In 1993 the Company changed its method of accounting for reinsurance contracts and certain investments in debt and equity securities. In 1992 the Company changed its method of accounting for postretirement benefits, income taxes and certain workers' compensation and disability claims. See Note 1 of the Notes to Consolidated Financial Statements.
Property and casualty and life insurance operations are wholly owned subsidiaries of CNA Financial Corporation ("CNA"). CNA is an 84% owned subsidiary of the Company. The prolonged soft market in commercial property and casualty lines that depressed property and casualty earnings last year in much of the insurance industry did not change significantly in 1994. Significant catastrophe claims related to the Northridge earthquake near Los Angeles and severe winter storms in the Northeast and declining bond portfolios due to rising interest rates put additional pressure on the industry. Catastrophe losses for the industry of $14.9 billion have already made 1994 the second worst year on record for catastrophic losses, behind the record $22.9 billion in 1992. The earthquake losses will approach $10.4 billion, more than four times earlier estimates of $2.5 billion. On the other hand, the workers' compensation line has improved steadily since 1992. Legislative reforms have cut costs in some states, residual market losses have dropped and insurance regulators have sharpened their focus on workers' compensation fraud. In this difficult business climate, CNA remains among the strongest and most competitive multi-line organizations in the insurance industry and remains committed to conservative financial strategies as the foundation for profitable growth. In 1994, CNA was impacted by all the industry factors mentioned above. Net income was reduced by substantial catastrophe losses and by realized investment losses due to rising interest rates. However, results were satisfactory in its core businesses. Workers' compensation profitability continued to improve. CNA's new Strategic Business Units ("SBUs") sharpened customer focus, increased efficiencies and strengthened management accountability in all its businesses. SBUs are operating groups dedicated to specific segments of CNA business in commercial, personal, life and health, and specialty insurance. Life operations experienced significant growth as a result of new products, with life profitability increasing primarily due to increased investment income and improved mortality experience. Other significant events included continued progress toward a global settlement regarding the Fibreboard asbestos claim and significant merger and acquisition activity resulting in agreements to acquire The Continental Corporation and Alexsis.
Fibreboard-As described in Note 18 of the Notes to Consolidated Financial Statements, Continental Casualty Company ("Casualty") has greatly reduced a major source of financial uncertainty by reaching a Global Settlement executed in December 1993 to resolve all future asbestos-related bodily injury claims involving Fibreboard Corporation ("Fibreboard"), a former asbestos manufacturer. On July 29, 1994 the United States District Court for the Eastern District of Texas preliminarily approved the Global Settlement agreement. A final fairness hearing, to determine whether to approve the Global Settlement agreement, commenced on December 12, 1994. During the hearing various parties presented evidence in opposition to the Global Settlement. Also pending in the United States District Court for the Eastern District of Texas is litigation over the Trilateral Agreement. Trial on the issues raised by this agreement occurred on February 13, 1995, with evidence submitted to the Court in opposition to final court approval of the Trilateral Agreement. CNA and the other parties to the Global Settlement agreement and the Trilateral Agreement undertook a comprehensive court approved notice program to provide potential claimants information about their rights and possible benefits under the Global Settlement agreement and Trilateral Agreement. Final arguments concerning the Global Settlement agreement occurred on February 27, 1995; the court's rulings are expected in the spring of 1995. No date has been set for final legal arguments for the Trilateral Agreement.
Diamond Offshore Drilling, Inc. and subsidiaries ("Diamond Offshore"). Oversupply of drilling rigs and low gas and crude oil prices continue to depress conditions in the drilling industry and to adversely impact Diamond Offshore. Although funds for future capital expenditures and working capital requirements are expected to be provided from operations, Diamond Offshore may require additional advances from the Company due to the cyclical nature of the industry.
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 income 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, prepayments, tax and credit considerations, or other similar factors. Accordingly, the fixed income securities are classified as available for sale. During 1994, consolidated investments increased $1.6 billion to $26.9 billion. This increase was the result of securities lending activity of $1.9 billion where CNA sells securities to brokers while agreeing to repurchase them at a future date. This increase was partially offset by a decline in fair values of fixed income securities due to rising interest rates. The general account portfolio consists primarily of high quality marketable debt securities, 95% of which are rated as investment grade. At December 31, 1994, tax exempt securities and short-term investments comprised approximately 13% and 18%, respectively, of the general account's total investment portfolio compared to 19% and 28%, respectively, at December 31, 1993. At December 31, 1994 and 1993, short-term investments primarily consisted of U.S. Treasury bills and commercial paper. As of December 31, 1994 CNA's general account investments in bonds and redeemable preferred stocks were carried at a fair value of $20.8 billion, compared to $17.6 billion at December 31, 1993. At December 31, 1994, net unrealized losses on fixed income securities amounted to approximately $795 million. This compares to $504 and $846 million of net unrealized gains at December 31, 1993 and 1992, respectively. The gross unrealized gains and losses for the fixed income securities portfolio at December 31, 1994 were $194 and $989 million, respectively, compared to $564 and $60 million, respectively, at December 31, 1993. Net unrealized losses on general account bonds at December 31, 1994 include net unrealized losses on high yield securities of $30 million, compared to net unrealized gains of $15 million at December 31, 1993. 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. Carrying values of high yield securities in the general account were $1.0 billion at December 31, 1994, compared to $727 million at December 31, 1993. At December 31, 1994, total Separate Account cash and investments amounted to $6.1 billion with taxable debt securities representing approximately 88% of the Separate Accounts portfolio. Approximately 88% of Separate Account investments are used to fund guaranteed investment contracts ("GIC's") for which Continental Assurance Company guarantees principal and a specified return to the contractholders. Securities included in the GIC portfolio are matched with the corresponding liability in the GIC contract. At December 31, 1994, all fixed income securities in the GIC portfolio were carried at fair value and amounted to $4.6 billion. At December 31, 1994, net unrealized losses on fixed income securities amounted to approximately $195 million. This compares to $148 and $158 million of net unrealized gains at December 31, 1993 and 1992, respectively. The gross unrealized gains and losses for the fixed income securities portfolio at December 31, 1994, were $34 and $229 million, respectively, compared to $163 and $15 million, respectively, at December 31, 1993. High yield securities in the GIC portfolio are carried at fair value and amounted to $1.1 billion at December 31, 1994 and 1993. Net unrealized losses on high yield securities held in such Separate Accounts were $108 million at December 31, 1994, compared to net unrealized gains of $56 and $28 million at December 31, 1993 and 1992, respectively. 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. As of December 31, 1994, CNA's concentration in high yield bonds including Separate Accounts was approximately 4.8% of its total assets. Included in CNA's fixed income securities at December 31, 1994 (general and GIC portfolios) are $4.6 billion of asset-backed securities, consisting of approximately 34% in U.S. government agency issued pass-through certificates, 50% in collateralized mortgage obligations ("CMO's"), and 16% in corporate asset-backed obligations. The majority of CMO's held are U.S. government agency issues, which are actively traded in liquid
Investment activities of non-insurance companies include investments in fixed maturities securities, equity securities, derivative instruments and short-term investments. Derivative instruments are marked to market and reported as realized investment gains or losses in the income statement. The remaining securities are carried at fair value with a net unrealized gain of $146.2 million at December 31, 1994, compared to $151.9 million at December 31, 1993. The Company invests in certain derivative instruments for income enhancements as part of its portfolio management strategy. These instruments include various swaps, forwards and futures contracts as well as both purchased and written options. These investments subject the Company to market risk for positions where the Company does not hold an offsetting security. The Company controls this risk through monitoring procedures which include daily detailed reports of existing positions and valuation fluctuations. These reports are reviewed by members of senior management 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. In addition, the amounts subject to credit risk are substantially mitigated by collateral requirements in many of these transactions. The Company does not believe that any of the derivative instruments utilized by it are unusually complex or volatile, or expose the Company to a higher degree of risk. These derivative instruments have not had, and are expected not to have, an adverse impact on the results of operations. See Note 5 of the Notes to Consolidated Financial Statements for additional information with respect to derivative instruments, including recognized gains and losses on these instruments. The Company's short-term investments portfolio included $2.1 billion of proceeds from securities sold under agreements to repurchase at December 31, 1994. These proceeds have been invested in U.S. government treasury securities. The cost is approximately equivalent to fair value at December 31, 1994 due to the Company repositioning this portfolio in December. The Company has recognized gross realized investment losses of $154.8 million. This loss reflects the impact that rising interest rates has had on the Company's U.S. government portfolio.
Revenues declined by $171.6 and $176.3 million, or 1.3% in each case as compared to 1993 and 1992, respectively. Income before accounting changes decreased by $326.3 million, or 54.9%, and increased by $289.9 million as compared to 1993 and 1992, respectively.
Property and casualty revenues decreased by $71.3 million, or 0.9%, and increased by $139.7 million, or 1.8%, as compared to 1993 and 1992, respectively. Property and casualty premium revenues increased by $563.5 and $485.0 million, or 9.0% and 7.6%, as compared to 1993 and 1992, respectively. Property and casualty earned premiums were $6.8 billion up 9.0% from the $6.3 billion earned in 1993 and up 7.6% from 1992. The 1994 earned premium increase was principally attributable to increases in medium commercial accounts ($211 million), group accident and health ($132 million), professional liability ($138 million), and international reinsurance ($65 million). In addition, involuntary risks premium was $84 million above the prior year. Property and casualty investment income was up 17.0% from the $1.1 billion reported in 1993 and up 1.3% from 1992. Investment income increased primarily due to the continuing increase in interest rates and a decrease in short-term investments (excluding investments relating to loaned securities) from $5.1 billion at December 31, 1993 to $2.3 billion at December 31, 1994. Property and casualty underwriting losses were $1.2 billion in 1994, compared to $1.8 and $3.0 billion in 1993 and 1992, respectively. The combined ratio was 115.0 for 1994, compared with 127.3 and 144.8 for 1993 and 1992, respectively. As previously discussed, the primary reason for the 1993 and 1992 poor operating results was the addition of $500 million in underwriting losses related to Fibreboard in 1993 and $1.5 billion in 1992. Catastrophe losses (pre-tax) for 1994 were approximately $283 million, compared with $74 million in 1993 and $270 million in 1992. CNA's 1994 catastrophe losses related primarily to the Northridge earthquake near Los Angeles and severe winter storms in the Northeast. While it is too early to estimate the magnitude of the insured losses from the January 17, 1995 earthquake in Kobe, Japan, the amounts are not expected to be significant. Property and casualty pre-tax results include losses for involuntary risks of $17.8 million in 1994. Involuntary risk charges were $80.8 and $257.3 million in 1993 and 1992, respectively. The improved results in 1994 are due to the overall improvement in the workers' compensation market over the last two years. Involuntary risks include mandatory participation in residual markets, statutory assessments for insolvencies of other insurers and other involuntary charges. CNA's share of involuntary risks is 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. These estimates are adjusted as premium, claim and expense activity is received from the residual markets' administrators. CNA records assessments for insolvencies as they are paid rather than on an accrual basis. Such an accrual process would be very difficult, as past experience is not a reliable indicator of future activity. Further, information currently available from all the states' life and property and casualty guarantee funds is fairly limited and would not provide reliable data on which to base an estimated liability. Many states allow recovery of insolvency assessments by a direct offset to premium taxes or a separate policy surcharge. In addition, some states assess prospectively based on current premiums written. CNA, consistent with sound insurance reserving practices, regularly adjusts its reserve estimates in subsequent reporting periods as new facts and circumstances emerge that indicate the previous estimates need to be modified. These adjustments, referred to as "reserve development," are inevitable given the complexities of the reserving process and are recorded in the income statement in the period the need for the adjustment is determined. The property and casualty underwriting losses include net reserve decreases of $71 million for 1994. Results for 1994 also reflect adverse development for asbestos and environmental pollution claims which were offset by favorable development in other lines. Favorable trends were represented primarily by positive severity experience in professional liability lines and improvement in voluntary and involuntary workers' compensation experience, resulting in reserve decreases of $188 and $100 million, respectively.
Revenues increased by $32.2 and $16.0 million, or 17.4% and 7.9%, as compared to 1993 and 1992, respectively. Results from operations before accounting changes increased by $18.8 and $15.1 million, as compared to 1993 and 1992, respectively. Intensive rate competition continues to adversely affect average room rates, although occupancies have improved. Revenues and results of operations include pre-tax and after-tax gain on sales of two hotel leases amounting to $30.2 and $15.4 million, respectively, for the year ended December 31, 1994. Excluding this gain, revenues increased due primarily to higher occupancy rates as compared to 1993. Revenues declined, as compared to 1992, due to lower average room rates as well as lower occupancy rates at the Loews Monte Carlo hotel resulting from depressed economic conditions in southern Europe coupled with an absence of Italian tourist business on the Riviera. Results from operations before accounting changes, excluding the sale of the hotel leases, improved due to the increased occupancy rates as compared to 1993. Results from operations declined slightly, as compared to 1992, due primarily to the lower revenues.
Revenues decreased by $2.1 and $29.9 million, or 1.4% and 16.5%, as compared to 1993 and 1992, respectively. Results from operations before accounting changes decreased by $1.6 and $3.6 million, or 66.6% and 81.5%, as compared to 1993 and 1992, respectively. Revenues and results from operations declined, as compared to 1993, due primarily to a gain on sale of an inactive defense manufacturing facility in the prior year. Revenues and results from operations declined, as compared to 1992, due primarily to lower industrial and defense sales volume related to a $19.5 million payment by the U.S. government in 1992 in favorable settlements of defense contract claims. This benefit was partially offset by a charge of approximately $2.4 million for the write-off of parts inventory and equipment related to these contracts, as well as a continuing decline of defense business. Bulova's watch business continues to benefit from a change in its product sales mix as well as lower interest expense.
Disclosures of Certain Significant Risks and Uncertainties-In December 1994, the Accounting Standards Division of the AICPA issued SOP 94-6. Disclosure of Certain Significant Risks and Uncertainties. This SOP requires reporting entities to include in their financial statements disclosures about the nature of their operations and the use of estimates in the preparation of financial statements. Additional disclosures are required for certain significant estimates utilized in the financial statements and current vulnerability due to certain concentrations if specific criteria are met. This Statement would be effective for financial statements issued for fiscal years ending after December 15, 1995 and will not have a significant impact on the Company.
Accounting Changes-Effective December 31, 1993, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." This Statement requires that investments in debt and equity securities classified as available for sale be carried at fair value. Previously, fixed income securities classified as available for sale were carried at the lower of aggregate amortized cost or fair value. Unrealized gains and losses are reflected as a separate component of shareholders' equity, net of deferred income taxes, participating policyholders' and minority interests. The effect of adopting this Statement was to increase shareholders' equity by $367,928,000 (net of $293,973,000 in deferred income taxes, participating policyholders' and minority interests). The adoption of this Statement did not impact net income. Separate Account assets invested in debt securities have also been classified as available for sale and are carried at fair value. Effective January 1, 1993, the Company adopted SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-duration and Long-duration Contracts." This Statement establishes the conditions required for a contract to be accounted for as reinsurance, prescribes accounting and reporting standards for those contracts, and requires that balances pertaining to reinsurance transactions be reported "gross" on the balance sheet rather than reductions of reserves for claim and claim expense, policy benefits or unearned premiums. The provisions of SFAS No. 113 that pertain to risk transfer and recognition of revenues and costs did not impact the Company's income or shareholders' equity as all material reinsurance arrangements are prospective and provided for the transfer of risk. In 1992 the Company adopted SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions" and SFAS No. 109, "Accounting for Income Taxes." CBS Inc. (accounted for under the equity method) has also adopted SFAS Nos. 106 and 109 as well as SFAS No. 112, "Employers' Accounting for Postemployment Benefits" which requires accrual of benefits to be provided to former or inactive employees after employment, but before retirement. In addition, CNA Financial Corporation ("CNA"), an 84% owned subsidiary, changed its method of accounting from reporting ultimate reserves for fixed and determinable claim reserves related to workers' compensation lifetime claims and accident and health disability claims to discounting such reserves consistent with accounting practices on other similar fixed and determinable claims. The cumulative effect as of January 1, 1992 of adopting these accounting changes is as follows:
Statutory Accounting Practices-CNA's insurance affiliates are domiciled in Illinois, California, Connecticut, New York, Pennsylvania and Texas. These affiliates prepare their statutory financial statements in accordance with accounting practices specifically "prescribed" or otherwise "permitted" by the respective state's insurance department. Prescribed statutory accounting practices are set forth in a variety of publications of the National Association of Insurance Commissioners ("NAIC"), as well as state laws, regulations and general administrative rules. CNA has no material "permitted" accounting practices.
Inventories-Tobacco products-These inventories, aggregating $171,532,000 and $174,377,000 at December 31, 1994 and 1993, respectively, are stated at the lower of cost or market, using the last-in, first-out (LIFO) method. Watches and other timing devices-These inventories, aggregating $56,961,000 and $52,109,000 at December 31, 1994 and 1993, respectively, are stated at the lower of cost or market, using the first-in, first-out (FIFO) method.
Research and Development Costs-Research and development costs are charged to expense as incurred and amounted to $11,751,000, $11,866,000 and $11,521,000 for the years ended December 31, 1994, 1993 and 1992, respectively.
The amortized cost and market values of securities available for sale are as follows:
In cases where quoted market prices are not available, fair values may be based on estimates using present value or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rates and estimates of future cash flows. Accordingly, the estimates presented herein are subjective in nature and are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The amounts reported in the balance sheet for fixed maturities securities, equity securities, derivative instruments, short-term investments and securities sold under agreements to repurchase are at fair value. As such, these financial instruments are not shown in the table above. See Note 5 for the fair value of derivative instruments. Since the disclosure excludes certain financial instruments and all nonfinancial instruments such as real estate and insurance reserves, the aggregate fair value amounts cannot be summed to determine the underlying economic value of the Company. The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: Fixed maturity securities, equity securities and separate account securities are based on quoted market prices where available. For securities not actively traded, fair values are estimated using values obtained from independent pricing services or quoted market prices of comparable instruments adjusted for differences between the quoted instruments and the instruments being valued. Fair value for mortgage loans and notes receivable and policy loans are estimated using discounted cash flow analyses, at interest rates currently being offered for similar loans to borrowers with comparable credit ratings. Loans with similar characteristics are aggregated for purposes of the calculations. Other investments and other Separate Account assets consist of investments in limited partnerships, short term securities and various miscellaneous assets. Valuation techniques to determine fair value consist of discounted cash flows and quoted market prices of (a) the investments, (b) comparable instruments or (c) underlying assets of the investments. The fair value of certain assets contained above approximates their carrying value. Premium deposits and annuity contracts are valued based on cash surrender values and the outstanding fund balances. 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 and spot interest rates.
Most of the unfavorable asbestos-related reserve development is attributable to CNA's on-going litigation with Fibreboard Corporation. A detailed discussion of CNA's litigation with Fibreboard Corporation regarding asbestos-related bodily injury claims can be found in Note 18. CNA, consistent with sound reserving practices, regularly adjusts its reserve estimates in subsequent reporting periods as new facts and circumstances emerge that indicate the previous estimates need to be modified. The following table summarizes for 1994 and 1993 the net favorable and adverse reserve development, after effect of reinsurance.
(a) Includes $500,000 related to Fibreboard for the year ended December 31, 1993.
Total income tax expense (benefit) for the years ended December 31, 1994, 1993 and 1992 was different than the amounts of $93,152,000, $241,275,000 and $(176,278,000), computed by applying the statutory U.S. federal income tax rate of 35%, 35% and 34%, respectively, to income (loss) before income taxes and minority interest for each of the years. The reasons for variances from the statutory rate are as follows:
Other Postretirement Benefit Plans-The Company and its subsidiaries have several postretirement benefit plans covering eligible employees and retirees. Participants generally become eligible after reaching age 55 with required years of service. Actual requirements for coverage vary by plan. Benefits for retirees who were covered by bargaining units vary by each unit and contract. Benefits for certain retirees are in the form of a company health care account which can have a maximum of $4,500 per year, with an equal amount for a spouse in the same age grouping. Benefits for retirees reaching age 65 are generally integrated with Medicare. Benefits for certain retirees are in the form of a company health care account which can have a maximum value of $1,500 per year, with an equal amount for a spouse in the same age grouping. Other retirees, based on plan provisions, must use Medicare as their primary coverage, with the Company reimbursing a portion of the unpaid amount; or are reimbursed for the Medicare Part B premium or have no company coverage. The benefits provided by the Company are basically health, and for certain retirees, life insurance type benefits. Effective January 1, 1994, a subsidiary of the Company amended its retirement plan to allow for early retirement when years of service and age equals a minimum of 65. This amendment generated $11,200,000 of unrecognized prior service costs for its postretirement benefit plan. The Company does not fund any of these benefit plans and accrues postretirement benefits during the active service of those employees who would become eligible for such benefits when they retire. The rates used in the actuarial assumptions were:
For measurement purposes, a trend rate for covered costs of 13.5% to 14% pre- 65 and 10.5% post-65, was used. These trend rates are expected to decrease gradually to 5% and 8.3% at rates from 0.5% to 1.0% per annum. An increase of one percentage point in assumed health care cost trend rates would increase the accumulated postretirement benefit obligation by approximately $25,016,000 and the net periodic postretirement benefit cost by approximately $3,811,000.
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 Illinois, CNA receives collateral primarily in the form of bank letters of credit, securing a large portion of the recoverables. Such collateral totaled approximately $165.0 and $155.0 million at December 31, 1994 and 1993, respectively. CNA's largest recoverable, including prepaid reinsurance premiums was approximately $348.0 and $484.0 million with Lloyd's of London at December 31, 1994 and 1993, respectively. Insurance claims and policyholders' benefits are net of reinsurance recoveries of $827.9, $177.6 and $570.2 million for the years ended December 31, 1994, 1993 and 1992, respectively.
In addition, Continental and Pacific Indemnity have entered into an agreement (the "Continental-Pacific Agreement") which sets forth the parties' agreement with respect to the means for allocating among themselves responsibility for payments arising out of the Fibreboard insurance policies whether or not the Global Settlement or the Trilateral Agreement is approved. Under the Continental-Pacific Agreement, Continental and Pacific Indemnity have agreed to pay 64.71% and 35.29%, respectively, of the $1.525 billion plus expenses and interest accrued in escrow to be used to satisfy the claims of future claimants. If neither the Global Settlement nor the Trilateral Agreement is approved, Continental and Pacific Indemnity would share, in the same percentages, most but not all liabilities and costs of either insurer including, but not limited to, liabilities in respect of unsettled present claims and presently settled claims (regardless of whether either such insurer would otherwise have any liability therefor). If either the Trilateral Agreement or the Global Settlement is approved by the court, Pacific Indemnity's share for unsettled present claims and presently settled claims will be $635 million.
Reserves-In the fourth quarter of 1992, Continental increased its reserve with respect to potential exposure to asbestos-related bodily injury cases by $1.5 billion. In connection with the agreement in principle announced on August 27, 1993, Continental added $500 million to such claim reserve. The Fibreboard litigation represents the major portion of Continental's asbestos-related claim exposure. There are inherent uncertainties in establishing a reserve for complex litigation of this type. Courts have tended to impose joint and several liability, and because the number of manufacturers who remain potentially liable for asbestos-related injuries has diminished on account of bankruptcies, as has the potential number of insurers due to operation of policy limits, the liability of the remaining defendants is difficult to estimate. Further, a recent trend by courts to consolidate like cases into mass tort trials limits the discovery ability of insurers, generally does not allow for individual claim adjudication, restricts the identification of appropriate allocation methods and thereby results in an increasing likelihood for fraud and disproportionate and potentially excessive judgments. Additionally, management believes that recent court decisions would appear to be based on social or other considerations irrespective of the facts and legal issues involved. The Global Settlement and the Trilateral Agreement are subject to court approval. There is limited precedent with settlements which determine the rights of future claimants to seek relief. It is extremely difficult to assess the magnitude of Continental's potential liability in respect of such future claimants if neither the Global Settlement nor the Trilateral Agreement is approved and upheld, keeping in mind that Continental's potential liability is limited to persons exposed to asbestos prior to the termination of the policy in 1959. Projections by experts of future trends differ widely, based upon different assumptions with respect to a host of complex variables. Some recently published studies, not specifically related to Fibreboard, conclude that the number of future asbestos-related bodily injury claims against asbestos manufacturers could be several times the number of claims brought to date. Such studies include claims asserted against asbestos manufacturers for all years, including claims filed or projected to be filed in respect of periods after 1959. As indicated above, as of December 31, 1994, Continental, Fibreboard and plaintiff attorneys have reached settlements with respect to approximately 135,000 claims, subject to the resolution of coverage issues. Such amount does not include presently pending or unsettled claims, claims previously dismissed or claims settled pursuant to agreements to which Continental is not a party. Another aspect of the complexity in establishing a reserve arises from the widely disparate values that have been ascribed to claims by courts and in the context of settlements. Under the terms of a settlement reached with plaintiffs' counsel in August 1993, the expected settlement for approximately 49,500 claims for exposure to asbestos both prior to and after 1959 is currently averaging approximately $13,400 per claim for the before 1959 claims processed through December 31, 1994. Based on reports by Fibreboard, between September 1988 and April 1993, Fibreboard resolved approximately 40,000 claims, approximately 45% of which involved no cost to Fibreboard other than defense costs, with the remaining claims involving the payment of approximately $11,000 per claim. On the other hand, a trial court in Texas in 1990 rendered a verdict in which Fibreboard's liability in respect of 2,300 claims was found to be approximately $310,000 per claim including interest and punitive damages. Fibreboard entered into a settlement of such claims by means of an assignment of its potential proceeds from its policy with Continental. Continental intervened and settled these claims for approximately $77,000 on average, with a portion of the payment contingent on approval of the Global Settlement or the Trilateral Agreement, and if neither is approved, subject to resolution of the coverage appeal.
Tobacco Litigation-A number of lawsuits have been filed 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 or exposure to tobacco smoke. Plaintiffs have asserted claims based on, among other things, theories of negligence, fraud, misrepresentation, strict liability, breach of warranty, enterprise liability, civil conspiracy, intentional infliction of harm, and failure to warn of the allegedly harmful and/or addictive nature of tobacco products. 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 $100 million in compensatory damages and $600 million in punitive damages. Presently, 54 such cases are pending in the United States federal and state courts against manufacturers of tobacco products generally; Lorillard is a named defendant in 17 of these cases and the Company is a defendant in three of these cases. Twenty of these cases have been commenced since January 1, 1994; Lorillard is a named defendant in six of the cases filed since January 1, 1994. In addition to cases brought by individuals, five purported class actions are pending against Lorillard and other cigarette manufacturers, and the Company is a defendant in one of these cases. Plaintiffs in four of the purported class actions seek damages for alleged nicotine addiction and health effects claimed to have resulted from the use of cigarettes, and plaintiffs in one of the purported class actions allege health effects from exposure to tobacco smoke. Theories of liability include a broad range of product liability theories, theories based upon consumer protection statutes and fraud and misrepresentation. Four of the purported class actions have been filed since January 1, 1994. These purported class actions are more fully described below. In Broin v. Philip Morris Companies, Inc., et al. (Circuit Court, Dade County, Florida, filed October 31, 1991), the purported class consists of flight attendants claiming injury as a result of exposure to environmental tobacco smoke in the cabins of aircraft. Plaintiffs seek an unspecified amount in compensatory damages and $5 billion in punitive damages. The trial court granted plaintiffs' motion for class certification on December 12, 1994. Defendants have appealed this ruling to the Florida Court of Appeals. In Castano v. The American Tobacco Company, et al. (U.S. District Court, Eastern District, Louisiana, filed March 29, 1994), the purported class consists of individuals in the United States who are allegedly nicotine dependent and the estates and heirs of individuals in the United States who were allegedly nicotine dependent. Plaintiffs in this action are represented by a well-funded and coordinated consortium of over 60 law firms from around the United States. Plaintiffs seek unspecified amounts in actual damages and punitive damages. The court issued an order on February 17, 1995 that granted in part plaintiffs' motion for class certification. The time for defendants to request an appeal from the order granting the motion for class certification has not expired. In Granier v. The American Tobacco Company, et al. (U.S. District Court, Eastern District, Louisiana, filed September 26, 1994), plaintiffs seek certification of a class to be comprised of all residents of the United States who are addicted to nicotine, and of survivors who claim their decedents were addicted to nicotine. Plaintiffs seek unspecified dollar amounts in actual damages and punitive damages and the creation of a medical monitoring fund to monitor the health of individuals allegedly injured by their addiction to nicotine. Plaintiffs' motion to consolidate this action with Castano, above, has not been decided by the court. In Engle v. R.J. Reynolds Tobacco Co., et al. (Circuit Court, Dade County, Florida, filed May 5, 1994). the purported class consists of citizens and residents of the United States, and the purported survivors of citizens and residents of the United States, who have had, presently have, or have died from diseases and medical conditions allegedly caused by smoking cigarettes containing nicotine. Plaintiffs in this case seek actual and punitive damages in excess of $100 billion each, and the creation of a medical fund to compensate individuals for future health care costs. Plaintiffs' motion for class certification was granted by the court on October 31, 1994. Defendants have appealed this ruling to the Florida Court of Appeal. In the fifth purported class action, Lacey v. Lorillard Tobacco Company, et al. (U.S. District Court, Northern District, Alabama, filed March 15, 1994), plaintiff alleges that the defendants, Lorillard and two other cigarette
manufacturers, did not disclose to the plaintiff or other cigarette smokers in the State of Alabama the nature, type, extent and identity of additives, additions, or additional substances that the defendants allegely caused or allowed to be made a part of cigarettes or cigarette components. Plaintiff requests injunctive relief requiring defendants to list the additives, additions or additional substances that defendants have caused or allowed to be placed onto or within cigarettes or cigarette components manufactured for sale and sold in the State of Alabama. Plaintiff seeks monetary damages on behalf of his individual claim and on behalf of each member of the purported class arising out of the complaint's allegation not to exceed $48,500 for the individual claim or for any individual member of the class. In addition to the foregoing cases, four actions have been initiated in which states or state agencies seek recovery of funds expended by the states or state agencies to provide health care to eligible citizens 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. Lorillard is named as a defendant in each of these four state or state agency actions and the Company is named as a defendant in three of them. The case of Moore v. The American Tobacco Company, et al. (Chancery Court, Jackson County, Mississippi, filed May 23, 1994), was filed by the Attorney General of Mississippi. The case of McGraw v. The American Tobacco Company, et al. (Circuit Court, Kanawha County, West Virginia, filed on September 20, 1994), was filed by the Attorney General of West Virginia. The case of State of Minnesota v. Philip Morris Incorporated, et al. (District Court, Ramsey County, Minnesota, filed August 17, 1994), was filed by the Attorney General of Minnesota and Blue Cross and Blue Shield of Minnesota. The case of The State of Florida, et al. v. The American Tobacco Company, et al. (Circuit Court, Palm Beach County, Florida, filed February 22, 1995), was filed by the State of Florida, the Governor of Florida, and two state agencies. Plaintiffs in this case seek reimbursement under a specific Florida statute that permits the state to sue a manufacturer to recover Medicaid costs incurred by the state that are claimed to result from the use of the manufacturer's product. In any such suit, the statute permits causation and damages to be proven by statistical analysis, abrogates all affirmative defenses, adopts a "market share" liability theory, applies joint and several liability and eliminates the statute of repose. An action for declaratory judgment has been commenced in Florida state court by companies and trade associations in several potentially affected industries challenging this statute. Lorillard also understands that elements of the Florida business community have initiated an effort to repeal or modify the statute in a future legislative session. It is impossible at this time to predict the ultimate outcome of this action or such efforts. Lorillard understands that several other states, and the Congress, have considered or are considering legislation similar to that passed in Florida. In a fifth state, Massachusetts, the Governor on July 10, 1994 signed legislation authorizing that state's attorney general to bring an action against tobacco manufacturers to recover medical assistance payments for which such companies may be liable under existing law. No action has been brought to date by the State of Massachusetts. The states pursuing the foregoing efforts are doing so at the urging and with the assistance of well known members of the plaintiffs bar and these lawyers have been meeting with attorneys general in other states to encourage them to file similar suits. In addition to the foregoing cases, 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. Plaintiff seeks an injunction ordering defendants to undertake a "corrective advertising campaign" in California to warn consumers of the health hazards associated with smoking, to provide restitution to the public for funds "unlawfully, unfairly, or fraudulently" obtained by defendants, and to "disgorge" all revenues and profits acquired as a result of defendants' "unlawful, unfair and/or fraudulent business practices." An adverse development in this case could encourage the filing of additional actions in other states with consumer protection laws similar to California's. In addition to the foregoing cases, several 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, almost forty years ago, into the filter material used in one of the brands of cigarettes manufactured by Lorillard. Presently twelve such cases are pending in federal and state courts against Lorillard. The Company is not named as a defendant in any of these cases. Six such cases have been filed since January 1, 1994. Allegations of liability against Lorillard include negligence, strict liability, fraud, misrepresentation and
The Company's subsidiaries are engaged primarily in insurance (property, casualty and life), the production and sale of cigarettes, the operation of hotels and oil and gas drilling rigs, and the distribution and sale of watches and other timing devices. The following table sets forth the major sources of the Company's consolidated revenues, income and assets.
(a) Realized investment (losses) gains included in Revenues, Income contribution and Net income are as follows:
(b) Includes $1,800,000, $1,700,000 and $1,600,000 under contracts covering U.S. government employees and their dependents for the respective periods. (c) Includes pre-tax and after-tax gain on sale of two hotel leases amounting to $30,250 and $15,400, respectively, for the year ended December 31, 1994. (d) Consists of investment income of non-insurance operations. Investment income of insurance operations is included in the Revenues, Income contribution and Net income of the related insurance operations. (e) Consists of income before minority interest, cumulative effect of changes in accounting principles and allocation for financial reporting purposes of interest expense, corporate expense and income taxes. (f) Includes interest expense, net of tax benefits, of $87,073, $83,127 and $71,499 for the respective periods.
The Continental Corporation-In the fourth quarter of 1994, CNA reached an agreement to purchase the outstanding shares of common stock of The Continental Corporation ("CIC") through a cash merger for approximately $1.1 billion, or $20 a share. The acquisition will be accounted for as a purchase and, accordingly CIC's results of operations will be included in CNA's consolidated results of operations for the period subsequent to the date of acquisition, which is expected in the second quarter of 1995. CNA and CIC are jointly seeking regulatory approvals as quickly as possible. The transaction closing is subject to the approvals of the CIC shareholders and state insurance regulators. Until the acquisition is complete CIC will continue to operate independently. CNA has reached an agreement in principle with a syndicate of banks to provide initial financing through a revolving loan facility. The revolving loan facility will have a maturity of 5 years without any prepayment restrictions. The loan will allow CNA to consummate the merger expeditiously and facilitate a smooth transition, while providing the needed flexibility to determine the ultimate financing structure following the consummation of the transaction, which is likely to include long-term debt financing or a combination of debt and equity financing. CIC, headquartered in New York, is the llth largest U.S. property and casualty insurance company based on 1993 premium volume. The revenues and net loss of CIC and subsidiaries for the year ended December 31, 1994 are approximately $5.1 billion and $602.9 million, respectively. Total assets are approximately $16.0 billion at December 31, 1994.