlement Funds are required to
be used for purposes other than health care or tobacco-related purposes;
(ii) such federal tobacco legislation does not provide for the abrogation,
settlement or relinquishment of state tobacco-related claims; or (iii) state
receipt of such Federal Settlement Funds is conditioned upon (A) the
relinquishment of rights or benefits under that respective state's
settlement (excepting any Ongoing Annual Payment amounts subject to the
offset); or (B) actions or expenditures by such state unrelated to health
care or tobacco (including but not limited to tobacco education, cessation,
control or enforcement).
The MFN amendments also supersede the MFN provisions contained in the
original settlement agreements. Under the revised MFN provision if the
settling defendants enter into any future pre-verdict settlement agreement
of similar health care cost recovery litigation on terms more favorable to a
non-federal governmental plaintiff, the Mississippi, Texas and Florida
settlements will not otherwise be revised except to the extent such future
Page 33
settlement provides for: (i) joint and several liability for monetary
payments, (ii) a parent company guaranty or other credit assurance, (iii)
the implementation of different non-economic tobacco-related public health
measures, or (iv) monetary offsets in the event of federal tobacco
legislation that are more favorable to such plaintiff than those described
above.
The settling defendants agreed as part of the MFN amendments to disclose
specified future payments for lobbying or related purposes in Mississippi,
Texas and Florida, to support enumerated legislative and regulatory
proposals and to not support legislation, rules or policies that would
diminish Mississippi's, Texas' and Florida's rights under the amended
settlement agreements.
The settling defendants also submitted to a Consent Judgment enjoining the
settling defendants from (i) offering or selling non-tobacco services or
merchandise (e.g., caps, jackets or bags) in Mississippi, Texas and Florida
bearing the name or logo of a tobacco brand other than tobacco products or
items with the sole function of advertising; (ii) making any material
misrepresentation of fact regarding the health consequences of using tobacco
products; (iii) entering into any contract, combination or conspiracy to
limit health information or research into smoking and health or product
development; and (iv) taking any action to target children in Mississippi,
Texas and Florida in the advertising, promotion or marketing of cigarettes.
In connection with the MFN amendments, the parties executed new agreements
governing settling defendants' payment of attorneys fees to counsel for
Mississippi, Texas and Florida. (Copies of the Mississippi and Texas
agreements are filed as Exhibits to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1998 and copies of the Florida
agreements are filed as Exhibits to this Form 10-Q, and the discussion
herein is qualified by reference thereto.) The agreements provide that
beginning in November 1998, a three-member arbitration panel will consider
and determine the amount of attorneys' fees to be awarded. These awards will
be allocated among the settling defendants in accordance with their relative
unit volume of domestic cigarette shipments. Under the agreements, there is
an annual cap of $500.0 on aggregate attorneys' fees to be paid pursuant to
arbitration awards, including those to be paid for counsel for Mississippi,
Texas and Florida. A one-time $250.0 payment may be paid for cases that were
settled in 1997. This aggregate annual cap includes; (i) all attorneys' fees
paid pursuant to an award by the panel in connection with settlements of any
smoking and health cases (other than individual cases), (ii) all attorneys'
fees paid pursuant to an award by the panel for activities in connection
with smoking and health cases resolved by operation of federal legislation
provided such legislation imposes an obligation on the settling defendants
to pay attorneys' fees, and (iii) all attorneys' and professional fees paid
pursuant to an award by the panel for contributions made toward the
enactment of federal tobacco legislation.
The settling defendants have made payments to counsel for Mississippi, Texas
and Florida totaling $283.5 as advances against awards of attorneys' fees by
the arbitration panel, such advances to be credited against the annual cap
over several years commencing in 1999.
These settlements resulted in pre-tax charges to earnings of $79.0 and $84.4
in the third and fourth quarter of 1997, respectively, and $30.6 and $215.8
in the quarter and nine months ended September 30, 1998.
Together with other companies in the United States tobacco industry,
Lorillard has discussed with a number of state attorneys general an
agreement that could settle the asserted and unasserted health care cost
Page 34
recovery claims of all of the states. Discussions have reached the stage
where those attorneys general are reporting to the remaining states the
terms of a proposed agreement. The proposed agreement is contingent upon a
sufficient number of states accepting the agreement. No assurance can be
given that the proposed agreement will be accepted by a number of states
sufficient to cause the industry to conclude an agreement. The proposed
agreement would effect significant changes in the advertising and marketing
of tobacco products. It would also require the industry to pay more than
$206,000 through 2025, including (i) more than $12,700 in initial payments
over the first five years (including $2,400 immediately); (ii) annual
payments commencing in 2000 in the original amount of $4,500 and increasing
periodically to $9,000 in 2018 and thereafter in perpetuity, and (iii)
$1,700 over ten years, the great preponderance of which is due during the
first five years. Lorillard's share of the $2,400 payment due immediately
would be 7.3% (based on relative market capitalization).All other payments
would be allocated among the original participating manufacturers based on
their relative unit volume of domestic cigarette shipments and would be
subject to adjustment for inflation and volume changes and for participation
by less than all the states and for other adjustments and offsets described
in the proposed agreement. The Company anticipates that Lorillard's share of
the $2,400 payment due immediately would be charged to expense in the fiscal
quarter and year during which the agreement is concluded and would be paid
from Lorillard's available cash. The Company further anticipates that
Lorillard's share of future annual industry payments related to cigarette
sales would be charged to expense as the related sales occur and may be
funded through price increases. The Company believes that any such agreement
would materially adversely affect its consolidated results of operations and
financial position. The degree of the adverse impact would depend, among
other things, on the rates of decline in United States cigarette sales in
the premium and discount segments, Lorillard's share of the domestic premium
and discount segments, and the effect of any resulting cost advantage of
manufacturers not subject to the agreement. The proposed agreement is filed
as an Exhibit to this Form 10-Q and the foregoing discussion is qualified by
reference thereto.
LIGGETT SETTLEMENT - Liggett Group, Inc. and its parent company, Brooke
Group, Ltd., Inc. ("Liggett"), and the Attorneys General for a total of 40
states, have announced that they have reached agreements (the "Liggett
Settlements") to settle the reimbursement claims made by those states. The
proposed settlements reportedly will require Liggett: to make one-time
payments to each of the settling states in an amount of as much as $1.0; to
pay to the settling states an aggregate percentage of as much as 30% of its
pre-tax profits annually for the next 25 years; to acknowledge that
cigarette smoking is addictive (Liggett has supplemented the warning notices
it places on its cigarette packages to reflect that acknowledgment); to
acknowledge that cigarette smoking causes disease; to acknowledge that
cigarette companies have targeted marketing programs towards minors; and to
cooperate in suits against the other cigarette manufacturers by releasing
Liggett documents to the Attorneys General and to allow its employees to
testify in these matters. The Liggett Settlements also purport to be on
behalf of "all persons who, prior to or during the term of [the Liggett
Settlements], have smoked cigarettes or have used other tobacco products and
have suffered or claim to have suffered injury as a consequence thereof."
Pursuant to the Liggett Settlements described above, Liggett has submitted
numerous documents from its files to courts and defendants in several of the
Reimbursement Cases and in other cases as well. Liggett has also served
descriptive logs of such documents on counsel for plaintiffs and defendants
in those cases. Defendants have reviewed the Liggett logs and the Liggett
documents to determine which Liggett documents are subject to a joint-
defense privilege claim by other defendants.
Page 35
DEFENSES - One of the defenses raised by Lorillard in certain cases is
preemption by the Federal Cigarette Labeling and Advertising Act (the
"Labeling Act"). In the case of Cipollone v. Liggett Group, Inc., et al.,
the United States Supreme Court, in a plurality opinion issued on June 24,
1992, held that the Labeling Act as enacted in 1965 does not preempt common
law damage claims but that the Labeling Act, as amended in 1969, does
preempt claims against tobacco companies arising after July 1, 1969, which
assert that the tobacco companies failed to adequately warn of the alleged
health risks of cigarettes, sought to undermine or neutralize the Labeling
Act's mandatory health warnings, or concealed material facts concerning the
health effects of smoking in their advertising and promotion of cigarettes.
The Supreme Court held that claims against tobacco companies based on
fraudulent misrepresentation, breach of express warranty, or conspiracy to
misrepresent material facts concerning the alleged health effects of smoking
are not preempted by the Labeling Act. The Supreme Court in so holding did
not consider whether such common law damage actions were valid under state
law. The effect of the Supreme Court's decision on pending and future cases
against Lorillard and other tobacco companies will likely be the subject of
further legal proceedings. Additional litigation involving claims such as
those held to be preempted by the Supreme Court in Cipollone could be
encouraged if legislative proposals to eliminate the federal preemption
defense, pending in Congress since 1991, are enacted. It is not possible to
predict whether any such legislation will be enacted.
Lorillard believes that it has a number of defenses to pending cases, in
addition to defenses based on preemption described above, and Lorillard will
continue to maintain a vigorous defense in all such litigation. These
defenses, where applicable, include, among others, statutes of limitations
or repose, assumption of the risk, comparative fault, the lack of proximate
causation, and the lack of any defect in the product alleged by a plaintiff.
Lorillard believes that some or all of these defenses may, in many of the
pending or anticipated cases, be found by a jury or court to bar recovery by
a plaintiff. Application of various defenses, including those based on
preemption, are likely to be the subject of further legal proceedings in the
Class Action cases and in the Reimbursement Cases.
Other Legal Proceedings: In September 1997, a purported class action was
commenced by private plaintiffs in Alabama state court alleging that the
U.S. tobacco companies and others conspired to fix cigarette prices in
Alabama, that agreements leading to price increases were reached during the
negotiations leading to the Proposed Resolution, and that prices were
increased pursuant to the alleged conspiracy in 1997 (Mosley, et al. v.
Philip Morris Companies Inc., et al.). The parties have settled this action
for a payment by defendants in an aggregate amount approximating sixty
thousand dollars to cover costs incurred by plaintiff's counsel.
Department of Justice Investigations - Early in 1994, the Energy and
Commerce Subcommittee on Health and the Environment of the U.S. House of
Representatives (the "Subcommittee") launched an oversight investigation
into tobacco products, including possible regulation of nicotine-containing
cigarettes as drugs. During the course of such investigation, the
Subcommittee held hearings at which executives of each of the major tobacco
manufacturers testified. Following the November 1994 elections, the incoming
Chairman of the Energy and Commerce Committee indicated that this
investigation by the Subcommittee would not continue, and on December 20,
1994, the outgoing majority staff of the Subcommittee issued two final
reports. One of these reports questioned the scientific practices of what it
characterized as the tobacco industry's "long-running campaign" related to
ETS, but reached no final conclusions. The second report asserted that
documents obtained from American Tobacco Company, a competitor of Lorillard,
"reflect an intense research and commercial interest in nicotine."
Page 36
The U.S. Department of Justice is investigating allegations of perjury in
connection with the testimony provided by tobacco industry executives,
including Lorillard executives, to the Subcommittee in April 1994. Lorillard
has not received any request for documents or testimony. It is impossible at
this time to predict the outcome of this investigation.
In 1996 Lorillard responded to a grand jury subpoena for documents in
connection with a grand jury investigation commenced in 1992 by the United
States Attorney's Office for the Eastern District of New York regarding
possible fraud by Lorillard and other tobacco companies relating to smoking
and health research undertaken or administered by the Council for Tobacco
Research - USA, Inc. There have been no requests for any testimony by any
Lorillard personnel. At the present time, Lorillard is unable to predict
whether the United States Attorney's Office will ultimately determine to
bring any proceeding against Lorillard. An adverse outcome of this
investigation could result in criminal, administrative or other proceedings
against Lorillard.
In March 1996, the Company and Lorillard each received a grand jury subpoena
duces tecum from the United States Attorney's Office for the Southern
District of New York seeking documents, advertisements or related materials
distributed by the Company and Lorillard to members of the general public
relating to, among other things, the health effects of cigarettes, nicotine
or tobacco products, the addictiveness of such products, and Congressional
hearings relating to cigarettes or the tobacco industry. The Company and
Lorillard responded to the subpoena. The Company and Lorillard were informed
in the latter part of 1996 that responsibility for this investigation has
been transferred from the United States Attorney's Office for the Southern
District of New York to the United States Department of Justice in
Washington, D.C. It is impossible at this time to predict the ultimate
outcome of this investigation.
On September 18, 1998, Lorillard was served with a grand jury subpoena for
documents in connection with an investigation being conducted by the Middle
Atlantic Office of the Antitrust Division of the United States Department of
Justice. Similar subpoenas have been served on other tobacco companies and
tobacco leaf purchasers. The investigation concerns possible violations of
the antitrust laws in connection with the purchase of tobacco leaf in the
United States. At the present time, Lorillard is unable to predict whether
the Department of Justice will ultimately determine to bring any proceedings
against Lorillard arising out of this investigation. An adverse outcome of
this investigation could result in criminal, civil or other proceedings
against Lorillard.
While Lorillard intends to defend vigorously all smoking and health related
litigation which may be brought against it, it is not possible to predict
the outcome of any of this litigation. Litigation is subject to many
uncertainties, and it is possible that some of these actions could be
decided unfavorably.
Many of the recent developments in relation to smoking and health discussed
above have received wide-spread media attention including the release of
documents by the industry. These developments may reflect adversely on the
tobacco industry and could have adverse effects on the ability of Lorillard
and other cigarette manufacturers to prevail in smoking and health
litigation.
Except for the effect of the Proposed Resolution if implemented as described
above, management is unable to make a meaningful estimate of the amount or
range of loss that could result from an unfavorable outcome of pending
litigation. It is possible that the Company's results of operations or cash
Page 37
flows in a particular quarterly or annual period or its financial position
could be materially affected by an unfavorable outcome of certain pending
litigation.
Other Litigation -- The Company and its subsidiaries are also parties to
other litigation arising in the ordinary course of business. The outcome of
this other litigation will not, in the opinion of management, materially
affect the Company's results of operations or equity.
7.In the opinion of Management, the accompanying consolidated condensed
financial statements reflect all adjustments (consisting of only normal
recurring accruals) necessary to present fairly the financial position as of
September 30, 1998 and December 31, 1997 and the results of operations for
the three and nine months and changes in cash flows for the nine months
ended September 30, 1998 and 1997, respectively.
Results of operations for the third quarter and the first nine months of
each of the years is not necessarily indicative of results of operations for
that entire year.
Page 38
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
----------------------------------------------------------------------
Liquidity and Capital Resources:
- - -------------------------------
Insurance
- - ---------
CNA Financial Corporation and subsidiaries ("CNA"). CNA is an 85% owned
subsidiary of the Company.
Statutory surplus of the property and casualty insurance subsidiaries was
approximately $7.0 billion at September 30, 1998 and December 31, 1997.
Statutory surplus increased by statutory net income of $291.0 million and a
change in net unrealized investment gains of $25.0 million. These increases
were more than offset by a $367.0 million reduction in surplus, primarily
dividends. The statutory surplus of the life insurance subsidiaries was
approximately $1.2 billion at September 30, 1998 and December 31, 1997.
The principal cash flow sources of CNA's property and casualty and life
insurance subsidiaries are premiums, investment income, and sales and
maturities of investments. The primary operating cash flow uses are payments
for claims, policy benefits and operating expenses.
For the first nine months of 1998, CNA's operating cash flows were a negative
$730.0 million, compared to a negative $359.2 million for the nine months ended
September 30, 1997. Negative cash flows for 1998 are primarily the result of
reduced income from operations while negative cash flows for 1997 are
substantially the result of the settlement of asbestos and environmental
claims, including those attributable to the Fibreboard litigation.
Net cash flows from operations are invested in marketable securities.
Investment strategies employed by CNA's insurance subsidiaries consider the
cash flow requirements of the insurance products sold and the tax attributes of
the various types of marketable investments.
On January 8, 1998, CNA issued $150.0 million principal amount of 6.45%
senior notes due January 15, 2008 and $150.0 million principal amount of 6.95%
senior notes due January 15, 2018. The net proceeds were used to pay down bank
loans drawn under a revolving credit facility. Concurrent with the reduction in
bank debt, CNA terminated $300.0 million notional amount of interest rate
swaps.
On April 15, 1998, CNA issued $500.0 million principal amount of 6.50% senior
notes due April 15, 2005. The net proceeds were used to pay down existing bank
debt, provide refinancing of certain senior notes and provide funds for
acquisitions.
In the past five years, several rating agencies have lowered CNA's ratings
with regard to its debt and claims paying ability. Some of the factors causing
these downgrades include Casualty's obligations under the Fibreboard settlement
and the merger with The Continental Corporation in 1995. More recently, rating
agencies in their evaluations of Casualty have expressed concern with regard to
the intensely competitive environment in the U.S. commercial insurance markets,
among other factors.
CNA intends to take a number of steps to address the issue of lowered ratings
and, among other things, intends to enhance its capital structure by
Page 39
approximately $500.0 million. It is anticipated that this will be accomplished
in the fourth quarter of 1998 and the first quarter of 1999 through several
transactions, including the issuance of preferred equity and debt securities by
CNA. The Company has advised CNA that it would be willing to purchase
approximately half of such securities.
As of November 2, 1998 CNA purchased 2,734,800 shares of its outstanding
Common Stock at an aggregate cost of approximately $102.4 million. Depending on
market conditions, CNA from time to time may purchase additional shares in the
open market or otherwise.
Cigarettes
- - ----------
Lorillard, Inc. and subsidiaries ("Lorillard"). Lorillard, Inc. is a wholly
owned subsidiary of the Company.
Lorillard and other cigarette manufacturers continue to be confronted with an
increasing level of litigation and regulatory issues.
The volume of lawsuits against Lorillard and other manufacturers of tobacco
products seeking damages for cancer and other health effects claimed to have
resulted from an individual's use of cigarettes, addiction to smoking, or
exposure to environmental tobacco smoke has increased substantially through
1997 and in 1998. See Note 6 of the Notes to Consolidated Condensed Financial
Statements. In a number of cases, the Company is named as a defendant. Tobacco
litigation includes claims brought by individual plaintiffs and claims brought
as class actions on behalf of a large number of individuals for damages
allegedly caused by smoking; and claims brought on behalf of governmental
entities, private citizens, or other organizations seeking reimbursement of
health care costs allegedly incurred as a result of smoking. In addition,
claims have been brought against Lorillard seeking damages resulting from
exposure to asbestos fibers which had been incorporated, for a limited period
of time, ending more than forty years ago, into filter material used in one
brand of cigarettes manufactured by Lorillard. In the foregoing actions,
plaintiffs claim substantial compensatory and punitive damages in amounts
ranging into the billions of dollars.
It has also been reported that the Executive branch of the government has
urged the U.S. Justice Department to commence an action against the tobacco
industry seeking reimbursement of Medicare expenditures resulting from injuries
or other health effects allegedly caused by use of tobacco products.
In 1997 and 1998, Lorillard, together with other companies in the United
States tobacco industry, reached agreements to settle certain tobacco related
litigation. See "Settlements of Reimbursement Cases" and "Broin v. Philip
Morris Companies, Inc. et al." in Note 6 of the Notes to Consolidated Condensed
Financial Statements.
Together with other companies in the United States tobacco industry,
Lorillard has discussed with a number of state attorneys general an agreement
that could settle the asserted and unasserted health care cost recovery claims
of all of the states. Discussions have reached the stage where those attorneys
general are reporting to the remaining states the terms of a proposed
agreement. The proposed agreement is contingent upon a sufficient number of
states accepting the agreement. No assurance can be given that the proposed
agreement will be accepted by a number of states sufficient to cause the
industry to conclude an agreement. The proposed agreement would effect
significant changes in the advertising and marketing of tobacco products. It
would also require the industry to pay more than $206 billion through 2025,
including (i) more than $12.7 billion in initial payments over the first five
Page 40
years (including $2.4 billion immediately); (ii) annual payments commencing in
2000 in the original amount of $4.5 billion and increasing periodically to $9
billion in 2018 and thereafter in perpetuity, and (iii) $1.7 billion over ten
years, the great preponderance of which is due during the first five years.
Lorillard's share of the $2.4 billion payment due immediately would be 7.3%
(based on relative market capitalization). All other payments would be
allocated among the original participating manufacturers based on their
relative unit volume of domestic cigarette shipments and would be subject to
adjustment for inflation and volume changes and for participation by less than
all the states and for other adjustments and offsets described in the proposed
agreement. The Company anticipates that Lorillard's share of the $2.4 billion
payment due immediately would be charged to expense in the fiscal quarter and
year during which the agreement is concluded and would be paid from Lorillard's
available cash. The Company further anticipates that Lorillard's share of
future annual industry payments related to cigarette sales would be charged to
expense as the related sales occur and may be funded through price increases.
The Company believes that any such agreement would materially adversely affect
its consolidated results of operations and financial position. The degree of
the adverse impact would depend, among other things, on the rates of decline in
United States cigarette sales in the premium and discount segments, Lorillard's
share of the domestic premium and discount segments, and the effect of any
resulting cost advantage of manufacturers not subject to the agreement. The
proposed agreement is filed as an Exhibit to this Form 10-Q and the foregoing
discussion is qualified by reference thereto.
FDA Regulations
The Food and Drug Administration ("FDA") has published regulations (the "FDA
Regulations") severely restricting cigarette advertising and promotion and
limiting the manner in which tobacco products can be sold. The FDA premised its
regulations on the need to reduce smoking by underage youth and young adults.
The FDA Regulations include:
(i) Regulations making unlawful the sale by retail merchants of cigarettes
to anyone under age 18. These regulations also require retail merchants
to request proof of age for any person under age 27 who attempts to
purchase cigarettes.
(ii) Regulations limiting all cigarette advertising to a black and white,
text only format in most publications and outdoor advertising such as
billboards, prohibiting billboards advertising cigarettes within 1,000
feet of a school or playground, banning the use of cigarette brand
names, logos and trademarks on premium items and prohibiting the
furnishing of any premium item in consideration for the purchase of
cigarettes or the redemption of proofs-of-purchase coupons.
(iii) Regulations prohibiting the use of cigarette brand names to sponsor
sporting and cultural events.
Lorillard and other cigarette manufacturers have filed a lawsuit, Coyne
Beahm, Inc., et al. v. United States Food & Drug Administration, et al., in the
United States District Court for the Middle District of North Carolina
challenging the FDA's assertion of jurisdiction over cigarettes. The Court
granted, in part, and denied, in part, plaintiffs' motion for summary judgment.
The Court held that if an adequate factual foundation is established, the FDA
has the authority to regulate tobacco products as medical devices under the
Federal Food, Drug & Cosmetic Act, may impose restrictions regarding access to
tobacco products by persons under the age of 18, and may impose labeling
requirements on tobacco products' packaging. The Court, however, also held that
the FDA is not authorized to regulate the promotion or advertisement of tobacco
products. The Court also stayed the effective date for the FDA Regulations
Page 41
relating to advertising and promotion of tobacco products, but allowed the
access restrictions to take effect as of February 27, 1997. Both the plaintiffs
and the defendants filed an appeal of the District Court's ruling to the Fourth
Circuit Court of Appeals and on August 14, 1998, that Court overturned the
District Court's decision, invalidating the FDA's assertion of authority over
cigarettes and the FDA Regulations promulgated pursuant to that asserted
authority. The plaintiffs petitioned the Appeals Court for rehearing with
suggestions for en banc reconsideration, and on November 10, 1998 the Appeals
Court denied such petition.
Proposed Resolution of Certain Regulatory and Litigation Issues
On June 20, 1997, Lorillard, together with other companies in the United
States tobacco industry, entered into a Memorandum of Understanding to support
the adoption of federal legislation and any necessary ancillary undertakings,
incorporating the features described in the proposed resolution attached to the
Memorandum of Understanding (together, the "Proposed Resolution"). The Proposed
Resolution would permit extensive regulation of the industry by the FDA and
would impose large monetary obligations on the industry to be paid to the
federal government and to the states. The Proposed Resolution would require the
manufacturers to sign private contracts, or Protocols, which embody significant
restrictions on the industry's commercial free speech advertising. In return,
the Proposed Resolution would resolve much of the industry's litigation and
establish a rational litigation system for future lawsuits. The Proposed
Resolution, by the nature of its terms, could be implemented only by federal
legislation. Incorporated by reference into this filing is the discussion of
the Proposed Resolution in the Company's annual report on Form 10-K for the
year ended December 31, 1997.
Since the Proposed Resolution was announced, it has been the subject of
intense review and criticism by the White House, the public health community,
and other interested parties. Certain members of Congress have offered, or
indicated that they intend to offer, alternative legislation. No bill
introduced would adopt the Proposed Resolution as agreed to. Over 50 bills have
been introduced in Congress regarding the issues raised in the Proposed
Resolution, including bills seeking more stringent regulation of tobacco
products by the Food and Drug Administration and more punitive monetary
payments by the companies. One particular bill initially introduced by Senator
John McCain from Arizona, was approved by the Senate Commerce Committee. The
McCain bill included, among other things, provisions more stringent than those
in the Proposed Resolution regarding FDA regulation, licensing of tobacco
manufacturers and retailers, surcharges against the industry for failure to
achieve underage smoking reduction goals, advertising restrictions and labeling
requirements, industry payments, smoking restrictions, civil liability
limitations, a method for determining the amount and payment of attorneys'
fees, and public disclosure of industry documents. On June 17, 1998, the United
States Senate voted to return the McCain bill to the Senate Commerce Committee
after several weeks of debate. No further action was taken on the McCain Bill,
and no similar bill was acted upon by the 105th Congress before it adjourned in
October.
On April 18, 1998, Lorillard, along with the other signatory companies to the
Proposed Resolution, announced a withdrawal from the legislative process to
enact a comprehensive tobacco settlement. Lorillard remains committed to the
Proposed Resolution, but does not believe that the current political process in
Washington can produce legislation that is fair to the industry.
For information with respect to these matters, as well as with respect to
discussions regarding an attempt to achieve a comprehensive legislative
resolution to litigation and regulatory issues affecting the United States
tobacco industry, see Note 6 of the Notes to Consolidated Condensed Financial
Page 42
Statements.
Cigarette Excise Taxes
The United States federal excise tax on cigarettes is presently $12.00 per
1,000 cigarettes ($0.24 per pack of 20 cigarettes). In August 1997, the United
States Congress approved, and the President signed into law, an increase in the
federal excise tax on cigarettes of $7.50 per 1,000 cigarettes ($0.15 per pack
of 20 cigarettes). This increase is phased in at a rate of $5.00 per 1,000
cigarettes in the year 2000 and an additional $2.50 per 1,000 cigarettes in the
year 2002. Various states have proposed, and certain states have recently
passed, increases in their state tobacco excise taxes. Such actions may
adversely affect Lorillard's volume, operating revenues and operating income.
Hotels
- - ------
Loews Hotels Holding Corporation and subsidiaries ("Loews Hotels"). Loews
Hotels Holding Corporation is a wholly owned subsidiary of the Company.
Funds from operations continue to exceed operating requirements. Loews Hotels
has entered into an agreement with the owners of the Universal Florida resort
to develop hotels at the resort. In addition, Loews Hotels is developing a
convention center hotel in Philadelphia. Capital expenditures in relation to
these hotel projects will be funded by a combination of equity and mortgages.
Loews Hotels will obtain its equity contributions for the development of these
hotels under arrangements with the Company.
Offshore Drilling
- - -----------------
Diamond Offshore Drilling, Inc. and subsidiaries ("Diamond Offshore").
Diamond Offshore Drilling, Inc. is a 52% owned subsidiary of the Company.
For the first nine months of 1998, Diamond Offshore's cash provided by
operating activities amounted to $389.1 million, compared to $243.7 million in
the 1997 period. This increase in operating cash flow was primarily
attributable to a $101.8 million increase in net income for the first nine
months of 1998, a $16.5 million increase in depreciation and amortization
expense, and various changes in operating assets and liabilities.
Diamond Offshore continues to enhance its fleet to meet customer demand for
diverse drilling capabilities, including those required for deep water and
harsh environment operations. Diamond Offshore has a revised budget of $125.2
million for capital expenditures on rig upgrades during 1998. Diamond Offshore
expended $66.5 million, including capitalized interest expenses, for
significant rig upgrades during the nine months ended September 30, 1998. Such
rig upgrade projects include the conversion of an accommodation vessel to a
semisubmersible drilling unit capable of operating in harsh environments and
ultra-deep water. Diamond Offshore has estimated the cost of conversion to be
approximately $210.0 million. Upon completion of the conversion, the rig will
begin a five year drilling program in the Gulf of Mexico, which is anticipated
to commence in late 1999. Other upgrade projects include the installation of
new engines and other equipment on the Ocean King which is expected to be
completed in November 1998, the cantilever conversion project on the Ocean
Warwick completed in March 1998, and leg strengthening and other modifications
on the Ocean Tower completed in May 1998. Diamond Offshore has also budgeted
$126.7 million for 1998 capital expenditures associated with its continuing rig
enhancement program, spare equipment and other corporate requirements. These
expenditures include purchases of anchor chain, drill pipe, riser, and other
drilling equipment. During the first nine months of 1998, $66.1 million was
Page 43
expended on this program.
Diamond Offshore believes it has the financial resources needed to meet its
business requirements in the foreseeable future, including capital expenditures
for major upgrades, continuing rig enhancements and working capital
requirements.
During the nine months ended September 30, 1998, Diamond Offshore purchased
3,518,100 shares of its outstanding Common Stock at an aggregate cost of
approximately $88.7 million. Depending on market conditions, Diamond Offshore
from time to time may purchase additional shares in the open market or
otherwise.
Watches and Clocks
- - ------------------
Bulova Corporation and subsidiaries ("Bulova"). Bulova Corporation is a 97%
owned subsidiary of the Company.
Funds from operations continue to exceed operating requirements. Bulova's
cash and cash equivalents, and investments amounted to $31.8 million at
September 30, 1998, as compared to $29.1 million at December 31, 1997. Funds
for other capital expenditures and working capital requirements are expected to
be provided from operations.
Parent Company
- - --------------
During the nine months ended September 30, 1998, the Company purchased
1,309,200 shares of its outstanding Common Stock at an aggregate cost of
approximately $110.1 million. Depending on market conditions, the Company from
time to time may purchase additional shares in the open market or otherwise.
Investments:
- - -----------
Investment activities of non-insurance companies include investments in fixed
income securities, equity securities including short sales, derivative
instruments and short-term investments. Equity securities, which are considered
part of the Company's trading portfolio, short sales and derivative instruments
are marked to market and reported as investment gains or losses in the income
statement. The remaining securities are carried at fair value with a net
unrealized gain (loss) of $.1 and $(3.2) million at September 30, 1998 and
December 31, 1997, respectively.
The Company enters into short sales and invests in certain derivative
instruments for a number of purposes, including: (i) for its asset and
liability management activities, (ii) for income enhancements for its portfolio
management strategy, and (iii) to benefit from anticipated future movements in
the underlying markets that Company management expects to occur. If such
movements do not occur or if the market moves in the opposite direction from
what management expects, significant losses may occur.
Monitoring procedures include senior management review of daily detailed
reports of existing positions and valuation fluctuations to ensure that open
positions are consistent with the Company's portfolio strategy.
The credit exposure associated with these instruments is generally limited to
the positive market value of the instruments and will vary based on changes in
market prices. The Company enters into these transactions with large financial
institutions and considers the risk of nonperformance to be remote.
Page 44
The Company does not believe that any of the derivative instruments utilized
by it are unusually complex or volatile, nor do these instruments contain
imbedded leverage features which would expose the Company to a higher degree of
risk. See "Results of Operations" and "Quantitative and Qualitative Disclosures
about Market Risk" for additional information with respect to derivative
instruments, including recognized gains and losses on these instruments. See
also Note 4 of the Notes to Consolidated Financial Statements in the 1997
Annual Report on Form 10-K.
Page 45
Insurance
- - ---------
A summary of CNA's general account fixed maturity securities portfolio and
short-term investments, at carrying value, are as follows:
Change in
Unrealized
September 30, December 31, Gains
1998 1997 (Losses)
-------------------------------------
(In millions)
Fixed maturity securities:
U.S. Treasury securities and
obligations of government agencies . $10,075.0 $12,980.0 $ 236.0
Asset-backed securities ............. 6,766.0 4,804.0 137.0
Tax exempt securities ............... 6,144.0 4,724.0 98.0
Taxable ............................. 6,337.0 7,040.0 (124.0)
----------------------------------
Total fixed maturity securities. 29,322.0 29,548.0 347.0
Stocks ................................ 1,362.0 814.0 272.0
Short-term and other investments....... 5,613.0 5,829.0 (107.0)
Derivative security investments ....... 8.0 12.0
----------------------------------
Total .......................... $36,305.0 $36,203.0 $ 512.0
==================================
Short-term investments:
Commercial paper .................... $ 1,981.0 $ 1,850.0
Security repurchase collateral ...... 58.0 154.0
Escrow .............................. 1,049.0 1,065.0
U.S. Treasuries ..................... 525.0 558.0
Money markets ....................... 312.0 624.0
Others .............................. 624.0 633.0
Other investments ..................... 1,064.0 945.0
-----------------------
Total short-term and other
investments ................... $ 5,613.0 $ 5,829.0
=======================
CNA's general account investment portfolio is managed to maximize after tax
investment return, while minimizing credit risks with investments concentrated
in high quality securities to support its insurance underwriting operations.
CNA has the capacity to hold its fixed maturity portfolio to maturity.
However, securities may be sold as part of CNA's asset/liability strategies or
to take advantage of investment opportunities generated by changing interest
rates, tax and credit considerations, or other similar factors. Accordingly,
fixed maturity securities are classified as available for sale.
CNA invests from time to time in certain derivative financial instruments
primarily to reduce its exposure to market risk (principally interest rate,
equity price and foreign currency risk). CNA also uses derivatives to mitigate
the risk associated with its indexed group annuity contract by purchasing S&P
500 futures contracts in a notional amount equal to the original customer
deposit.
Page 46
CNA considers its derivatives as being held for purposes other than trading.
Derivative securities, except for interest rate swaps associated with certain
corporate borrowings, are recorded at fair value at the reporting date with
changes in market value reflected in investment gains and losses. The interest
rate swaps on corporate borrowings are accounted for on the accrual basis with
the related income or expense recorded as an adjustment to interest expense;
the changes in fair value are not recorded.
The general account portfolio consists primarily of high quality (BBB or
higher) marketable fixed maturity securities, approximately 93.7% of which are
rated as investment grade. At September 30, 1998, tax exempt securities and
short-term investments excluding collateral for securities sold under
repurchase agreements, comprised approximately 16.9% and 12.4%, respectively,
of the general account's total investment portfolio compared to 13.1% and
13.1%, respectively, at December 31, 1997. Historically, CNA has maintained
short-term assets at a level that provided for liquidity to meet its short-term
obligations, as well as reasonable contingencies and anticipated claim payout
patterns. Short-term investments at both September 30, 1998 and December 31,
1997 are substantially higher than historical levels in anticipation of
Fibreboard-related claim payments. At September 30, 1998, the major components
of the short-term investment portfolio consist primarily of high grade
commercial paper and U.S. Treasury bills.
As of September 30, 1998, the market value of CNA's general account
investments in fixed maturities was $29.3 billion and was greater than
amortized cost by approximately $876.0 million. This compares to a market value
of $29.5 billion and approximately $528.0 million of net unrealized investment
gains at December 31, 1997. The gross unrealized investment gains and losses
for the fixed maturity securities portfolio at September 30, 1998 were $1,138.0
and $262.0 million, respectively, compared to $644.0 and $116.0 million,
respectively, at December 31, 1997.
Net unrealized investment gains on general account fixed maturities at
September 30, 1998 include net unrealized investment losses on high yield
securities of $137.0 million, compared to net unrealized investment losses of
$2.0 million at December 31, 1997. High yield securities are bonds rated as
below investment grade by bond rating agencies, plus private placements and
other unrated securities which, in the opinion of management, are below
investment grade (below BBB). CNA's investment in high yield securities in the
general account decreased $377.0 million to approximately $1.9 billion at
September 30, 1998 when compared to December 31, 1997.
At September 30, 1998, total Separate Account cash and investments amounted
to approximately $5.3 billion with taxable fixed maturity securities
representing approximately 83.9% of the Separate Accounts' portfolios.
Approximately 68.0% of Separate Account investments are used to fund guaranteed
investments for which CNA's life insurance affiliate guarantees principal and a
specified return to the contract holders. The duration of fixed maturity
securities included in the guaranteed investment portfolio is generally matched
with the corresponding payout pattern of the liabilities of the guaranteed
investment contracts. The fair value of all fixed maturity securities in the
guaranteed investment portfolio was $3.4 billion at September 30, 1998 compared
to $3.8 billion at December 31, 1997. At September 30, 1998, fair value
exceeded amortized cost by approximately $101.0 million, as compared to an
unrealized gain of approximately $71.0 million at December 31, 1997. The gross
unrealized investment gains and losses for the guaranteed investment fixed
maturity securities portfolio at September 30, 1998 were $118.0 and $17.0
million, respectively, as compared to unrealized gains of $87.0 million and
unrealized losses of $16.0 million at December 31, 1997.
Carrying values of high yield securities in the guaranteed investment
Page 47
portfolio were $278.0 and $310.0 million at September 30, 1998 and December 31,
1997, respectively. Net unrealized investment losses on high yield securities
held in such Separate Accounts were $19.0 million at September 30 1998,
compared to $1.0 million at December 31, 1997.
High yield securities generally involve a greater degree of risk than that of
investment grade securities. Expected returns should, however, compensate for
the added risk. The risk is also considered in the interest rate assumptions in
the underlying insurance products. At September 30, 1998, CNA's investment in
high yield bonds, including Separate Accounts, was approximately 3.7% of its
total assets as compared to 3.2% at December 31, 1997. In addition, CNA's
investments in mortgage loans and real estate are substantially below the
industry average, representing less than one quarter of one percent of its
total assets.
Included in CNA's fixed maturity securities at September 30, 1998 (general
and guaranteed investment portfolios) are $9.0 billion of asset-backed
securities, consisting of approximately 54.5% in collateralized mortgage
obligations ("CMO's"), 15.2% in corporate asset-backed obligations, 16.6% in
corporate mortgage backed security pass-through obligations and 13.7% in U.S.
government agency issued pass-through certificates. The majority of CMO's held
are corporate mortgage-backed securities, which are actively traded in liquid
markets and are priced monthly by broker-dealers. At September 30, 1998, the
fair value of asset-backed securities exceeded the amortized cost by
approximately $299.0 million compared to net unrealized investment gains of
$114.0 million at December 31, 1997. CNA limits the risks associated with
interest rate fluctuations and prepayment by concentrating its CMO investments
in early planned amortization classes with relatively short principal repayment
windows.
At September 30, 1998, 36.2% of the general account's fixed maturity
securities portfolio was invested in U.S. government securities, 36.4% in other
AAA rated securities and 15.1% in AA and A rated securities. CNA's guaranteed
investment fixed maturity securities portfolio is comprised of 5.7% U.S.
government securities, 61.9% in other AAA rated securities and 13.9% in AA and
A rated securities. These ratings are primarily from Standard and Poor's.
Results of Operations:
- - ----------------------
Revenues increased by $840.5 and $1,352.2 million, or 16.4% and 9.1%,
respectively, and net income increased by $419.5 and $279.9 million,
respectively, for the quarter and nine months ended September 30, 1998 as
compared to the corresponding periods of the prior year. The following table
sets forth the major sources of the Company's consolidated revenues and net
income.
Page 48
Three Months Ended Nine Months Ended
September 30, September 30,
-----------------------------------------------------
1998 1997 1998 1997
-----------------------------------------------------
(In millions)
Revenues (a):
Property and casualty insurance ....... $3,196.4 $3,286.7 $ 9,950.4 $ 9,618.7
Life insurance ........................ 936.7 1,029.8 2,945.1 3,059.4
Cigarettes ............................ 788.8 648.9 2,074.1 1,769.7
Hotels ................................ 57.8 57.3 171.2 164.3
Offshore drilling ..................... 326.6 256.4 950.5 698.0
Watches and clocks .................... 35.4 34.4 96.2 92.3
Investment income (loss)-net (non-
insurance companies) ................. 605.1 (198.4) (38.1) (592.6)
Other and eliminations-net ............ 5.1 (3.7) 2.4 (10.2)
----------------------------------------------------
$5,951.9 $5,111.4 $16,151.8 $14,799.6
====================================================
Net income (a):
Property and casualty insurance ....... $ 14.6 $ 199.9 $ 336.4 $ 484.3
Life insurance ........................ (14.8) 45.8 64.2 122.9
Cigarettes ............................ 195.5 72.4 356.2 275.4
Hotels ................................ 6.5 6.6 18.0 15.7
Offshore drilling ..................... 54.0 36.4 144.0 93.8
Watches and clocks .................... 3.2 3.0 7.3 5.7
Investment income (loss)-net (non-
insurance companies) ................. 391.9 (129.8) (29.5) (390.4)
Corporate interest expense ............ (20.7) (17.2) (64.7) (49.6)
Unallocated corporate expense and
other-net ............................ (13.1) (19.5) (51.3) (57.1)
----------------------------------------------------
$ 617.1 $ 197.6 $ 780.6 $ 500.7
====================================================
(a) Includes investment gains (losses) as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------------------------
1998 1997 1998 1997
---------------------------------------------------
Revenues:
Property and casualty insurance ....... $ 88.4 $ 192.6 $ 414.3 $ 338.6
Life insurance ........................ 9.3 48.1 99.8 120.6
Investment income-net ................. 565.3 (239.2) (176.1) (724.3)
---------------------------------------------------
$ 663.0 $ 1.5 $ 338.0 $(265.1)
===================================================
Net income:
Property and casualty insurance ....... $ 46.3 $ 106.7 $ 221.7 $ 186.2
Life insurance ........................ 1.7 24.6 48.0 61.5
Investment income-net ................. 367.5 (155.1) (114.2) (472.4)
---------------------------------------------------
$ 415.5 $ (23.8) $ 155.5 $(224.7)
===================================================
Page 49
Insurance
- - ---------
Property and casualty revenues, excluding investment gains, increased by
$13.9 and $256.0 million, or .4% and 2.8%, for the quarter and nine months
ended September 30, 1998, as compared to the same periods a year ago.
Property and casualty premium revenues increased by $25.0 and $218.0 million,
or 1.0% and 2.9%, for the quarter and nine months ended September 30, 1998,
from the prior year's comparable periods. The increase is attributable to
higher involuntary risk earned premium of approximately $207.0 million, an
increase in personal lines premium of approximately $92.0 million, $80.0
million of premium from CNA Surety Corporation, which was formed in September
1997, and $48.0 million of premium from Omega Aseguradora de Reisgo de Trabajo,
an Argentinean workers' compensation carrier that was acquired in June 1997.
These increases were partially offset by a decrease in commercial lines
premiums of approximately $150.0 million and group lines of approximately $92.0
million.
Involuntary premium for 1997 reflected reductions in estimates of premium for
1996 and prior periods, primarily in the workers' compensation line of
business, and a greater willingness on the part of the voluntary market,
including CNA, to write these types of risks. The 1998 estimated premiums
reflect a return to historical levels. The increase in personal lines premium
is attributable to increases in California Earthquake Authority premium of
$34.0 million as well as an increase of $45.0 million across various lines. The
decrease in commercial lines is primarily due to competitive pricing pressures
throughout the industry. The decrease in group lines is mainly due to the
decision to exit the Employer Health and Affinity Health lines of business. Net
investment income decreased by $20.0 and $30.0 million, or 4.6% and 2.2%, for
the quarter and nine months ended September 30, 1998, compared with the same
period in the prior year, due to lower yielding investments. The bond segment
of the investment portfolio yielded 6.1% in the first nine months of 1998
compared with 6.3% for the same period a year ago.
Life insurance revenues, excluding investment gains, decreased by $54.3 and
$93.5 million, or 5.5% and 3.2%, for the quarter and nine months ended
September 30, 1998 as compared to the same periods a year ago. Life premium
revenues decreased by $62.2 and $114.6 million, or 7.3% and 4.5%, for the
quarter and nine months ended September 30, 1998. The decrease is primarily due
to lower premiums for the Federal Employees Health Benefit Plan ("FEHBP"). The
decrease in FEHBP premiums is due to improved claim experience upon which
premiums are based and continues the trend from the first half of this year.
Life net investment income increased by $9.0 and $29.0 million, or 8.8% and
9.5%, for the quarter and nine months ended September 30, 1998, compared to the
same periods a year ago. The bond segment of the life investment portfolio
yielded approximately 6.4% in the first nine months of 1998, as compared to
6.3% for the comparable period in 1997.
On August 5, 1998, CNA announced a reassessment of its businesses which would
involve reorganization of a number of its businesses and corporate support
areas. In the third quarter of 1998, CNA finalized and approved a plan to
restructure its operations. In connection with this plan, CNA recorded a pre-
tax restructuring and other related charges amounting to approximately $220.0
million. The restructuring plan focused on a net reduction in the current
workforce of approximately 4,500 employees resulting in net reduction of
approximately 2,400 employees, the consolidation of certain processing
centers, the closing of various facilities, and the exiting of certain
businesses. The charges recorded in the third quarter of 1998 relate to
employee termination benefits ($72.0 million), the writedown of certain assets
to their fair values ($74.0 million), lease abandonment costs ($42.0 million)
Page 50
and losses related to the exiting of businesses ($32.0 million). These
activities and changes are more fully discussed below.
Within its risk management business, pre-tax restructuring and other related
charges totaled approximately $79.0 million for the third quarter. The charges
relate to costs associated with the consolidation of claim offices in
approximately 36 market territories totaling approximately $8.0 million (lease
abandonment costs), employee termination benefits related to the net reduction
in workforce of approximately 200 employees at a cost of approximately $7.0
million and the writedown of fixed and intangible assets of approximately $64.0
million.
Within its commercial insurance business, pre-tax restructuring and other
related charges for the third quarter totaled approximately $57.0 million. The
charges relate primarily to the consolidation of four regional offices into two
zone offices and a reduction of claim processing offices from 24 to 8 at a cost
of approximately $21.0 million (lease abandonment costs). The charges also
consist of approximately $31.0 million of employee termination benefits related
to the net reduction in workforce of approximately 1,200 employees and an
additional $5.0 million relating to fixed asset writedowns.
Within its group insurance business, pre-tax restructuring and other related
charges for the third quarter totaled approximately $38.0 million. The charges
relate primarily to the Employer Health and Affinity lines of business that CNA
decided to exit and include the employee termination benefit costs related to
the net reduction in its current workforce of approximately 400 employees.
For various other departments within CNA, pre-tax restructuring and other
related charges totaled approximately $25.0 million and relate primarily to the
closing of leased facilities and employee termination benefits related to the
reductions in the current workforce. Additionally, CNA recorded approximately
$21.0 million in incremental benefit plan expenses associated with the
reductions in its workforce.
CNA expects to record an additional $125.0 to $175.0 million in charges over
the next 12 to 15 months, primarily related to employee related expenses,
computer systems, consulting fees and other related costs. While such costs
relate to CNA's overall plans of reorganization, generally accepted accounting
principles do not allow for accrual of these in the period the plan is adopted.
Rather such costs will be recorded in the period which they are incurred.
While CNA has not yet completed its analysis of anticipated cost savings, it
estimates that its reorganization, which includes the restructuring plan as
well as revenue enhancements and operating efficiencies, will result in
anticipated reductions of approximately 200 basis points in CNA's expense ratio
and savings of approximately $300.0 to $350.0 million on an annualized basis.
CNA expects a portion of the anticipated savings will be realized beginning in
the latter part of 1998 and to achieve the full expense ratio reduction within
15 months.
Property and casualty underwriting losses for the quarter and nine months
ended September 30, 1998 were $465.0 million and $1.1 billion, compared to
$273.4 and $843.8 million for the same periods in 1997. The increase in
underwriting losses is primarily due to restructuring and other related charges
recorded during the third quarter (as discussed above), as well as an increase
in pre-tax catastrophe losses for the first nine months of 1998. Pre-tax
catastrophe losses were approximately $66.0 and $217.0 million for the quarter
and nine months ended September 30, 1998 as compared to $2.5 and $78.5 million
in 1997. The increase in catastrophe losses is mainly due to spring storms
throughout the United States and hurricane damage sustained during the third
quarter of 1998.
Page 51
The components of CNA's investment gains are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------------------
1998 1997 1998 1997
-------------------------------------------------
(In millions)
Bonds:
U.S. Government ....................... $ 69.0 $ 54.0 $165.0 $103.0
Tax exempt ............................ 26.0 24.0 58.0 26.0
Asset-backed .......................... 3.0 9.0 30.0 18.0
Taxable ............................... 14.0 18.0 83.0 102.0
-------------------------------------------------
Total bonds ........................ 112.0 105.0 336.0 249.0
Stocks .................................. (1.0) 18.0 12.0 57.0
Derivative instruments .................. (6.0) 2.0 28.0 2.0
Separate Accounts and other (1) ......... (8.0) 112.0 136.0 167.0
-------------------------------------------------
Total investment gains ............. $ 97.0 $237.0 $512.0 $475.0
=================================================
(1) Includes $88.8 for the three and nine months ended September 30, 1997 from issuance of
subsidiary's stock.
CNA's primary property and casualty subsidiary, Continental Casualty Company,
is party to litigation with Fibreboard Corporation involving coverage for
certain asbestos-related claims and defense costs (see Note 6 of the Notes to
Consolidated Condensed Financial Statements).
Cigarettes
- - ----------
Revenues increased by $139.9 and $304.4 million, or 21.6% and 17.2%,
respectively, and net income increased by $123.1 and $80.8 million,
respectively, for the quarter and nine months ended September 30, 1998 as
compared to the corresponding periods of the prior year.
The increase in revenues is composed primarily of higher average unit prices
amounting to approximately $113.3 and $248.6 million, or 17.7% and 14.2%,
respectively, and an increase of approximately $16.1 and $32.7 million, or 2.5%
and 1.9%, reflecting higher unit sales volume for the quarter and nine months
ended September 30, 1998, as compared to the corresponding periods of the prior
year. Revenues also benefited from increased investment income.
Net income for the quarter and nine months ended September 30, 1998 and 1997
includes a pre-tax charge of $30.8, $109.3, $218.3 and $109.3 million ($18.4,
$65.3, $130.5 and $65.3 million after taxes), respectively, to reflect the
settlement of tobacco litigation (see Note 6 of the Notes to Consolidated
Condensed Financial Statements). Excluding these charges, net income would have
increased by $76.2 and $146.0 million for the quarter and nine months ended
September 30, 1998, respectively, as a result of the improved revenues, and for
the three months ended September 30, 1998, lower legal expenses. These
increases were partially offset by higher sales promotion expenses and, for the
nine months ended September 30, 1998, increased legal expenses.
Lorillard's unit sales volume increased by 1.6% and 1.2%, while Newport's
sales volume increased by 1.4% and 4.0% for the quarter and nine months ended
September 30, 1998, as compared to the corresponding periods of the prior year.
Page 52
Newport, a full price brand, accounted for 78.0% of Lorillard's unit sales.
Discount brand sales have decreased from an average of 31.4% of industry sales
during 1994 to an average of 27.0% during 1997. At September 30, 1998, they
represented 26.4% of industry sales.
Hotels
- - ------
Revenues increased by $.5 and $6.9 million, or .9% and 4.2%, respectively,
and net income decreased by $.1 million, or 1.5%, and increased by $2.3
million, or 14.6%, respectively, for the quarter and nine months ended
September 30, 1998, as compared to the prior year, due primarily to higher
overall average room rates, partially offset by lower occupancy rates.
Net income decreased for the quarter due primarily to higher costs. Net
income improved for the nine month period, as compared to the prior year, due
to higher average room rates, partially offset by lower overall occupancy rates
and increased administrative expenses.
Offshore drilling
- - -----------------
Revenues increased by $70.2 and $252.5 million, or 27.4% and 36.2%, and net
income increased by $17.6 and $50.2 million, or 48.4% and 53.5%, respectively,
for the quarter and nine months ended September 30, 1998, as compared to the
prior year.
Revenues from semisubmersible rigs increased by $62.6 and $206.6 million, or
24.4% and 29.6%, for the quarter and nine months ended September 30, 1998. The
revenue increase is due to higher dayrates ($51.5 and $176.9 million),
recognized by semisubmersible rigs located in the North Sea and the Gulf of
Mexico. These increases were partially offset by revenues foregone ($5.3 and
$37.4 million) during mandatory inspections. Revenues from jackup rigs
increased by $5.9 and $38.8 million, or 2.3% and 5.6%, due to improvements in
dayrates, primarily in the Gulf of Mexico ($10.8 and $48.3 million).
Depressed product prices in the oil and gas industry have resulted in
declining dayrates and decreased utilization, primarily in the shallow waters
of the Gulf of Mexico. As a result, Diamond Offshore has cold stacked and
suspended marketing efforts on two of its low-end specification
semisburmersible rigs located in the Gulf of Mexico. In addition, due to the
excess supply in the current jack-up market, several of Diamond Offshore's
jack-up rigs are idle in the Gulf of Mexico. To date, Diamond Offshore has been
able to mitigate the effect of these conditions on its results of operations
primarily with existing term contract commitments and the diversity of Diamond
Offshore's fleet. However, the offshore contract drilling industry historically
has been and is expected to continue to be highly competitive and cyclical. The
current trends in market conditions could have a material adverse effect on
Diamond Offshore's future results of operations, although the extent of such
effect cannot be accurately predicted.
Diamond Offshore's results of operations have also been impacted by the loss
of revenues and associated costs incurred during required regulatory
inspections of its drilling rigs. As of September 30, 1998, eight of these
inspections had been completed with four anticipated to occur in the fourth
quarter of 1998. Diamond Offshore intends to focus on returning these rigs to
operations as soon as reasonably possible, in order to minimize the downtime
and associated loss of revenues.
Net income for the quarter and nine months ended September 30, 1998 increased
Page 53
due primarily to the higher revenues discussed above, partially offset by an
overall increase in contract drilling costs, including labor and drilling
supplies and increased depreciation and administrative expenses.
Watches and Clocks
- - ------------------
Revenues increased by $1.0 and $3.9 million, or 2.9% and 4.2%, respectively,
and net income increased by $.2 and $1.6 million, or 6.7% and 28.1%,
respectively, for the quarter and nine months ended September 30, 1998 as
compared to the corresponding periods of the prior year.
Revenues increased for the quarter and nine months ended September 30, 1998
due primarily to increased watch unit sales volume and higher interest income,
partially offset by lower clock unit sales.
Net income increased for the quarter and nine months ended September 30, 1998
due primarily to the increased revenue discussed above and lower cost of sales.
In addition, net income benefited from a $.8 million pre-tax credit recorded in
the third quarter of 1998 related to an actuarial adjustment to postretirement
benefit costs.
Other
- - -----
Revenues increased by $812.3 and $567.1 million, respectively, and net income
increased by $524.6 and $351.6 million, respectively, for the quarter and nine
months ended September 30, 1998 as compared to the corresponding periods of the
prior year.
The components of investment gains (losses) included in Investment income
(loss)-net are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
1998 1997 1998 1997
-------------------------------------
(In millions)
Revenues:
Derivative instruments (1) ............ $484.7 $(187.7) $ (15.5) $(568.4)
Equity securities, including short
positions (1) ........................ 54.5 (46.1) (174.8) (195.4)
Fixed maturities ...................... 25.3 (.1) 13.3 14.8
Short-term investments, primarily U.S.
government securities ................ (.9) .8 (.3) .4
Gain on issuance of subsidiary's stock 29.1
Other ................................. 1.7 (6.1) 1.2 (4.8)
-----------------------------------
565.3 (239.2) (176.1) (724.3)
Income tax benefit ...................... (198.0) 83.8 61.6 253.5
Minority interest ....................... .2 .3 .3 (1.6)
-----------------------------------
Net income (loss) .................. $367.5 $(155.1) $(114.2) $(472.4)
===================================
Page 54
(1) Includes gains (losses) on short sales, equity index futures and options
aggregating $491.8, $(278.3), $(221.6) and $(800.4) for the quarter and
nine months ended September 30, 1998 and 1997, respectively. The Company
continues to maintain these positions but has reduced its exposure in
these instruments.
Exclusive of securities transactions, revenues increased $7.8 and $18.9
million, or 21.0% and 15.6%, for the quarter and nine months ended September
30, 1998 due primarily to increased revenues from a shipping joint venture and,
for the nine month period, higher investment income. Net income increased by
$2.0 million, or 17.5%, and decreased by $6.6 million, or 26.7%, for the
quarter and nine months ended September 30, 1998, respectively. Net income
increased for the quarter due to the increased revenues discussed above,
partially offset by higher corporate interest expenses. Net income decreased
for nine months ended September 30, 1998 due to higher corporate interest
expenses, partially offset by increased interest income.
Year 2000 Issue
- - ---------------
The widespread use of computer programs, both in the United States and
internationally, that rely on two digit date fields to perform computations and
decision making functions may cause computer systems to malfunction when
processing information involving dates beginning in 1999. Such malfunctions
could lead to business delays and disruptions. The Company is in the process of
renovating or replacing many of its legacy systems to accommodate business for
the Year 2000 and beyond. In addition, the Company is checking embedded systems
in computer hardware and other infrastructure such as elevators, heating and
ventilating systems, and security systems. To date, approximately 89% of all
planned hours have been expended, and a similar percentage of milestones have
been completed.
Approximately 81% of the Company's internal systems have been internally
tested and are expected to be running in a production environment by December
1, 1998. This deadline allows a full year for re-validation of already tested
and implemented Year 2000 remediated systems, as well as for shake-out of any
previously unidentified problems and for interacting with business partners and
vendors that are still working on making their programs Year 2000 ready.
Based upon its current assessment, the Company estimates that the total cost
to replace and upgrade its systems to accommodate Year 2000 processing will be
approximately $70.0 to $80.0 million. As of September 30, 1998, approximately
$53.0 million has been spent. While some hardware charges are included in the
budget figures, the Company's hardware costs are typically included as part of
ongoing technology updates and not specifically as part of the Year 2000
project. All funds spent and to be spent will be financed from current
operating funds.
The Company believes that it will be able to resolve the Year 2000 issue in a
timely manner. However, due to the interdependent nature of computer systems,
the Company may be adversely impacted depending upon whether it or other
entities not affiliated with the Company (vendors and business partners)
address this issue successfully. To mitigate this impact, the Company is
communicating with its vendors and business partners to coordinate the Year
2000 conversion. CNA has already sent Year 2000 information packages to more
than 12,000 independent agents to encourage them to become Year 2000 ready on a
timely basis. CNA has also sent Year 2000 information to almost 300,000
business policyholders to increase their awareness of the Year 2000 issue.
Similar information packages have been sent to health care providers, lawyers
and others with whom CNA has business relationships. Because of the
Page 55
interdependent nature of the issue, the Company cannot be sure that there will
not be a disruption to its business.
The Company has also developed business resumption plans to ensure that the
Company is able to continue critical processes through other means in the event
that it becomes necessary to do so. Formal strategies have been developed
within each business unit and support organization to include appropriate
recovery processes and use of alternative vendors. More than 200 strategies
have been developed to address recovery plans for approximately 400 processes.
These plans are being updated quarterly.
In addition, property and casualty insurance subsidiaries may have an
underwriting exposure related to the Year 2000 issue. Although CNA has not
received any claims for coverage from its policyholders based on losses
resulting from Year 2000 issues, there can be no assurances that policyholders
will not suffer losses of this type and seek compensation under insurance
policies underwritten by CNA. If any claims are made, coverage, if any, will
depend on the facts and circumstances of the claim and the provisions of the
policy. The range of potential insurance exposure created by the Year 2000
problem is sufficiently broad that it is impossible to estimate with any degree
of accuracy the extent to which various types of policies issued by CNA may
afford coverage for loss or claims. At this time, in the absence of any claims
experience, CNA is unable to forecast the nature and range of the losses, the
availability of coverage for the losses, or the likelihood of significant
claims. As a result, CNA is unable to determine whether the adverse impact, if
any, in connection with the foregoing circumstances would be material to it.
Accounting Standards
- - --------------------
In December 1997, the AICPA's Accounting Standards Executive Committee issued
SOP 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments," which provides guidance on accounting for insurance-related
assessments. It requires that entities recognize liabilities for insurance-
related assessments when all of the following criteria have been met: an
assessment has been imposed or it is probable that an assessment will be
imposed; the event obligating an entity to pay an imposed or probable
assessment has occurred on or before the date of the financial statements; and
the amount of the assessment can be reasonably estimated. This SOP is effective
for fiscal years beginning after December 15, 1998. The Company is currently
evaluating the effects of this SOP on its accounting for insurance-related
assessments. Certain insurance industry information required for compliance is
not currently available and therefore the Company is studying alternatives for
estimating the accrual. While it is possible that the cumulative effect of
adoption could be material, the ongoing impact of this standard is not expected
to be material to the results of operations, liquidity or financial position of
the Company.
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits." This Statement standardizes
disclosure requirements for pension and other postretirement benefits to the
extent practicable, and requires additional information on changes in benefit
obligations and fair values of plan assets that will facilitate financial
analysis, and eliminates certain disclosures that are no longer useful to users
of financial statements. It also suggests combined formats for presentation of
pension and other postretirement benefit disclosures. The Statement supersedes
the disclosure requirements of a number of earlier opinions of the FASB and
does not address measurement or recognition. It is effective for fiscal years
beginning after December 15, 1997. The Company is currently evaluating the
effects of this Statement on its benefit plan disclosures.
Page 56
In March 1998, the AICPA's Accounting Standards Executive Committee issued
SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained
for Internal Use," which provides guidance on accounting for costs of computer
software developed or obtained for internal use and for determining whether
computer software is for internal use. For purposes of this SOP, internal-use
software is software acquired, internally developed or modified solely to meet
the entity's internal needs for which no substantive plan exists or is being
developed to market the software externally during the software's development
or modification. Accounting treatment for costs associated with software
developed or obtained for internal use, as defined by this SOP, is based upon a
number of factors, including the point in time during the project that costs
are incurred as well as the types of costs incurred. This SOP is effective for
financial statements for fiscal years beginning after December 15, 1998. The
Company is currently evaluating the effects of this SOP.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which establishes standards for the
accounting and reporting for derivative instruments and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. If certain conditions are met, a derivative may be
specifically designated as (a) a hedge of the exposure to changes in the fair
value of a recognized asset or liability or an unrecognized firm commitment,
(b) a hedge of the exposure to variable cash flows of a forecasted transaction,
or (c) a hedge of the foreign currency exposure of a net investment in a
foreign operation, an unrecognized firm commitment, an available-for-sale
security, or a foreign-currency-denominated forecasted transaction. The
accounting for changes in the fair value of a derivative depends on the
intended use of the derivative and the resulting designation. This Statement is
effective for all fiscal quarters of fiscal years beginning after June 15,
1999. The Company is currently evaluating the effects of this Statement on its
accounting and reporting for derivatives and hedges.
Forward-Looking Statements
- - --------------------------
When included in this Report, the words "believes," "expects," "intends,"
"anticipates," "estimates," and analogous expressions are intended to identify
forward-looking statements. Such statements inherently are subject to a variety
of risks and uncertainties that could cause actual results to differ materially
from those projected. Such risks and uncertainties include, among others,
general economic and business conditions, competition, changes in financial
markets (interest rate, currency, commodities and stocks), changes in foreign,
political, social and economic conditions, regulatory initiatives and
compliance with governmental regulations, judicial decisions and rulings in
smoking and health litigation, the impact of bills introduced in Congress in
relation to tobacco operations, implementation of the Proposed Resolution,
changes in foreign and domestic oil and gas exploration and production
activity, customer preferences and various other matters, many of which are
beyond the Company's control. These forward-looking statements speak only as of
the date of this Report. The Company expressly disclaims any obligation or
undertaking to release publicly any updates or revisions to any forward-looking
statement contained herein to reflect any change in the Company's expectations
with regard thereto or any change in events, conditions or circumstances on
which any statement is based.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
-----------------------------------------------------------
The Company is a large diversified financial services company. As such, it
has significant amounts of financial instruments that involve market risk. The
Page 57
Company's measure of market risk exposure represents an estimate of the change
in fair value of its financial instruments. Changes in the trading portfolio
would be recognized as investment gains (losses) in the income statement.
Market risk exposure is presented for each class of financial instrument held
by the Company at September 30, 1998, assuming immediate adverse market
movements of the magnitude described below. The Company believes that the
various rates of adverse market movements represent a measure of exposure to
loss under hypothetically assumed adverse conditions. The estimated market risk
exposure represents the hypothetical loss to future earnings and does not
represent the maximum possible loss nor any expected actual loss, even under
adverse conditions, because actual adverse fluctuations would likely differ. In
addition, since the Company's investment portfolio is subject to change based
on its portfolio management strategy as well as in response to changes in the
market, these estimates are not necessarily indicative of the actual results
which may occur.
The following tables present the Company's market risk by category (equity
markets, interest rates, foreign currency exchange rates and commodity prices)
on the basis of those entered into for trading purposes and other than trading
purposes.
Trading portfolio:
September 30, 1998
- - -------------------------------------------------------------------------------
Fair Value Market
Category of risk exposure: Asset (Liability) Risk
- - -------------------------------------------------------------------------------
(In millions)
Equity markets (1):
Equity securities $ 228.7 $ 57.2
Options purchased 649.1 (584.9)
Options written (56.6) 47.1
Futures 86.5
Short sales (643.9) (161.0)
Commodities:
Oil (2):
Swaps .2 (1.6)
Energy purchase obligations (14.2) (5.9)
Gold (3):
Options purchased 18.7 (18.7)
Options written (3.9) 3.9
- - -------------------------------------------------------------------------------
Note: The calculation of estimated market risk exposure is based on assumed
adverse changes in the underlying reference price or index of (1) an
increase in equity prices of 25%, (2) a decline in oil prices of 20% and
(3) an increase in gold prices of 20%. Adverse changes on options which
differ from those presented above would not necessarily result in a
proportionate change to the estimated market risk exposure.
The most significant areas of market risk in the Company's trading portfolio
result from positions held in S&P futures contracts, short sales of certain
equity securities and put options purchased on the S&P 500 index. The Company
enters into these positions primarily to benefit from anticipated future
Page 58
movements in the underlying markets that Company management expects to occur.
If such movements do not occur or if the market moves in the opposite direction
from what management expects, significant losses may occur. The Company
continues to maintain these positions but has reduced its exposure in these
instruments.
Exposure to market risk is managed and monitored by senior management. Senior
management approves the overall investment strategy employed by the Company and
has responsibility to ensure that the investment positions are consistent with
that strategy and the level of risk acceptable to it. The Company may manage
risk by buying or selling instruments or entering into offsetting positions.
Other than trading portfolio:
September 30, 1998
- - -------------------------------------------------------------------------------
Fair Value Market
Category of risk exposure: Asset (Liability) Risk
- - -------------------------------------------------------------------------------
(In millions)
Equity market (1):
Equity securities:
CNA Financial general accounts (a) $ 1,362.0 $ (341.0)
CNA Financial separate accounts 186.0 (46.0)
Equity index futures, separate accounts (b) (205.0)
Interest rate (2):
Fixed maturities (a) 29,612.2 (1,456.2)
Short-term investments (a) 9,204.2 (6.0)
Interest rate swaps (15.0) 11.0
Separate Accounts:
Fixed maturities (a) 4,405.0 (157.0)
Short-term investments (a) 457.0 (1.0)
Long-term debt (5,739.7)
- - -------------------------------------------------------------------------------
Note: The calculation of estimated market risk exposure is based on assumed
adverse changes in the underlying reference price or index of (1) a
decrease in equity prices of 25% and (2) an increase in interest rates
of 100 basis points.
(a) Certain securities are denominated in foreign currencies. Assuming a 20%
decline in the underlying exchange rates would result in an aggregate
foreign currency exchange rate risk of $(391.0).
(b) This market risk would be offset by decreases in liabilities to
customers under variable insurance contracts.
Equity Price Risk - The Company has exposure to equity price risk as a result
of its investment in equity securities and equity derivatives. Equity price
risk results from changes in the level or volatility of equity prices that
affect the value of equity securities or instruments which derive their value
from such securities or indexes. Equity price risk was measured assuming an
instantaneous 25% change in the underlying reference price or index from its
level at September 30, 1998, with all other variables held constant.
Interest Rate Risk - The Company has exposure to interest rate risk arising
Page 59
from changes in the level or volatility of interest rates. The Company attempts
to mitigate its exposure to interest rate risk by utilizing instruments such as
interest rate swaps, interest rate caps, commitments to purchase securities,
options, futures and forwards. The Company monitors its sensitivity to interest
rate risk by evaluating the change in its financial assets and liabilities
relative to fluctuations in interest rates. The evaluation is made using an
instantaneous parallel change in interest rates by varying magnitudes on a
static balance sheet to determine the effect such a change in rates would have
on the Company's market value at risk and the resulting effect on shareholders'
equity. The analysis presents the sensitivity of the market value of the
Company's financial instruments to selected changes in market rates and prices
which the Company believes are reasonably possible over a one-year period.
The analysis assumes that the composition of the Company's interest sensitive
assets and liabilities existing at the beginning of the period remains constant
over the period being measured and also assumes that a particular change in
interest rates is reflected uniformly across the yield curve regardless of the
time to maturity. Also, the interest rates on certain types of assets and
liabilities may fluctuate in advance of changes in market interest rates, while
interest rates on other types may lag behind changes in market rates.
Accordingly the analysis may not be indicative of, is not intended to provide,
and does not provide a precise forecast of the effect of changes of market
interest rates on the Company's earnings or shareholders' equity. Further, the
computations do not contemplate any actions the Company would undertake in
response to changes in interest rates.
The Company's long-term debt, including interest rate swap agreements, as of
September 30, 1998 is denominated in U.S. Dollars. The Company's debt has been
primarily issued at fixed rates, and as such, interest expense would not be
impacted by interest rate shifts.
The sensitivity analysis assumes an instantaneous shift in market interest
rates increasing 100 basis points from their levels at September 30, 1998, with
all other variables held constant.
Foreign Exchange Risk - Foreign exchange rate risk arises from the
possibility that changes in foreign currency exchange rates will impact the
value of financial instruments. The Company has foreign exchange exposure when
it buys or sells foreign currencies or financial instruments denominated in a
foreign currency. This exposure is mitigated by the Company's asset/liability
matching strategy and through the use of futures for those instruments which
are not matched. The Company's foreign transactions are primarily denominated
in Canadian Dollars, British Pounds, German Deutschmarks and Japanese Yen. The
sensitivity analysis also assumes an instantaneous 20% change in the foreign
currency exchange rates versus the U.S. Dollar from their levels at September
30, 1998, with all other variables held constant.
Commodity Price Risk - The Company has exposure to commodity price risk as a
result of its investments in energy purchase obligations, gold options and
other investments. Commodity price risk results from changes in the level or
volatility of commodity prices that impact instruments which derive their value
from such commodities. Commodity price risk was measured assuming an
instantaneous change of 20% in the value of the underlying commodities.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
-----------------
1. CNA is involved in various lawsuits involving environmental pollution
claims and litigation with Fibreboard Corporation. Information involving such
Page 60
lawsuits is incorporated by reference to Note 6 of the Notes to Consolidated
Condensed Financial Statements in Part I.
2. Lorillard is involved in various lawsuits involving tobacco products
seeking damages for cancer and other health effects claimed to have resulted
from the use of cigarettes or from exposure to tobacco smoke. Information
involving such lawsuits is incorporated by reference to Note 6 of the Notes to
Consolidated Condensed Financial Statements in Part I.
Item 6. Exhibits and Reports on Form 8-K.
--------------------------------
(a) Exhibits--
(3.1) By-Laws.
(10.1) Stipulation of Amendment to Settlement Agreement and for Entry
of Consent Decree, dated September 11, 1998, regarding the settlement of the
Florida health care cost recovery action.
(10.2) Florida Fee Payment Agreement dated September 11, 1998,
regarding the payment of attorney's fees.
(27.1) Financial Data Schedule for the nine months ended September 30,
1998.
(99.1) Proposed Master Settlement Agreement relating to state health
care cost recovery claims.
(b) Current reports on Form 8-K--There were no reports on Form 8-K filed for
three months ended September 30, 1998.
Page 61
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
LOEWS CORPORATION
-----------------
(Registrant)
Dated: November 16, 1998 By /s/ Peter W. Keegan
-------------------------
PETER W. KEEGAN
Senior Vice President and
Chief Financial Officer
(Duly authorized officer
and principal financial
officer)
Page 62