Property and casualty and life insurance operations are conducted through subsidiaries of CNA Financial Corporation ("CNA"). CNA is an 84% owned subsidiary of the Company.
Statutory surplus of CNA's life insurance subsidiaries grew from $1.1 billion at December 31, 1994 to $1.2 billion at December 31, 1997.
For the year ended December 31, 1997, CNA's operating activities generated negative cash flows of $193.0 million compared to positive cash flows of $620.2 million in 1996 and $875.0 million in 1995. CNA's negative cash flows were primarily due to claim payments made resulting from the settlement of the Fibreboard litigation. The impact on cash flow for these claim payments was approximately $1.0 billion in 1997 (see Note 18 of the Notes to Consolidated Financial Statements).
The following table reflects ratings issued by A.M. Best, Standard and Poor's, Moody's and Duff & Phelps for CNA's Continental Casualty Company ("CCC") Intercompany Pool, Continental Insurance Company ("CIC") Intercompany Pool and Continental Assurance Company ("CAC") Intercompany Pool. Also, rated were the senior debt of both CNA and The Continental Corporation (Continental) and CNA's preferred stock.
The ratings in the two tables above are primarily from independent rating agencies (89.8% and 89.0% of the general account portfolio, and 82.1% and 84.7% of the guaranteed investment portfolio in 1997 and 1996, respectively, were rated by major rating agencies). In addition, CNA's investments in mortgage loans and real estate as a percentage of total assets are substantially below industry average.
At December 31, 1997 and 1996, short-term investments consisted primarily of U.S. treasury bills and commercial paper.
CNA invests from time to time in certain derivative financial instruments to reduce its exposure to market risk (principally interest rate, equity price and foreign currency risk). CNA also uses derivatives to mitigate the risk associated with its indexed group annuity contract by purchasing S&P 500 futures contracts in a notional amount equal to the original customer deposit.
As of December 31, 1997 CNA's general account investments in bonds and redeemable preferred stocks were carried at a fair value of $29.5 billion, compared to $27.7 billion at December 31, 1996. At December 31, 1997 and 1996, net unrealized gains on fixed maturity securities amounted to approximately $528.0 and $181.0 million, respectively. The gross unrealized gains and losses for the fixed maturity securities portfolio at December 31, 1997 were $644.0 and $116.0 million, respectively, compared to $444.0 and $263.0 million, respectively, at December 31, 1996.
Net unrealized gains on general account bonds at December 31, 1997 include net unrealized losses on high yield securities of $2.0 million, compared to unrealized gains of $34.0 million at December 31, 1996. Carrying and fair values of high yield securities in the general account were $1.5 billion at December 31, 1997, compared to $1.6 billion at December 31, 1996.
High yield securities in the guaranteed investment contract portfolio are carried at fair value and amounted to $310.0 and $324.0 million at December 31, 1997 and 1996, respectively. Net unrealized losses on high yield securities held in such Separate Account portfolio were $1.0 million at December 31, 1997, compared to $8.0 million at December 31, 1996.
Revenues in 1997 decreased by $303.6 million, or 1.5%, and increased by $1.5 billion, or 7.8%, in each case as compared to 1996 and 1995, respectively. Net income declined by $590.3 and $972.1 million, or 42.7% and 55.1% as compared to 1996 and 1995, respectively. Revenues include $(113.6), $676.5 and $1,578.0 million and net income includes $(159.9), $363.6 and $971.9 million of investment (losses) gains for the years 1997, 1996 and 1995, respectively.
The Company continues to maintain its equity index and short sale positions in 1998 and has experienced additional significant losses from these positions.
Professional and specialty earned premiums declined due primarily to lower financial insurance premiums of approximately $90.0 million and agricultural insurance of $85.0 million. General liability and commercial automobile earned premiums declined as a result of a soft market which has made profitable growth difficult to achieve. The reduced premiums from reinsurance are attributable to a decline in CNA's London business.
Premium revenues increased, as compared to 1995, due primarily to higher workers' compensation ($369.0 million), accident and health ($363.0 million), and multiple peril ($188.0 million) premiums. The increase over 1995 is primarily a result of an improvement in the involuntary market and CNA voluntarily writing more of that business, and a full year of CIC's business included in 1997, as compared to the period of May 10 to December 31, 1995.
CNA's property and casualty results of operations are significantly impacted by actuarial estimates of claim and claim expense reserves. These reserves represent an accumulation of the amounts CNA feels are necessary to settle all outstanding claims, including incurred but not reported claims.
Unfavorable 1997 asbestos reserve development of $105.0 million results from CNA's ongoing
Other 1996 and 1995 favorable reserve development, which aggregated $206.2 and $377.7 million, respectively, was principally due to favorable claim frequency (rate of claim occurrence) and severity (average cost per claim) experience in the workers' compensation line of business. These trends reflect the positive effects of changes in workers' compensation laws, more moderate increases in medical costs, and a generally strong economy in which individuals return to the workplace more quickly.
Life insurance revenues increased by $87.9 and $514.7 million, or 2.2% and 14.2%, as compared to 1996 and 1995, respectively. Life premium revenues increased by $83.4 and $424.0 million, or 2.5% and 14.1%, as compared to 1996 and 1995, respectively. Life and annuity group premiums increased by $68.0 million, as compared to 1996. Group accident and health premiums increased by $337.0 million and individual life and annuity premiums increased by $145.0 million, as compared to 1995. These increases reflect increased business for CNA's Viaterm and single premium guaranteed annuities, partially offset by a reduction in CNA's foreign operations. Life investment income increased by approximately 4.8% due to a larger asset base generated from increased cash flows resulting from premium growth. The bond segment of the life investment portfolio yielded 6.4% in 1997, compared to 6.5% and 6.9% in 1996 and 1995, respectively.
Revenues increased by $177.7 and $335.7 million, or 7.9% and 16.1%, as compared to 1996 and 1995, respectively. Net income decreased by $81.3 and $21.9 million, or 18.3% and 5.7%, as compared to 1996 and 1995, respectively.
Revenues increased, as compared to 1996, by approximately $70.2 million, or 3.2%, due to an increase in unit sales volume and by approximately $108.5 million, or 4.9%, due to increased unit prices. Compared to 1995, revenues increased by approximately $180.3 million, or 8.8%, due to increased sales volume and by approximately $158.9 million, or 7.7%, due to higher unit prices.
Lorillard's unit sales volume increased by 3.4% and 8.7% as compared to 1996 and 1995, respectively. Newport, a full price brand which accounts for approximately 76% of Lorillard's unit sales, increased by 7.5% and 17.0% as compared to 1996 and 1995, respectively.
Virtually all of Lorillard's sales are in the full price brand category. Discount brand sales have decreased from an average of 31.4% of industry sales during 1994 to an average of 27.0% during 1997. At December 31, 1997, they represented 27.0% of industry sales.
and entered into an agreement to settle a class action lawsuit in Florida. Based on the agreements, Lorillard recorded pre-tax and after tax settlement charges of $198.8 and $122.0 million, respectively.
Revenues increased by $21.9 and $4.5 million, or 10.9% and 2.1%, as compared to 1996 and 1995, respectively. Net income increased by $11.9 and $2.0 million, as compared to 1996 and 1995, respectively.
The increases in 1997 are due primarily to higher average room rates and higher occupancy rates, partially offset by costs of a legal settlement in 1997.
Net income increased as a result of the higher revenues discussed above and lower interest expense, partially offset by increased operating costs related to the drilling rigs acquired from Arethusa, and higher depreciation expense resulting from capital expenditures associated with drilling rig upgrades and modifications.
In October 1995 Diamond Offshore sold shares of its common stock through an initial public offering, the proceeds of which were used to retire intercompany debt. Accordingly, operating results in 1997 and 1996 benefited from lower interest expense as compared to 1995.
Revenues and net income increased due primarily to higher watch unit sales volume of 6.6% and 21.9% as compared
The Company has completed an assessment of the scope of this problem and is working to modify or replace the affected software so that its computer systems will function properly with respect to dates in the year 2000 and thereafter. The total Year 2000 project cost is estimated at approximately $61.0 million. To date, the Company has incurred and expensed approximately $24.0 million.
The cost of the project and the date on which the Company believes it will complete the Year 2000 modifications are based on management's best estimates, which were derived utilizing numerous assumptions of future events, including the continued availability of certain resources and other factors. However, there can be no guarantee that these estimates will be achieved and actual results could differ materially from those anticipated. Specific factors that might cause such material differences include, but are not limited to, the availability and cost of personnel trained in this area, the ability to locate and correct all relevant computer codes, and similar uncertainties.
In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 130, "Reporting Comprehensive Income," which establishes accounting standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. This Statement requires that an enterprise (a) classify items of other comprehensive income by
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits." This Statement standardizes disclosure requirements for pension and other postretirement benefits to the extent practicable, requires additional information on changes in benefit obligations and fair values of plan assets that will facilitate financial analysis, and eliminates certain disclosures that are no longer useful to users of financial statements. It also suggests combined formats for presentation of pension and other postretirement benefit disclosures. The Statement supersedes the disclosure requirements of a number of earlier opinions of the FASB and does not address measurement or recognition. It is effective for fiscal years beginning after December 15, 1997. The Company is currently evaluating the effects of this Statement on its benefit plan disclosures.
When included in this Report, the words "believes," "expects," "intends," "anticipates," "estimates," and analogous expressions are intended to identify forward-looking statements. Such statements inherently are subject to a variety of risks and uncertainties that could cause actual results to differ materially from those projected. Such risks and uncertainties include, among others, general economic and business conditions, competition, changes in financial markets (interest rate, currency, commodities and stocks), changes in foreign, political, social and economic conditions, regulatory initiatives and compliance with governmental regulations, judicial decisions and rulings in smoking and health litigation, the impact of bills introduced in Congress in relation to tobacco operations, implementation of the Proposed Resolution, changes in foreign and domestic oil and gas exploration and production activity, customer preferences and various other matters, many of which are beyond the Company's control. These forward-looking statements speak only as of the date of this Report. The Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statement contained herein to reflect any change in the Company's expectations with regard thereto or any change in events, conditions or circumstances on which any statement is based.
Short-term investments include U.S. government securities, repurchase agreements and commercial paper and are carried at fair value, which approximates amortized cost.
All securities transactions are recorded on the trade date. The cost of securities sold is determined by the identified certificate method. Unrealized appreciation in shareholders' equity reflects the unrealized gain or loss on investments which are available for sale and carried at fair value, net of applicable deferred income taxes and participating policyholders' and minority interests. Investments are written down to estimated fair values and losses are charged to income when a decline in value is considered to be other than temporary.
Other invested assets consist primarily of investments in joint ventures and limited partnerships and other investments not classified elsewhere. The joint ventures and limited partnerships are carried at equity value.
Claim and claim expense reserves represent management's estimates of ultimate liabilities based on currently available facts and case law. CNA regularly reviews its reserves, and any adjustments that are made to the reserves are reflected in operating income in the period the need for such adjustments become apparent. See Note 9 for a further discussion of claim and claim expense reserves.
Workers' compensation lifetime claims and accident and health disability claim reserves are discounted at interest rates allowed by insurance regulators ranging from 3.5% to 6.0% with mortality and morbidity assumptions reflecting CNA's and current industry experience. Such discounted reserves totaled $2,196.0 and $2,165.4 (reflecting a discount of $882.0 and $903.0, respectively) at December 31, 1997 and 1996, respectively.
products' assumed durations, which are regularly evaluated and adjusted, as appropriate.
Restricted investments - On December 30, 1993, CNA deposited $986.8 in an escrow account, pursuant to the Fibreboard Global Settlement Agreement, as discussed in Note 18. The funds are included in short-term investments and are invested in U.S. treasury securities. The escrow account amounted to $1,098.0 and $1,071.2 at December 31, 1997 and 1996, respectively.
Participating business - Participating business represented 0.7%, 0.5% and 0.6% of CNA's gross life insurance in force and 0.7%, 0.7% and 0.8% of life insurance premium income for 1997, 1996 and 1995, respectively. Participating policyholders' equity is determined by allocating 90% of related net income or loss and unrealized investment gains or losses related to such business as allowed by applicable laws, less dividends determined by CNA's Board of Directors. In the accompanying Consolidated Statements of Income, revenues and benefits and expenses include amounts related to participating policies; the net income or loss allocated to participating policyholders' equity is a component of insurance claims and policyholders' benefits.
Goodwill and other intangible assets - Goodwill, representing the excess of the purchase price over the fair value of the net assets of the acquired entities, is generally amortized on a straight-line basis over the period of expected benefit of twenty years. Other intangible assets are amortized on a straight-line basis over their estimated economic lives. Accumulated amortization at December 31, 1997 and 1996 was $283.0 and $243.4, respectively. Amortization expense amounted to $39.6, $36.3 and $25.6 for the years ended December 31, 1997, 1996 and 1995, respectively. Intangible assets are periodically reviewed to determine whether an impairment in value has occurred.
Buildings and building equipment 40 Building fixtures 10 to 20 Machinery and equipment 5 to 12 Hotel equipment 4 to 12 Offshore drilling equipment 10 to 25
(a) Includes losses on short sales, equity index futures and options aggregating $936.6, $285.7 and $122.6 for the years ended December 31, 1997, 1996 and 1995 respectively. The Company continued to experience significant losses from these short sales and its open contracts on equity index positions in 1998. (b) On November 24, 1995, Westinghouse Electric Corporation completed its acquisition of CBS Inc. ("CBS") for cash consideration of $82.06 per share. The Company received proceeds of $901.7 for its CBS shares and recorded a pre-tax and after tax gain of $579.2 and $376.5, respectively.
The amortized cost and market value of fixed maturities at December 31, 1997 and 1996 are shown below by contractual maturity. Actual maturities may differ from contractual maturities because securities may be called or prepaid with or without call or prepayment penalties.
Other investments consist of mortgage loans and notes receivable, policy loans, investments in limited partnerships and various miscellaneous assets. Valuation techniques to determine fair value of other investments and other Separate Account assets consist of discounted cash flows and quoted market prices of (a) the investments, (b) comparable instruments or (c) underlying assets of the investments.
The Company enters into various transactions involving off-balance-sheet financial instruments through a variety of futures, swaps, options, forwards and other contracts (the "Contracts") as part of its investing activities. These Contracts are commonly referred to as derivative instruments since their underlying values may be linked to, among other things, interest rates, exchange rates, prices of securities and financial or commodity indexes. The Company uses these Contracts for a number of purposes, including: (i) for its asset and liability management activities; (ii) for income enhancements for its portfolio management strategy; and (iii) to benefit from anticipated future movements in the underlying markets that Company management expects to occur. If such movements do not occur or if the market moves in the opposite direction from what management expects, significant losses may occur. These Contracts also involve the risk of dealing with counterparties and their ability to meet the terms of the Contracts.
CNA also uses derivatives to mitigate the risk associated with its indexed group annuity contracts by purchasing S&P 500 futures contracts in a notional amount equal to the original customer deposit. CNA generally does not hold or issue these instruments for trading purposes. The gross notional principal or contractual amounts of these instruments in the Separate Accounts totaled $615.0 and $319.0 at December 31, 1997 and 1996, respectively.
Through August 1, 1989, CNA's property and casualty operations wrote financial guarantee insurance contracts. These contracts primarily represent industrial development bond guarantees and equity guarantees typically extending from ten to thirteen years. For these guarantees, CNA received an advance premium which is recognized over the exposure period and in proportion to the underlying exposure insured.
At December 31, 1997 and 1996, gross exposure of financial guarantee insurance contracts amounted to $181.0 and $582.0, respectively. The degree of risk attached to this exposure is substantially reduced through reinsurance, diversification of exposures and collateral requirements. In addition, security interests in real estate are also obtained. Approximately 54% and 47% of the risks were ceded to reinsurers at December 31, 1997 and 1996, respectively. Total exposure, net of reinsurance, amounted to $83.0 and $311.0 at December 31, 1997 and 1996, respectively. At December 31, 1997 and 1996, collateral consisting of letters of credit and debt service reserves amounted to $22.0 and $28.0, respectively. Gross unearned premium reserves for financial guarantee contracts were $5.0 and $11.0 at December 31, 1997 and 1996, respectively. Gross claim and claim expense reserves totaled $377.0 and $371.0 at December 31, 1997 and 1996, respectively.
Note 9. Liability for Unpaid Claims and Claim Adjustment Expenses -
(a) Excludes life claim and claim expense reserves and intercompany eliminations of $986.8, $999.5 and $988.0 as of December 31, 1997, 1996 and 1995, respectively, included in the Consolidated Balance Sheets.
Due to the inherent uncertainties described above, including the inconsistency of court decisions, the number of waste sites subject to clean-up, and the standards for clean-up and liability, CNA's ultimate liability for environmental pollution claims may vary substantially from the amount currently recorded.
CNA's insurance subsidiaries have exposure to asbestos-related claims, including those attributable to CNA's litigation with Fibreboard Corporation (see Note 18). Estimation of asbestos-related claim reserves involves many of the same limitations discussed above for environmental pollution claims such as inconsistency of court decisions, specific policy provisions, allocation of liability among insurers, missing policies and proof of coverage. As of December 31, 1997 and 1996, CNA carried approximately $1,400.0 and $1,506.2, respectively, of claim and claim expense reserves, net of reinsurance recoverable, for reported and unreported asbestos-related claims.
The results of operations in future years may continue to be adversely affected by environmental pollution and asbestos claims and claim expenses. Management will continue to monitor these liabilities and make further adjustments as warranted.
involuntary risk business, and approximately $200.0 in personal lines business, partially offset by unfavorable loss and loss adjustment expense development of $379.0 in commercial lines. The 1997 favorable loss development was offset in part by unfavorable premium development of approximately $340.0 in involuntary risk business and $170.0 favorable premium development in commercial lines.
The other favorable development during 1996 and 1995, of $206.2 and $377.7 respectively, was principally due to favorable claim experience in the workers' compensation line of business.
The following tables provide additional data related to CNA's environmental pollution and asbestos-related claims activity.
Gross deferred tax assets amounted to $2,891.8 and $2,826.5 and liabilities amounted to $1,947.5 and $1,688.5 for the years ended December 31, 1997 and 1996, respectively.
Total income tax expense for the years ended December 31, 1997, 1996 and 1995 was different than the amounts of $557.6, $842.7 and $993.8, computed by applying the statutory U.S. federal income tax rate of 35% to income before income taxes and minority interest for each of the years.
Federal, foreign, state and local income tax payments, net of refunds, amounted to approximately $565.3, $407.8 and $386.5 for the years ended December 31, 1997, 1996 and 1995, respectively.
(a) Net of $7.2 held by the Company. (b) Redeemable in whole or in part at June 1, 2003 at 103.8%, and decreasing percentages thereafter. (c) Redeemable in whole or in part at October 15, 2003 at 102.4%, and decreasing percentages thereafter. (d) The notes are exchangeable into 15.376 shares of Diamond Offshore's common stock per $1,000 principal amount of notes, at a price of $65.04 per share. Redeemable in whole or in part at September 15, 2002 at 101.6%, and decreasing percentages thereafter. (e) The notes are convertible into 24.691 shares of Diamond Offshore's common stock per $1,000 principal amount of notes, at a price of $40.50 per share. Redeemable in whole or in part at February 22, 2001 at 102.1%, and decreasing percentages thereafter.
In February 1997, Diamond Offshore issued $400.0 million principal amount of 3 3/4% convertible subordinated notes convertible into 24.691 shares of Diamond Offshore's common stock per one thousand dollar principal amount of notes, at a price of $40.50 per share. Redeemable in whole or in part at February 22, 2001 at 102.1%, and decreasing percentages thereafter.
To finance the 1995 acquisition of CIC, CNA entered into a five-year $1,325.0 revolving credit facility (the "Bank Facility"). In 1996, CNA renegotiated the facility extending the maturity to May 2001. The interest rate is based on the one, two, three or six month London Interbank Offered Rate ("LIBOR"), as elected, plus 16 basis points. Additionally, there is a facility fee of 9 basis points. Under the terms of the facility, CNA may prepay the debt without penalty.
In 1995, to take advantage of favorable interest rate spreads, CNA established a commercial paper program borrowing from investors to reduce a like amount of the Bank Facility. These borrowings are classified as long-term debt, as the Bank Facility supports the commercial paper program. At December 31, 1997, there was no unused borrowing capacity under the Bank Facility after the effects of the commercial paper program.
The weighted average interest rate (interest and facility fees) on the acquisition debt, which includes the Bank Facility, commercial paper and the effect of the interest rate swaps, was 6.4% and 6.3% at December 31, 1997 and 1996, respectively.
The aggregate of long-term debt maturing in each of the next five years is approximately as follows: $125.0 in 1998, $135.5 in 1999, $9.3 in 2000, $1,090.6 in 2001 and $144.6 in 2002. The Company paid interest expenses of approximately $325.1, $315.3 and $276.0 for the years ended December 31, 1997, 1996 and 1995, respectively.
Payment of dividends by insurance subsidiaries of CNA without prior regulatory approval is limited to certain formula-derived amounts. At December 31, 1997, approximately $5,231.8 of retained earnings was not available for dividends.
In October 1995 the Company's then wholly owned subsidiary, Diamond Offshore, sold 29.9 million shares of its common stock through an initial public offering at $12 per share. Diamond Offshore used the net proceeds of approximately $338.4 to fund the repayment of its intercompany debt as well as a dividend to the Company. As a result of the offering, the Company's ownership interest in Diamond Offshore declined to approximately 70% and the Company recorded a gain of approximately $192.9 ($125.4 after provision for deferred income taxes).
Written premiums were $13,500.0, $13,892.0 and $12,952.0 at December 31, 1997, 1996 and 1995, respectively. The ceding of insurance does not discharge the primary liability of the original insurer. CNA places reinsurance with other carriers only after careful review of the nature of the contract and a thorough assessment of the reinsurers' credit quality and claim settlement performance. Further, for carriers that are not authorized reinsurers in CNA's states of domicile, CNA receives collateral, primarily in the form of bank letters of credit. Such collateral totaled approximately $857.0 and $800.9 at December 31, 1997 and 1996, respectively. CNA's largest recoverable from a single reinsurer, including prepaid reinsurance premiums, is with Lloyd's of London and approximates $451.0 and $440.0 at December 31, 1997 and 1996, respectively.
In the above table, life premium revenue is primarily from long duration contracts and the property and casualty earned premium is from short duration contracts. Approximately three quarters of accident and health earned premiums are from short duration contracts.
No further appeal was filed with respect to the Trilateral Agreement; therefore, court approval of the Trilateral Agreement has become final.
Global Settlement - On April 9, 1993, Casualty and Fibreboard entered into an agreement pursuant to which, among other things, the parties agreed to use their best efforts to negotiate and finalize a global class action settlement with asbestos-related bodily injury and death claimants.
Through December 31, 1997, Casualty, Fibreboard and plaintiff attorneys had reached settlements with respect to approximately 135,400 claims, for an estimated settlement amount of approximately $1,600.0 plus any applicable interest. Final court approval of the Trilateral Agreement obligates Casualty to pay under these settlements. Approximately $1,600.0 including interest was paid through December 31, 1997. Such payments are partially recoverable from Pacific Indemnity. Casualty may negotiate other agreements with various classes of claimants including groups who may have previously reached agreement with Fibreboard.
Final court approval of the Trilateral Agreement and its implementation has resolved Casualty's exposure with respect to Fibreboard asbestos claims. Casualty does not anticipate further material exposure with respect to the Fibreboard matter, and subsequent reserve adjustments, if any, will not materially affect the results of operations or equity of the Company.
Tobacco Litigation - CNA's primary property/casualty subsidiaries have been named as defendants as part of a "direct action" lawsuit, Richard P. Ieyoub v. The American Tobacco Company, et al., filed by the
Attorney General for the State of Louisiana, in state court, Calcasieu Parish, Louisiana. In that suit, filed against certain tobacco manufacturers and distributors (the "Tobacco Defendants") and over 100 insurance companies, the State of Louisiana seeks to recover medical expenses allegedly incurred by the State as a result of tobacco-related illnesses.
The original suit was filed on March 13, 1996, against the Tobacco Defendants only. The insurance companies were added to the suit in March 1997 under a direct action statute in Louisiana. Under the direct action statute, the Louisiana Attorney General is pursuing liability claims against the Tobacco Defendants and their insurers in the same suit, even though none of the Tobacco Defendants has made a claim for insurance coverage.
There has been a substantial increase in the number of cases filed. For instance, 15 Class Actions that name Lorillard and/or the Company as defendants were filed and served during 1996; at least 32 such suits have been filed during 1997. Nineteen Reimbursement Cases were filed by state or local governmental entities during 1996; at least 29 Reimbursement Cases have been filed by governmental entities during 1997 as well as suits by five Indian Tribes and 45 suits by unions. Conventional Product Liability Cases also have been filed with greater frequency in recent years. During 1994, approximately 30 such suits were filed and served against U.S. cigarette manufacturers, including Lorillard. Approximately 140 such suits were filed and served during 1995. Approximately 340 such suits were filed and served during 1996. In 1997, approximately 450 such suits have been filed and served on the major U.S. cigarette manufacturers, including Lorillard, and other defendants, including the Company.
On June 20, 1997, together with other companies in the United States tobacco industry, Lorillard entered into a Memorandum of Understanding to support the adoption of federal legislation and any necessary ancillary undertakings incorporating the features described in the proposed resolution attached to the Memorandum of Understanding (together, the
"Proposed Resolution"). The Proposed Resolution can be implemented only by federal legislation. If enacted into law, the legislation would resolve many of the regulatory and litigation issues affecting the United States tobacco industry thereby reducing uncertainties facing the industry. (See "Proposed Resolution of Certain Regulatory and Litigation Issues" below.)
On September 26, 1997, a jury in the case of Gordon v. R.J. Reynolds Tobacco Company, et al. (Superior Court, Middlesex County, Massachusetts), returned a special verdict favorable to the defendants, which included Lorillard. The court entered judgment in favor of the defendants. Trial was held on the limited issue of the cigarettes smoked by the decedent and the time period in which she smoked them. Plaintiff has filed a motion for new trial, which is pending.
During 1997, juries returned verdicts in favor of the defendants in trials in two smoking and health cases in which Lorillard was not a party, Connor v. R.J. Reynolds Tobacco Company (verdict returned May 5, 1997) and Karbiwnyk v. R.J. Reynolds Tobacco Company (verdict returned October 31, 1997) (both cases were tried in the Circuit Court of Duval County, Florida). Appeals are not pending in either case.
CLASS ACTIONS - There are 53 purported class actions pending against cigarette manufacturers and other defendants, including the Company. Most of the suits seek class certification on behalf of residents of the states in which the cases have been filed, although some suits seek class certification on behalf of residents of multiple states. All but one of the purported class actions seek class certification on behalf of individuals who smoked cigarettes or were exposed to environmental tobacco smoke. One case seeks class certification on behalf of individuals who have paid insurance premiums to Blue Cross and Blue Shield organizations.
CONTRIBUTION CLAIMS - In addition to the foregoing cases, five cases are pending in which private companies seek recovery of funds expended by them to individuals whose asbestos disease or illness was alleged to have been caused in whole or in part by smoking-related illnesses. Lorillard is named as a defendant in each action. The Company is named as a defendant in two of the cases. Each of these cases is in the pre-trial, discovery stage.
Trials were held in three cases of this type during 1995. In two of the cases, the juries returned verdicts in favor of Lorillard. In the third case, the jury returned a
verdict in favor of plaintiffs, which was upheld on appeal. The Company has paid the compensatory judgment award, trial costs and interest thereon in the amount of $1.6 on December 30, 1997. The Company has filed a petition for writ of certiorari to the United States Supreme Court as to the punitive damage award, which is pending.
In addition, on December 5, 1997, certain documents as to which defendants had claimed privilege were provided to the Chairman of the House Commerce Committee in response to a subpoena. These documents were subsequently made available on the Internet. On February 19, 1998, the Committee subpoenaed an additional approximately 39,000 documents which Lorillard and other companies in the tobacco industry have asserted to be privileged. These documents are the subject of a March 7, 1998 ruling in the Reimbursement Case brought by the State of Minnesota, in which the judge ordered that the documents should be released on the basis of the crime/fraud exception. Defendants have sought appellate review of this ruling.
Under the Proposed Resolution discussed below, Lorillard and other companies in the tobacco industry agreed to establish an industry-funded document depository to allow public viewing of certain industry documents. In recent Congressional testimony, representatives of the tobacco companies offered to make tens of millions of pages of documents public prior to the enactment of any comprehensive legislation to demonstrate their commitment to the principles set forth in the Proposed Resolution. On February 27, 1998, Lorillard and other companies in the tobacco industry posted on the Internet the first installment of these documents for public access. In addition, the tobacco companies have asked the court in the Reimbursement Case brought by the State of Minnesota to grant public access to the Minnesota document depository established in that case. The publicly available materials will not include documents containing trade secret information, certain personnel and third party information, or documents for which attorney-client privilege or work product doctrine claims have been asserted.
DEFENSES - One of the defenses raised by Lorillard in certain cases is preemption by the Federal Cigarette Labeling and Advertising Act (the "Labeling Act"). In the case of Cipollone v. Liggett Group, Inc., et al., the United States Supreme Court, in a plurality opinion issued on June 24, 1992, held that the Labeling Act as enacted in 1965 does not preempt common law damage claims but that the Labeling Act, as amended in 1969, does preempt claims against tobacco companies arising after July 1, 1969, which assert that the tobacco companies failed to adequately warn of the alleged health risks of cigarettes, sought to undermine or neutralize the Labeling Act's mandatory health warnings, or concealed material facts concerning the health effects of smoking in their advertising and promotion of cigarettes. The Supreme Court held that claims against tobacco companies based on fraudulent misrepresentation, breach of express warranty, or conspiracy to misrepresent material facts concerning the alleged health effects of smoking are not preempted by the Labeling Act. The Supreme Court in so holding
Lorillard believes that it has a number of defenses to pending cases, in addition to defenses based on preemption described above, and Lorillard will continue to maintain a vigorous defense in all such litigation. These defenses, where applicable, include, among others, statutes of limitations or repose, assumption of the risk, comparative fault, the lack of proximate causation, and the lack of any defect in the product alleged by a plaintiff. Lorillard believes that some or all of these defenses may, in many of the pending or anticipated cases, be found by a jury or court to bar recovery by a plaintiff. Application of various defenses, including those based on preemption, are likely to be the subject of further legal proceedings in the Class Action cases and in the Reimbursement Cases.
The Proposed Resolution, which can be implemented only by federal legislation, would resolve many of the issues relating to tobacco litigation.
The Proposed Resolution would require participant manufacturers to make substantial payments in the year of implementation and thereafter ("Industry Payments"). Participating manufacturers would be required to make an aggregate $10,000 initial Industry Payment on the date federal legislation implementing the terms of the Proposed Resolution is signed. This Industry Payment would be based on relative market capitalizations and Lorillard currently estimates that its share of the initial Industry Payment would be approximately $750 (to be adjusted downward for initial payments made to Florida, Mississippi and Texas pursuant to settlements, see "Settlements of Reimbursement Cases," discussed below). Thereafter,
the companies would be required to make specified annual Industry Payments determined and allocated among the companies based on volume of domestic sales as long as the companies continue to sell tobacco products in the United States. These Industry Payments, which would begin on December 31 of the first full year after implementing federal legislation is signed, would be in the following amounts (at 1996 volume levels): year 1: $8,500; year 2: $9,500; year 3: $11,500; year 4: $14,000; and each year thereafter; $15,000. These Industry Payments would be increased by the greater of 3% or the previous year's inflation rate determined with reference to the Consumer Price Index. The Industry Payments would increase or decrease in proportion to changes from 1996 domestic sales volume levels. Volume declines would be measured based on adult sales volume figures; volume increases would be measured by total sales volume. If sales volume declines but the industry's domestic net operating profit exceeds base year inflation-adjusted levels, the reduction in the annual Industry Payment due to volume decline, if any, would be offset to the extent of 25% of the increased profit. At current levels of sales and prior to any adjustment for inflation, the Proposed Resolution would require total Industry Payments of $368,500 over the first 25 years (subject to credits described below in connection with potential civil tort liability).
The Industry Payments would be separate from any surcharges discussed below. The Industry Payments would receive priority and would not be dischargeable in any bankruptcy or reorganization proceeding and would be the obligation only of entities manufacturing and selling tobacco products in the United States (and not their affiliated companies). The Proposed Resolution provides that all payments by the industry would be ordinary and necessary business expenses in the year of payment, and no part thereof would be either in settlement of an actual or potential liability for a fine or penalty (civil or criminal) or the cost of a tangible or intangible asset. The Proposed Resolution would provide for the pass-through to consumers of the annual Industry Payments in order to promote the maximum reduction in underage use.
If enacted, the federal legislation provided for in the Proposed Resolution would settle present attorney general health care cost recovery actions (or similar actions brought by or on behalf of any governmental entity), parens patriae and smoking and health class actions and all addiction/dependence claims and would bar similar actions from being maintained in the future. However, the Proposed Resolution provides that no stay applications will be made in pending governmental actions without the mutual consent of the parties. On July 2 and August 25, 1997, and January 16, 1998, together with other companies in the United States tobacco industry, Lorillard entered into Memoranda of Understanding with the States of Florida, Mississippi and Texas, respectively, with respect to those states' health care cost recovery actions. See "Settlements of Reimbursement Cases" discussed below. Lorillard may enter into discussions with certain other states with health care cost recovery actions scheduled to be tried this year with regard to the postponement or settlement of such actions pending the enactment of the legislation contemplated by the Proposed Resolution. No assurance can be given whether a postponement or settlement will be achieved, or, if achieved, as to the terms thereof. The Proposed Resolution would not affect any smoking and health class action or any health care cost recovery action that is reduced to final judgment before implementing federal legislation is effective.
Under the Proposed Resolution, the rights of individuals to sue the tobacco industry would be preserved, as would existing legal doctrine regarding the types of tort claims that can be brought under applicable statutory and case law except as expressly changed by implementing federal legislation. Claims, however, could not be maintained on a class or other aggregated basis and could be maintained only against tobacco manufacturing companies (and not their retailers, distributors or affiliated companies). In addition, all punitive damage claims based on past
conduct would be resolved as part of the Proposed Resolution and future claimants could seek punitive damages only with respect to claims predicated upon conduct taking place after the effective date of implementing federal legislation. Finally, except with respect to actions pending as of June 9, 1997, third-party payor (and similar) claims could be maintained only based on subrogation of individual claims. Under subrogation principles, a payor of medical costs can seek recovery from a third party only by "standing in the shoes" of the injured party and being subject to all defenses available against the injured party.
Under the Mississippi settlement agreement, the Settling Defendants paid $170 representing Mississippi's estimated share of the $10,000 initial payment under the Proposed Resolution, and paid an additional $15 to reimburse Mississippi and its private counsel for out-of-pocket costs. The Settling Defendants also paid approximately $62 to support a pilot program aimed at reducing the use of tobacco products by persons under the age of eighteen. Lorillard's share of all the foregoing payments, approximately $19.5, was charged to expense in 1997.
Beginning December 31, 1998, the Settling Defendants will pay Mississippi amounts based on its anticipated share of the annual industry payments under the Proposed Resolution. These payments, which (except for the payment with respect to 1998) will be adjusted as provided in the Proposed Resolution, are estimated to be $68 with respect to 1998 and will increase annually thereafter to an estimated $136 by 2003, continuing at that level thereafter, and will be allocated among the Settling Defendants in accordance with their relative unit volume of domestic tobacco product sales.
On September 15, 1998, and annually thereafter on December 31, the Settling Defendants will make ongoing payments to Florida in the following estimated amounts - 1998: $220; 1999: $247.5; 2000: $275; 2001: $357.5; 2002: $357.5; and each year thereafter $440. These amounts are projected to approximate that portion of the annual industry payments under the Proposed Resolution which is contemplated to be paid to Florida. These payments (except for the payment with respect to 1998) will be adjusted as provided in the Proposed Resolution and will be allocated among the Settling Defendants in accordance with their relative unit volume of domestic tobacco product sales.
Defendants agreed to pay Texas an up-front payment of $725 in 1998, representing Texas's estimated share of the $10,000 initial payment under the Proposed Resolution, and agreed to reimburse Texas and its private counsel for expenses in the estimated amount of $45. The Settling Defendants also agreed to pay Texas $264 to support a pilot program aimed at reducing the use of tobacco by persons under the age of eighteen. Lorillard's share of all of the foregoing payments, approximately $84.4, was charged to expense in 1997.
Beginning in November and December 1998, and on December 31 of each subsequent year, the Settling Defendants will pay Texas 7.25% of the annual industry payments contemplated to be paid to the states under the Proposed Resolution. These payments, which (except for the payments with respect to 1998) will be adjusted as provided in the Proposed Resolution, will be in the following estimated amounts - 1998: $290; 1999: $326; 2000: $363; 2001: $471; 2002: $471; and 2003 and each year thereafter: $580. These payments will be allocated among the Settling Defendants in accordance with their relative unit volume of domestic tobacco product sales.
The Settling Defendants have also agreed to pay reasonable attorneys' fees of private contingency fee counsel of Florida, Mississippi and Texas as set by a panel of independent arbitrators. Each of these payments would be allocated among the Settling Defendants in accordance with their relative unit volume of domestic tobacco product sales and will be subject to an aggregate national annual cap of $500. Certain of Florida's private contingency fee counsel have challenged the attorney's fees provision set forth in the Florida settlement agreement, arguing that the settlement agreement has no effect on their rights under their contingency fee agreement with Florida. In November 1997, the court ordered all parties to comply with the provisions for obtaining attorneys' fees, as set forth in the settlement agreement. Certain contingency fee counsel are appealing this ruling. One of these contingency fee counsel has filed suit against certain companies in the tobacco industry, although not Lorillard, alleging, among other things, tortious interference with such counsel's contingency fee agreement with the State.
Finally, the settlement agreements provide that they are not an admission or concession or evidence of any liability or wrongdoing on the part of any party, and were entered into by the Settling Defendants solely to avoid the further expense, inconvenience, burden and uncertainty of litigation.
Many of the recent developments in relation to smoking and health discussed above have received wide-spread media attention including the release of documents by the industry. These developments may reflect adversely on the tobacco industry and could have adverse effects on the ability of Lorillard and other cigarette manufacturers to prevail in smoking and health litigation.
Loews Corporation is a holding company. Its subsidiaries are engaged in the following lines of business: property, casualty and life insurance (CNA Financial Corporation, an 84% owned subsidiary, "CNA"); the production and sale of cigarettes (Lorillard, Inc., a wholly owned subsidiary, "Lorillard"); the operation of hotels (Loews Hotels Holding Corporation, a wholly owned subsidiary, "Loews Hotels"); the operation of offshore oil and gas drilling rigs (Diamond Offshore Drilling, Inc., a 50.3% owned subsidiary, "Diamond Offshore"); and the distribution and sale of watches and clocks (Bulova Corporation, a 97% owned subsidiary, "Bulova").
(a) Investment (losses) gains included in Revenues, Income contribution and Net income are as follows:
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Dated: March 30, 1998 By /s/ Peter W. Keegan --------------------------------- (Peter W. Keegan, Senior Vice President and Chief Financial Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Dated: March 30, 1998 By /s/ Laurence A. Tisch --------------------------------- (Laurence A. Tisch, Co-Chairman of the Board and Principal Executive Officer)
Dated: March 30, 1998 By /s/ Guy A. Kwan --------------------------------- (Guy A. Kwan, Controller)
Dated: March 30, 1998 By /s/ Charles B. Benenson --------------------------------- (Charles B. Benenson, Director)
Dated: March 30, 1998 By /s/ John Brademas --------------------------------- (John Brademas, Director)
Dated: March 30, 1998 By /s/ Dennis H. Chookaszian --------------------------------- (Dennis H. Chookaszian, Director)
Dated: March 30, 1998 By /s/ Edward J. Noha --------------------------------- (Edward J. Noha, Director)
Dated: March 30, 1998 By /s/ James S. Tisch --------------------------------- (James S. Tisch, Director)
Dated: March 30, 1998 By /s/ Jonathan M. Tisch --------------------------------- (Jonathan M. Tisch, Director)
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Loews Corporation and its subsidiaries at December 31, 1997 and 1996 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. Also, in our opinion, such financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly in all material respects the information set forth therein.
The aggregate of long-term debt maturing in the next five years is $117.8 for the year ending December 31, 1998.
(c) Cash dividends paid to the Company by affiliates amounted to $113.2, $445.4 and $1,085.7 for the years ended December 31, 1997, 1996 and 1995, respectively.