CNA is one of the largest commercial insurers in the United States and the third largest property and casualty company and the twenty-second largest life insurance company in the country, based on 1996 net written premiums.
CNA's property and casualty insurance subsidiaries' statutory surplus grew from $3.4 billion in 1994 to $7.1 billion in 1997. Surplus rose in part ($1.7 billion) due to the acquisition of The Continental Corporation in 1995. Dividends of $175.0, $545.0 and $325.0 million were paid to CNA by Continental Casualty Company in 1997, 1996 and 1995, respectively.
The liquidity requirements of CNA have been met by funds generated from operations and investing activities. 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.
Net cash flows are primarily 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 securities.
Approximately 73.8% of Separate Account investments are used to fund guaranteed investments contracts for which CAC guarantees principal and a specified return to the contract holders. The following table summarizes the ratings of CNA's guaranteed investment contract Separate Account fixed maturity bond portfolio at fair value:
High yield securities are bonds rated below investment grade by bond rating agencies and other unrated securities which, in the opinion of management, are below investment grade (below BBB). High yield securities generally involve a greater degree of risk than 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. CNA's concentration in high yield bonds including Separate Account business was approximately 3.2% of its total assets at December 31, 1997 and 1996.
Included in CNA's fixed maturity securities at December 31, 1997 (general and guaranteed investment portfolios) are $7.2 billion of asset-backed securities, consisting of approximately 11.2% in U.S. government agency issued pass-through certificates, 40.0% in collateralized mortgage obligations ("CMO's"), 29.8% in corporate asset-backed obligations and 19.0% in corporate mortgage-backed pass- through securities.
CMO's are subject to prepayment risks that tend to vary with changes in interest rates. During periods of declining interest rates, CMO's generally prepay faster as the underlying mortgages are prepaid and refinanced by borrowers in order to take advantage of the lower rates. Conversely, during periods of rising interest rates, prepayments are generally slow which may result in a decrease in yield or a loss as a result of the slower prepayments. CNA limits the risks associated with interest rate fluctuations and prepayment by concentrating its CMO investments in planned amortization classes with relatively short principal repayment windows. CNA avoids investments in complex mortgage derivatives without readily ascertainable market prices. At December 31, 1997, the fair value of asset-backed securities was greater than the amortized cost by approximately $114.0 million, as compared to net unrealized losses of approximately $5.0 million for the comparable period a year ago.
CNA considers its derivatives as being held for purposes other than trading. Derivative securities, except for interest rate swaps associated with 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.
At December 31, 1997, total Separate Account cash and investments amounted to $5.7 billion with taxable fixed maturities representing approximately 83.4% of the Separate Account portfolio. Approximately 73.8% of Separate Account investments are used to fund guaranteed investments contracts for which CAC guarantees principal and a specified return to the contract holders. The duration of fixed maturity securities included in the guaranteed investment contract portfolio are matched approximately with the corresponding payout pattern of the liabilities of the guaranteed investment contracts. One Separate Account product is an indexed group annuity contract for institutional investors which guarantees the S&P 500 rate of return plus 25 basis points per annum. Deposits are taken for a three- year period with no payout until the end of the period. CNA mitigates the risk associated with the contract liability by a combination of purchasing S&P 500 futures contracts in a notional amount equal to the original deposit and investing in high quality securities. The futures contracts are adjusted regularly to approximate the future liability to the contract holder. The gross notional amount of these futures totaled $860.0 and $394.0 million at December 31, 1997 and 1996, respectively.
At December 31, 1997, fixed maturity securities in the guaranteed investment contract portfolio are carried at fair value, and amounted to $4.0 billion. At December 31, 1997, net unrealized gains on fixed maturity securities in these Separate Accounts amounted to approximately $71.0 million. This compares to net unrealized losses of $0.7 million at December 31, 1996. The gross unrealized gains and losses for the fixed maturity securities portfolio at December 31, 1997 were $87.0 and $16.0 million, respectively, compared to $55.0 and $55.7 million, respectively, at December 31, 1996.
Net investment losses in 1997 resulted primarily from losses on equity index securities and short sales by non-insurance companies, partially offset by net investment gains of insurance companies (see information concerning the components of investment (losses) gains of non-insurance companies included in "Results of Operations-Other," below). The Company enters into these investment positions for a number of purposes: (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.
Property and casualty operations showed a modest improvement in 1997 as a result of increased net investment gains.
Property and casualty revenues decreased by $47.3 million, or 0.4%, and increased $1.9 billion, or 16.7%, as compared to 1996 and 1995, respectively.
Property and casualty premium revenues decreased by $200.0 million, or 2.0%, and increased $1.2 billion, or 13.8%, as compared to 1996 and 1995, respectively. Premium revenues declined, as compared to 1996, due primarily to lower professional and specialty ($157.0 million), general liability and commercial automobile ($72.0 million), and reinsurance and other premiums ($106.0 million). These declines were partially offset by increased accident and health premiums ($163.0 million).
Property and casualty investment income decreased by $91.0 million, or 4.8%, and increased $91.0 million, or 5.4%, as compared to 1996 and 1995, respectively. The decline, as compared to 1996, is principally due to overall lower yields primarily in the bond market due to lower interest rates. The increase, as compared to 1995, reflects a higher base of invested assets, partially offset by lower bond yields. The bond segment of the investment portfolio yielded 6.5% in 1997, compared with 6.8% and 6.9% in 1996 and 1995, respectively.
Pre-tax investment gains amounted to $592.5, $473.6 and $320.6 million for the years 1997, 1996 and 1995, respectively.
Net income excluding net investment gains of CNA's property and casualty insurance subsidiaries was $386.2 million for 1997, compared to $444.8 and $355.3 million in 1996 and 1995, respectively. Net investment gains for 1997 were $323.6 million, compared to $255.6 and $174.8 million in 1996 and 1995, respectively.
Underwriting results, which include insurance and insurance-related operations, deteriorated by 1.7%, primarily the result of an extremely competitive commercial market place exerting pressure on pricing and increased operating expenses. Operating expenses increased as a result of technology and system upgrades and consulting costs. Property and casualty underwriting losses were $1.2 billion in 1997, compared to $1.1 and $1.1 billion in 1996 and 1995, respectively. Underwriting results in 1996 generally reflected improved loss experience from workers' compensation business, partially offset by lower results from personal lines.
Catastrophe losses for 1997 on a pre-tax basis were approximately $92.0 million, compared with $315.0 million in 1996 and $149.0 million in 1995. CNA's 1997 and 1996 catastrophe losses were primarily weather related losses, including winter storms, tornadoes and flooding. CNA's 1995 catastrophe losses related primarily to tropical storms and hail storms in Texas.
The following favorable (adverse) reserve development reflects the effects of management's ongoing evaluation of reserve levels and is comprised of the following components:
Management believes its reserves for environmental pollution and asbestos claims are appropriately established based upon known facts and current case law. However, due to the inconsistencies of court coverage decisions, the number of waste sites subject to clean-up, the standards for clean-up and liability, and other factors, the ultimate exposure to CNA for these claims may vary materially from the amounts currently recorded, resulting in a potential increase in the claim reserves recorded. In addition, issues related to, among other things, specific policy provisions, allocation of liability among insurers, consequences of conduct of the insured, missing policies and proof of coverage make quantification of liabilities exceptionally difficult and subject to adjustment based upon newly available data. Due to the uncertainties and factors described above, the ultimate exposure to CNA for environmental pollution claims may vary substantially from the amounts currently recorded.
monitoring of current payment and settlement patterns, current pending cases and potential future claims.
Other 1997 favorable loss reserve development of $361.0 million was attributable to approximately $540.0 million in involuntary risk business, and approximately $200.0 million in personal lines business, partially offset by unfavorable loss and loss adjustment expense development of $379.0 million in commercial lines. The 1997 favorable loss development was offset in part by unfavorable premium development of approximately $340.0 million in involuntary risk business and $170.0 million favorable premium development in commercial lines.
Net income declined due primarily to the settlement of certain tobacco related litigation. As discussed in Note 18 of the Notes to Consolidated Financial Statements, Lorillard and other companies in the United States tobacco industry have entered into agreements to settle health care cost recovery actions in Florida, Mississippi and Texas,
Without the charges for tobacco related litigation, net income would have increased by $40.7 and $100.1 million as compared to 1996 and 1995, respectively. These increases were due primarily to the increased revenues, partially offset by higher legal expenses in 1997. The rise in legal expenses reflects the increasing number of cases seeking damages against Lorillard for cancer and other health effects claimed to have resulted from an individual's use of cigarettes or exposure to tobacco smoke. At December 31, 1997, Lorillard was named as a defendant in approximately 384 lawsuits, compared to 143 lawsuits in the prior year. Lorillard continues to vigorously defend itself against these actions.
Revenues in 1995 included gains of $14.5 and $4.0 million ($9.4 and $2.6 million after taxes) related to the transfer of the Monte Carlo casino operations and the settlement of a management contract.
Revenues increased by $329.4 and $638.0 million, as compared to 1996 and 1995, respectively. Net income increased by $78.8 and $139.6 million, as compared to 1996 and 1995, respectively. Revenues increased by $106.6 and $223.4 million, as compared to 1996 and 1995, respectively, due to the 11 rigs acquired in the acquisition of Arethusa in April 1996.
In addition, revenues increased $189.4 and $313.5 million as a result of higher dayrates, and $11.5 and $35.5 million from increased utilization rates as compared to 1996 and 1995, respectively. The increased dayrates and utilization rates reflect the overall improvement in the offshore drilling market as previously discussed. Revenues also increased by $61.4 and $67.3 million, as compared to 1996 and 1995, respectively, due to the completion of upgrade projects on four drilling rigs. In addition, during 1996 Diamond Offshore recognized gains totaling $34.8 million from the sale of all of its land drilling rigs and related equipment, and three offshore drilling rigs. Diamond Offshore's revenues also benefitted from higher interest income, partially offset by the absence of revenues from the sale of its land drilling rigs.
Revenues increased by $8.1 and $19.4 million, or 6.7% and 17.7%, as compared to 1996 and 1995, respectively. Net income increased by $2.9 and $6.9 million, as compared to 1996 and 1995, respectively.
to 1996 and 1995, respectively, and an overall increase in watch unit prices. The increased net income was partially offset by higher brand support advertising in 1997. In addition, revenues and net income in 1995 included interest income of $4.2 million and a tax expense of $3.2 million resulting from a tax audit adjustment.
Revenues decreased by $881.3 and $1,901.9 million, as compared to 1996 and 1995, respectively. Net income decreased by $604.3 and $1,282.4 million as compared to 1996 and 1995, respectively. Other operations consist primarily of investment income of non-insurance companies, including investment (losses) gains from the Company's investment portfolio.
The components of investment (losses) gains included in other operations are as follows:
Exclusive of securities transactions, other revenues increased by $27.7 and $86.0 million, or 17.3% and 84.3%, as compared to 1996 and 1995, respectively. Revenues increased due primarily to higher investment income reflecting increased levels of invested assets. Net loss increased by $11.9 million and decreased by $7.7 million, as compared to 1996 and 1995, respectively. Net loss increased, as compared to 1996, due primarily to higher corporate interest expense, partially offset by higher investment income. Net loss declined, as compared to 1995, due primarily to the increased investment income, partially offset by higher corporate interest and administrative expenses.
Most of the Company's older computer programs were written using two digits rather than four to define the applicable year. As a result, those computer programs contain time-sensitive software that recognize a date using "00" as the year 1900 rather than the year 2000. This could cause a system failure or miscalculations causing disruptions of operations, including, among other things, a temporary inability to process transactions, send invoices, or engage in similar normal business activities.
The project is estimated to be completed not later than December 31, 1998, which is prior to any anticipated impact on its operating systems. The Company believes that with modifications to existing software and conversions to new software, the Year 2000 issue will not pose significant operational problems for its computer systems. However, if such modifications and conversions are not made, or are not completed timely, the Year 2000 issue could have a material impact on the operations of the Company. In addition, 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. In addition, property and casualty insurance subsidiaries may have an underwriting exposure related to the Year 2000. Although CNA has not received any claims for coverage from its policyholders based on losses resulting from Year 2000 issues, there can be no assurance that policyholders will not suffer losses of this type and seek compensation under CNA's insurance policies. If any claims are made, coverage, if any, will depend on the facts and circumstances of the claim and the provisions of the policy. At this time, CNA is unable to determine whether the adverse impact, if any, in connection with the foregoing circumstances would be material.
their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of the statement of financial position. This Statement is effective for fiscal years beginning after December 15, 1997. This Statement will not have a significant impact on the Company.
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 by all entries that are subject to insurance-related assessments. The SOP requires entities to recognize liabilities for insurance-related assessments when certain criteria are met. 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.
Condensed Balance Sheet Information Loews Corporation and Subsidiaries (Including CNA and Diamond Offshore on the Equity Method)
Condensed Statements of Cash Flow Information Loews Corporation and Subsidiaries (Including CNA and Diamond Offshore on the Equity Method)
Securities sold under agreements to repurchase - The Company has a securities lending program where securities are loaned to third parties, primarily major brokerage firms. Borrowers of these securities must deposit 100% of the fair value of these securities if the collateral is cash, or 102% if the collateral is securities. Cash deposits from these transactions are invested in short-term investments (primarily U.S. government securities and commercial paper). The Company continues to receive the interest on loaned debt securities, as beneficial owner, and accordingly, loaned debt securities are included within fixed maturity securities. The liabilities for securities sold under agreements to repurchase are recorded at their contracted repurchase amounts.
Insurance Operations - Premium revenue - Insurance premiums on property and casualty and health insurance contracts (included in life premiums) are earned ratably over the terms of the policies after provision for estimated adjustments on retrospectively rated policies and deductions for ceded insurance. Revenues on universal life type contracts are comprised of contract charges and fees which are recognized over the coverage period. Other life insurance premiums are recognized as revenue when due after deductions for ceded insurance.
Claim and claim expense reserves - Claim and claim expense reserves, except reserves for structured settlements, workers' compensation lifetime claims and accident and disability claims, are not discounted and are based on (a) case basis estimates for losses report-
ed on direct business, adjusted in the aggregate for ultimate loss expectations, (b) estimates of unreported losses based upon past experience, (c) estimates of losses on assumed insurance, and (d) estimates of future expenses to be incurred in settlement of claims. In establishing these estimates, consideration is given to current conditions and trends as well as past company and industry experience. The effects of inflation, which can be significant, are implicitly considered in the reserving process and are part of the recorded reserve balance.
Structured settlements have been negotiated for claims on certain property and casualty insurance policies. Structured settlements are agreements to provide periodic payments to claimants, which are fixed and determinable as to the amount and time of payment. Certain structured settlements are funded by annuities purchased from CNA's life insurance subsidiary. Related annuity obligations are recorded in future policy benefits reserves. Obligations for structured settlements not funded by annuities are carried at the present value of future benefits. At December 31, 1997 and 1996, such reserves, discounted at interest rates ranging from 6.3% to 7.5%, totaled $913.0 and $924.0, respectively (reflecting a discount of $1,527.0 and $1,556.0, respectively).
Future policy benefits reserves - Reserves for traditional life insurance products are computed based upon the net level premium method using actuarial assumptions as to interest rates, mortality, morbidity, withdrawals and expenses. Actuarial assumptions include a margin for adverse deviation and generally vary by plan, age at issue and policy duration. Interest rates range from 3.0% to 11.0%, and mortality, morbidity and withdrawal assumptions reflect CNA and industry experience prevailing at the time of issue. Expense assumptions include the estimated effects of inflation and expenses beyond the premium paying period.
Involuntary risks - CNA's share of involuntary risks is mandatory and generally a function of its share of the voluntary market by line of insurance in each state. CNA records the estimated effects of its mandatory participation in residual markets on an accrual basis. CNA records assessments for insolvencies as they are paid. Accrual for such assessments have not been practical as the availability of information, in sufficient detail, regarding related assessments has been limited.
Separate Account business - CNA's life insurance subsidiary, Continental Assurance Company ("CAC"), issues certain investment and annuity contracts. The supporting assets and liabilities of these contracts are legally segregated and reflected in the accompanying Consolidated Balance Sheets as assets and liabilities of Separate Account business. CAC guarantees principal and a specified return to the contract holders on approximately 74% of the Separate Account business. Substantially all assets of the Separate Account business are carried at fair value. Separate Account liabilities are carried at contract value.
Statutory capital and surplus - Statutory capital and surplus and net income, determined in accordance with accounting practices prescribed by the regulations and statutes of various insurance departments, for property and casualty and life insurance subsidiaries, are as follows:
Statutory accounting practices - CNA's insurance affiliates are domiciled in various jurisdictions. These affiliates prepare statutory financial statements in accordance with accounting practices "prescribed" or otherwise "permitted" by the respective jurisdiction's insurance regulator. Prescribed statutory accounting practices are set forth in a variety of publications of the National Association of Insurance Commissioners, as well as state laws, regulations and general administrative rules. CNA has no material permitted accounting practices.
Tobacco products - These inventories, aggregating $227.9 and $247.4 at December 31, 1997 and 1996, respectively, are stated at the lower of cost or market, using the last-in, first-out (LIFO) method.
Watches and clocks - These inventories, aggregating $35.7 and $37.1 at December 31, 1997 and 1996, respectively, are stated at the lower of cost or market, using the first-in, first-out (FIFO) method.
Reclassification - Certain amounts applicable to prior periods have been reclassified to conform to the classifications followed in 1997.
The fair value of the liability for financial guarantee contracts is based on discounted cash flows utilizing interest rates currently being offered for similar contracts.
The fair value of guaranteed investment contracts and deferred annuities of the Separate Accounts business are estimated using discounted cash flow calculations, based on interest rates currently being offered for similar contracts with similar maturities. The fair value of the liabilities for variable Separate Accounts business are based on the quoted market values of the underlying assets of each variable Separate Account. The fair value of other Separate Account business liabilities approximates carrying value.
Fair value of long-term debt is based on quoted market prices when available. The fair values for other long-term debt are based on quoted market prices of comparable instruments adjusted for differences between the quoted instruments and the instruments being valued or are estimated using discounted cash flow analyses, based on current incremental borrowing rates for similar types of borrowing arrangements.
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 Contracts with large financial institutions and considers the risk of nonperformance to be remote.
The Company's investments in derivative instruments held for trading are as follows:
The Company also enters into short sales as part of its portfolio management strategy. Short sales are commitments to sell a financial instrument not owned at the time of sale, usually done in anticipation of a price decline. These sales resulted in proceeds of $602.3 and $543.5 with fair value liabilities of $880.7 and $588.9 at December 31, 1997 and 1996, respectively. These positions are marked to market and investment gains or losses are included in the income statement.
The pro forma consolidated condensed results of operations presented below assume the above transaction had occurred at January 1, 1995.
The pro forma consolidated condensed financial information is not necessarily indicative either of the results of operations that would have occurred had this transaction been consummated at January 1, 1995 or of future operations of the combined companies.
Depreciation and amortization expense, including amortization of intangibles, and capital expenditures, by business segment, are as follows:
CNA's property and casualty insurance claims and claims expense reserve represents the estimated amounts necessary to settle all outstanding claims, including claims which are incurred but not reported, as of the reporting date. The Company's reserve projections are based primarily on detailed analysis of the facts in each case, CNA's experience with similar cases, and various historical development patterns. Consideration is given to such historical patterns as field reserving trends, loss payments, pending levels of unpaid claims and product mix, as well as court decisions, economic conditions and public attitudes. All of these can affect the estimation of reserves.
Establishing loss reserves is an estimation process. Many factors can ultimately affect the final settlement of a claim and, therefore, the reserve that is needed. Changes in the law, results of litigation, medical costs, the cost of repair materials and labor rates can all impact ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably predictable than long-tail claims, such as general liability and professional liability claims.
The table below provides a reconciliation between beginning and ending claim and claim expense reserve balances for 1997, 1996 and 1995:
The Comprehensive Environmental Response Compensation and Liability Act of 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 establish mechanisms to pay for clean-up of waste sites if PRP's fail to do so, and to assign liability to PRP's. 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 1997 and it is unclear as to what positions Congress or the 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 materially 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 regulation that would result.
As of December 31, 1997 and 1996, CNA carried approximately $773.0 and $907.8, 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, which coincides with CNA's adoption of the Simplified Commercial General Liability coverage form which included an absolute pollution exclusion.
Other 1997 favorable loss reserve development of $361.0 was attributable to approximately $540.0 in
At December 31, 1997, the Company had net operating loss carryforwards of $870.0 for income tax purposes that expire in years 2000 through 2017. Of the $870.0 in loss carryforwards approximately $800.0 of those carryforwards resulted from CNA's acquisition of CIC.
The Company has a past history of profitability and anticipates sufficient future taxable income to fully support recognition of its deferred tax balance at December 31, 1997, including but not limited to the reversal of existing temporary differences and the implementation of tax planning strategies, if needed.
A valuation allowance is maintained due to the uncertainty regarding the realizability of certain deferred tax assets.
The Company has entered into separate tax allocation agreements with Bulova and CNA, majority-owned subsidiaries in which its ownership exceeds 80% (the "Subsidiaries"). Each agreement provides that the Company will (i) pay to the Subsidiary the amount, if any, by which the Company's consolidated federal income tax is reduced by virtue of inclusion of the Subsidiary in the Company's return, or (ii) be paid by the Subsidiary an amount, if any, equal to the federal income tax which would have been payable by the Subsidiary if it had filed a separate consolidated return. Under these agreements, CNA will pay or has paid the Company approximately $210.0 and $99.0 for 1997 and 1996, respectively, and received from the Company approximately $78.0 for 1995. The federal income tax to be received from Bulova amounted to approximately $2.6 and $5.3 for 1997 and 1996, respectively, and Bulova has received approximately $2.1 for 1995. Each agreement may be cancelled by either of the parties upon thirty days' written notice.
The Company's federal income tax returns have been settled through 1990 and the years 1991 through 1994 are currently under examination. While tax liabilities for subsequent years are subject to audit and final determination, in the opinion of management the amount accrued in the consolidated balance sheet is believed to be adequate to cover any additional assessments which may be made by federal, state and local tax authorities and should not have a material effect on the financial condition or results of operations of the Company.
In September 1997, the Company issued $1,150.0 principal amount of 3 1/8% exchangeable subordinated notes due 2007 (the "Notes"). The Notes are exchangeable into shares of common stock of Diamond Offshore Drilling, Inc. at any time from October 1, 1998 until maturity at an exchange rate of 15.376 shares per one thousand dollar principal amount of Notes (equivalent to an exchange price of $65.04 per share). The Company may elect cash settlement in lieu of delivering Diamond Offshore common stock. The Notes are redeemable in whole or in part at September 15, 2002 at 101.6%, and decreasing percentages thereafter.
In 1995, CNA entered into interest rate swap agreements with a notional principal amount of $1,200.0, which terminate from May to December 2000. These agreements effectively convert variable rate debt into fixed rate debt and provide that CNA pay interest at a fixed rate, averaging 6.2% at December 31, 1997, in exchange for the receipt of interest at the three month LIBOR rate. Concurrent with the pay down of $250.0 on the Bank Facility, CNA terminated interest rate swaps with a total notional amount of $250.0. As a result, the borrowing capacity under the Bank Facility was reduced to $1,075.0. The effect of these interest rate swaps was to increase interest expense by approximately $4.0 and $7.0 for the years ended December 31, 1997 and 1996, respectively.
In conjunction with the merger with Capsure Holdings Corp. CNA's affiliate, CNA Surety entered into a $130.0, 5 year revolving credit facility which closed and was funded on September 30, 1997. The interest rate for the facility is based on LIBOR plus 20 basis points. Additionally there is a facility fee of 10 basis points annually. At December 31, 1997 the interest rate was 6.2%.
The Company's hotels in some instances are constructed on leased land or are leased. Other leases cover office facilities, computer and transportation equipment. Rent expense amounted to $127.2, $128.6 and $118.9 for the years ended December 31, 1997, 1996 and 1995, respectively. It is expected, in the normal course of business, that leases which expire will be renewed or replaced by leases on other properties; therefore, it is believed that future minimum annual rental commitments will not be less than the amount of rental expense incurred in 1997. At December 31, 1997 future aggregate minimum rental payments approximated $635.9.
For measurement purposes, a trend rate for covered costs of 8.3% to 9.0% pre-65 and 7.3% post-65, was used. These trend rates are expected to decrease gradually to 5.0% at rates from .3% to .5% per annum. An increase of one percentage point in assumed health care cost trend rates would increase the accumulated postretirement benefit obligation by approximately $33.8 and the net periodic postretirement benefit cost by approximately $4.1.
Savings Plans - The Company and its subsidiaries have several contributory savings plans which allow employees to make regular contributions based upon a percentage of their salary. Effective January 1, 1998, a savings plan was changed where the Company will provide a matching contribution of two-thirds of a participant's contribution, up to the first 6% of their pay. The Company's contributions to these plans amounted to $29.1, $28.6 and $25.9 for the years ended December 31, 1997, 1996 and 1995, respectively.
In April 1997, Diamond Offshore Drilling Inc., (Diamond Offshore) completed a public offering of 2.5 million shares of its common stock for net proceeds of approximately $82.3. Diamond Offshore used these funds to acquire the Polyconfidence, a semisubmersible accommodation vessel currently working in the U.K. sector of the North Sea for approximately $81.0. As a result of the public offering, the Company's ownership interest in Diamond Offshore declined to 50.3% and the Company recorded a pre-tax gain of approximately $29.1 ($18.9 after provision for deferred taxes).
On April 29, 1996, Diamond Offshore, then a 70% owned subsidiary, acquired Arethusa (Off-Shore) Limited ("Arethusa"). Diamond Offshore issued 35.8 million shares of its common stock and assumed Arethusa stock options as consideration for the purchase price of approximately $550.7. Arethusa owned a fleet of 11 mobile offshore drilling rigs and operated two additional mobile offshore rigs pursuant to bareboat charters. The acquisition of Arethusa has been accounted for as a purchase, and Arethusa's operations are included in the Consolidated Financial Statements as of April 29, 1996. Pro forma operating results for the years ended December 31, 1996 and 1995, assuming the transaction had occurred at the beginning of the respective periods, would not be materially different from those reported in the Consolidated Financial Statements. The Company recognized a gain of approximately $186.6 ($121.3 after provision for deferred income taxes) and its interest in Diamond Offshore declined to approximately 51%.
Earnings per share are based on the weighted average number of shares outstanding during each year (115,000,000, 116,161,000 and 117,835,000 for the years ended December 31, 1997, 1996 and 1995, respectively).
Insurance claims and policyholders' benefits are net of reinsurance recoveries of $1,309.0, $1,220.0 and $934.8 for the years ended December 31, 1997, 1996 and 1995, respectively.
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") which is subject to court approval to resolve all future asbestos-related bodily injury claims involving Fibreboard.
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 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. On June 27, 1997, the Supreme Court granted two petitions for certiorari vacating the Fifth Circuit's judgment as respects 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. Objectors have ninety days after the judgment is entered by the Fifth Circuit to file a Petition for Certiorari to the Supreme Court.
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 $1,530.0 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, although the Global Settlement has so far been approved on appeal, further review may be sought. There is limited precedent for settlements which determine the rights of future claimants to seek relief.
In these actions, plaintiffs claim substantial compensatory, statutory and punitive damages in amounts ranging into the billions of dollars. These 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 consumer protection statutes, and failure to warn of the allegedly harmful and/or addictive nature of tobacco products. Some cases are scheduled for trial during 1998.
CONVENTIONAL PRODUCT LIABILITY CASES - There are approximately 590 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 200 of these cases. The Company is a defendant in eight of these cases.
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.
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 49 of the 53 cases seeking class certification. The Company is a defendant in 20 of the purported class actions. 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 finally approved by the 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. The amount to be paid by Lorillard is to be based upon each of the four settling defendants' share of the United States market for the sale of cigarettes. Lorillard presently has 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, 1997 which enabled them to be members of the class. The defendants that executed the settlement agreement agreed to 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 some have noticed an appeal from the February 3, 1998 order.
REIMBURSEMENT CASES - Approximately 110 actions are pending in which governmental entities, private citizens, or other organizations, including labor unions 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 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. The Company is named as a defendant in 19 of them.
State or Local Governmental Reimbursement Cases - To date, suits filed by 40 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 15 cases filed by state or local governmental entities. Since January 1, 1997, cases brought by Florida, Mississippi and Texas have been settled (see "Settlements of Reimbursement Cases"). Trial for the case brought by the State of Minnesota began on January 20, 1998 and is proceeding. Many of the pending Reimbursement Cases are in the pre-trial, discovery stage.
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 reimbursement suits in two of the four states. The Company is a defendant in four 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.
Reimbursement Cases by Indian Tribes - Indian Tribes have filed five reimbursement suits in their tribal courts, one of which has been dismissed. Lorillard is a defendant in each of the cases. The Company is not named as a defendant in any of the five tribal suits filed to date. Each of the pending cases is in the pre-trial, discovery stage.
Reimbursement Cases by Labor Unions - Labor unions have filed approximately 45 reimbursement suits in various states in federal or state courts. Lorillard is named as a defendant in each of the suits filed to date by unions. The Company is not a defendant in any of the cases filed to date by unions. Each of these cases is in the pre-trial, discovery stage.
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. Sixteen such cases 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 $10.0 in compensatory damages and $100.0 in punitive damages. 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, which Lorillard has appealed, requires Lorillard to pay the amount of $.14, although the award subsequently was reduced to $.07.
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 and work product protection. 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.
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.
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.
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.
The Proposed Resolution is the subject of continuing review and comment by the White House, Congress, the public health community and other interested parties. The White House and certain members of the public health community have expressed concern with certain aspects of the Proposed Resolution. Certain members of Congress have offered or indicated that they may offer alternative legislation. Currently, over thirty bills have been introduced in Congress regarding the issues raised in the Proposed Resolution, including bills seeking more stringent regulation of the tobacco industry by the Food and Drug Administration (the "FDA") and bills to increase the federal excise tax on tobacco products. Several of these bills seek to increase the payments by the tobacco industry from the levels reflected in the Proposed Resolution and deny the industry any form of relief from civil litigation. No bill currently introduced would adopt the Proposed Resolution as agreed to. There can be no assurance that federal legislation in the form of the Proposed Resolution will be enacted or that it will be enacted without modification that is materially adverse to Lorillard or that any modification would be acceptable to Lorillard or that, if enacted, the legislation would not face legal challenges. In any event, the Company believes implementation of the Proposed Resolution 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 final form of implementing federal legislation, the rates of decline in United States cigarette sales in the premium and discount segments and Lorillard's share of the domestic premium and discount cigarette segments. Moreover, the negotiation and signing of the Proposed Resolution could affect other federal, state and local regulation of the United States tobacco industry.
The Proposed Resolution includes provisions relating to advertising and marketing restrictions, product warnings and labeling, access restrictions, licensing of tobacco retailers, the adoption and enforcement of "no sales to minors" laws by states, surcharges against the industry for failure to achieve underage smoking reduction goals, regulation of tobacco products by the FDA, public disclosure of industry documents and research, smoking cessation programs, compliance programs by the industry, public smoking and smoking in the workplace, enforcement of the Proposed Resolution, industry payments and litigation.
The Proposed Resolution would require the FDA to impose annual surcharges on the industry if targeted reductions in underage smoking are not achieved in accordance with a legislative timetable. The surcharge would be based upon an approximation of the present value of the profit the companies would earn over the lives of all underage consumers in excess of the target and would be allocated among participating manufacturers based on their market share of the United States cigarette industry.
SETTLEMENTS OF REIMBURSEMENT CASES - In furtherance of the Proposed Resolution, Lorillard and other companies in the United States tobacco industry (the "Settling Defendants") have settled reimbursement cases brought by the States of Florida, Mississippi and Texas on terms consistent with the Proposed Resolution. The Mississippi action was settled in July 1997, Florida was settled in September 1997 and Texas was settled in January 1998, although final approval of the Texas settlement has been deferred until March 25, 1998 to enable the state and certain of its political subdivisions and hospital systems an opportunity to litigate issues with respect to the scope of the agreement. These settlements resulted in a pre-tax charge to earnings of $163.4 in 1997.
Under the Florida settlement agreement, the Settling Defendants paid $550, representing Florida's estimated share of the $10,000 initial payment under the Proposed Resolution, and also reimbursed Florida's expenses and those of its private counsel. The Settling Defendants also paid $200 to support a pilot program by Florida aimed at reducing the use of tobacco products by persons under the age of eighteen. Lorillard's share of all the foregoing payments, approximately $59.5, was charged to expense in 1997.
If legislation implementing the Proposed Resolution or its substantial equivalent is enacted, the settlements will remain in place, but the terms of the federal legislation will supercede the settlement agreements (except for the terms of the pilot programs and payments thereunder, the initial payments and the annual payments with respect to 1998), and the other payments described above will be adjusted so that Florida, Mississippi and Texas will receive the same payments as they would receive under such legislation.
If the Settling Defendants enter into any future pre-verdict settlement agreement with a non-federal governmental plaintiff on more favorable terms (after due consideration of relevant differences in population or other appropriate factors), Florida, Mississippi and Texas will obtain treatment at least as relatively favorable as such governmental plaintiff.
If federal legislation implementing the Proposed Resolution or its substantial equivalent is enacted, the parties contemplate that Florida, Mississippi and Texas and any other state that has made an exceptional contribution to secure resolution of these matters may apply to a panel of independent arbitrators for reasonable compensation for its efforts in securing the Proposed Resolution. The Settling Defendants have agreed not to oppose applications for $75 by Mississippi, $250 by Florida and $329.5 by Texas, subject to a nationwide annual cap for all such payments of $100.
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.
As multiple-line insurers, CNA's insurance operations underwrite property, casualty, life, and accident and health coverages in the United States. Foreign operations are not significant. Insurance products are marketed by CNA through independent agents and brokers.
Loews Hotels owns and/or operates 14 hotels, 11 of which are in the United States, two are in Canada and one is located in Monte Carlo.
Diamond Offshore's business primarily consists of operating 46 offshore drilling rigs that are chartered on a contract basis for fixed terms by companies engaged in exploration and production of hydrocarbons. Offshore rigs are mobile units that can be relocated based on market demand. Currently 65% of these rigs operate in the Gulf of Mexico, 11% operate in the North Sea and the remaining 24% are located in various foreign markets.
The following table sets forth the major sources of the Company's consolidated revenues, income and assets.
There were no reports filed for the three months ended December 31, 1997.
Dated: March 30, 1998 By /s/ Gloria R. Scott --------------------------------- (Gloria R. Scott, Director)
Dated: March 30, 1998 By /s/ Andrew H. Tisch --------------------------------- (Andrew H. Tisch, Director)
Dated: March 30, 1998 By /s/ Preston R. Tisch --------------------------------- (Preston R. Tisch, Director)
We have audited the accompanying consolidated balance sheets of Loews Corporation and its subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1997. Our audits also included the financial statement schedules listed in the Index at Item 14(a)2. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.
(b) The Company is included in a consolidated federal income tax return with certain of its subsidiaries and, accordingly, participates in the allocation of certain components of the consolidated provision for federal income taxes. Such taxes are generally allocated on a separate return bases.