Management's Discussion and Analysis of Financial Condition and Results of Operations.
Property and casualty and life insurance operations are wholly owned subsidiaries of CNA Financial Corporation ("CNA"). CNA is an 83% owned subsidiary of the Company- For the year ended December 31, 1993, CNA reported a $251.7 million operating loss net of tax (exclusive of realized gains/losses and accounting changes), compared to $897.8 million for the prior year. In each of the last two years, results were adversely affected by substantial additions to reserves for asbestos-related bodily injury claims. The 1993 operating loss reflects a third quarter $500 million addition to Continental Casualty Company's ("Casualty") claim reserves, which resulted in a $270.1 million charge, or $4.21 per share, against the Company's net income. In 1992 Casualty also increased its claim reserves with respect to asbestos-related bodily injury cases by $1.5 billion, resulting in an after-tax charge of $822.7 million, or $12.53 per share. These reserving actions were taken in recognition of Casualty's litigation with Fibreboard Corporation ("Fibreboard"), a former asbestos manufacturer. In February 1993, CNA reported that Casualty intended to discuss a global agreement to settle third party asbestos-related bodily injury claims with Fibreboard. An agreement in principle was reached in August 1993 and executed in December 1993 with Fibreboard, Pacific Indemnity Company (a subsidiary of Chubb Corporation) and a negotiating committee of asbestos claimant attorneys. CNA worked aggressively throughout the year with all involved parties to reach this settlement. Assuming final court approval, the Fibreboard agreement removes a major source of financial uncertainty for CNA and enables management to focus even more attention and resources on strengthening the economic value of CNA's businesses. No material reserve increases are anticipated to fulfill CNA's obligations in regard to Fibreboard liabilities. See Note 16 of the Notes to Consolidated Financial Statements for a further discussion of Fibreboard. While CNA's 1993 and 1992 results were affected most significantly by the Fibreboard litigation, they also reflect the impact of serious external pressures on profitability throughout the insurance industry. Foremost among these are the long standing cycle of inadequate pricing in property and casualty commercial lines and low investment yields due to declining interest rates. In addition, complex and costly litigation has been continuing, fueled by the tendency of the courts to interpret insurance contracts beyond their stated intent. CNA's commercial lines remain subject to an industry downcycle that has lasted over seven years and has seriously depressed profitability. CNA cannot predict when the current negative cycle will turn. The current phase of the downcycle has been characterized by a difficult pricing environment caused by strong market competitiveness, a trend toward alternative risk mechanisms such as self- insurance and regulatory constraints on adequate premium rates, especially in the workers' compensation line of business. Profitability for the life segment remains stable, although negatively affected by intense competition, high health care costs and weak investment yields. Increasing costs of health care have resulted in a continued market shift away from traditional forms of health coverage toward managed care products. The federal government's initiative to control health care costs and provide universal access to health care was presented in 1993. The impact of potential health care reform cannot be determined at this time. Such reform may impact both individual and group accident and health, workers' compensation, automobile liability and medical malpractice business of CNA. CNA has urged a meaningful role for the private sector in any proposed plan. The present health care system is clearly in need of reform, and CNA has emphasized that the competitive strengths of the insurance industry must be an integral part of a workable solution. CNA's ability to compete in this market will be increasingly dependent on its ability to control costs through managed care techniques, innovation, and quality customer focused service. While CNA's strong financial position continues to represent a major competitive advantage, CNA continues to take a number of initiatives to respond to the many uncertainties and changes impacting the insurance environment. One of these has been to continue to focus on the risk characteristics and premium rates in commercial lines. CNA will continue to seek business in lines where it his sizable market share,
Lorillard, Inc. and subsidiaries ("Lorillard")- Funds from operations continue to exceed operating requirements. Lorillard generated net cash flow from operations of approximately $538 million for the year ended December 31, 1993, compared to $595 million for the prior year. No material capital expenditures are anticipated during 1994. For a number of years through 1992 leading cigarette marketers, including Lorillard, had increased the price of their premium brands. For the period 1982 to 1992 the annual price increase for Lorillard's premium brands averaged approximately 10%. Lorillard's cash flows from operations during this period benefited significantly from these price increases since virtually all of Lorillard's sales are in the premium priced segment, with Newport accounting for more than two-thirds of Lorillard's total unit sales. On April 2, 1993, Philip Morris USA, the largest marketer of premium priced cigarettes in the United States, announced significant changes in pricing policies for its premium priced brands, including a decision to reduce the average price of its Marlboro brand through various price promotions. Philip Morris stated that it "expects to forego further price increases on premium brands for the foreseeable future." R.J. Reynolds Tobacco Co., the second largest U.S. marketer of premium priced cigarettes, announced that it would take appropriate steps to maintain its competitive position. Philip Morris and R.J. Reynolds subsequently announced new lower pricing policies to replace these promotions. Effective August 9, 1993 Lorillard reduced its premium brand wholesale cigarette unit prices by approximately 25% to maintain its competitive position. These price moves have established two price tiers for the industry, eliminating much of the price confusion in the market place, and substantially narrowing the price gap between premium and discount cigarettes. These developments may tend to stabilize volume and perhaps slow the rapid growth of discount cigarettes. While promotional spending can be reduced, the overall impact of the new lower pricing will substantially reduce Lorillard's revenues, income contribution and cash flow. In November 1993, Philip Morris, R.J. Reynolds and Lorillard announced a price increase of $2.00 per thousand cigarettes. Forty-four lawsuits are pending in U.S. federal and state courts against cigarette manufacturers seeking damages for cancer or other health effects claimed to have resulted from the use of or exposure to cigarettes or other tobacco products. Lorillard is a defendant in 14 such cases. Lorillard is also a defendant in 10 lawsuits seeking damages for 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 brand of cigarettes manufactured by Lorillard. Plaintiffs seek unspecified amounts of 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 as much as $5 billion in punitive damages.
To date, no lawsuit has resulted in damages being awarded against Lorillard. Two cases, tried in late 1993 and January 1994, resulted in verdicts in favor of Lorillard. However, the fact that a cigarette manufacturer prevails in a case does not necessarily mean that a cigarette manufacturer will prevail in future cases; likewise, a loss in any of the pending cases would not necessarily mean that additional cases will be lost. Lorillard intends to defend vigorously all product liability lawsuits filed against it.
Bulova Corporation and subsidiaries ("Bulova"). Bulova is a 97% owned subsidiary of the Company. Competition and oversupply of watch products continue to adversely affect Bulova. The defense products segment continues to be adversely impacted by the contraction of defense spending by the United States government. Bulova may require additional working capital advances from the Company from time to time. While the Company has no obligation to enter into or maintain arrangements for any further funding requirements, it is anticipated that it would be provided through various arrangements with Bulova.
During 1993 the Company purchased 3,574,000 shares of its outstanding Common Stock at an aggregate cost of approximately $336.3 million. The funds required for such purchases were provided from working capital. Depending on market conditions, the Company, from time to time, may purchase additional shares in the open market or otherwise. In February 1993 the Company redeemed, at par, its outstanding 10% subordinated notes due 1996. In April 1993 the Company redeemed, at 105.8%, its outstanding 9% senior sinking fund debentures due 2016. The aggregate cost of these redemptions totaled $368 million and was provided from internally generated funds. In June 1993 the Company sold $300 million principal amount of 7.6% senior notes due 2023 at an effective rate of 7.8% per annum. In October 1993 the Company sold $400 million principal amount of 7% senior notes due 2023 (the "7% Notes") at an effective rate of 7.2% per annum. The Company currently has an aggregate $300 million of debt securities and/or preferred stock available for issuance under a shelf registration statement. In November 1993 the Company redeemed all of its currently outstanding zero coupon convertible subordinated notes due 2004 for an aggregate redemption price of approximately $411 million. The Company used the net proceeds received from the sale of the 7% Notes, together with general corporate funds, to redeem these notes.
Revenues declined by $4.7 million and increased by $66.5 million as compared to 1992 and 1991, respectively. Income before accounting changes increased by $616.2 million and decreased by $310.2 million, as compared to 1992 and 1991, respectively.
Revenues decreased by $16.2 and $15.7 million, or 8.0% and 7.8%, as compared to 1992 and 1991, respectively. Results from operations before accounting changes declined $3.7 and $6.6 million, as compared to 1992 and 1991, respectively. Oversupply of hotel rooms and the highly competitive nature of the hotel industry continue to adversely affect average room rates. Although demand has increased in some areas, it has not compensated for the lower average room rates. Revenues declined due primarily to lower occupancy rates at the Loews Monte Carlo Hotel resulting from the depressed general economic conditions in southern Europe as well as the impact of a weak Italian Lira and resulting absence of Italian tourist business on the Riviera. In addition, average room rates declined at North American properties, partially offset by increased occupancy rates. Results from operations before accounting changes declined due primarily to the lower revenues. The prior year included a charge of $3.7 million relating to renegotiation of a hotel land lease.
Revenues increased by $27.5 and $98.4 million, as compared to 1992 and 1991, respectively. Results from operations decreased by $6.9 million and increased by $77.7 million, as compared to 1992 and 1991, respectively. Other operations consist primarily of investment income of non-insurance companies and the Company's investment in CBS Inc. Revenues increased due primarily to higher earnings (accounted for under the equity method) of CBS Inc. and higher realized investment gains, partially offset by lower investment income. Results from operations before accounting changes declined, as compared to 1992, due to increased interest expense relating to the write off of unamortized discount for the early retirement of debt, partially offset by the increased revenues. Results from operations increased, as compared to 1991, due to the increased revenues, and lower interest expense.
In November 1992, the Financial Accounting Standards Board ("FASB") issued SFAS No.112, "Employers' Accounting for Postemployment Benefits." This Statement establishes accounting standards for employers who provide benefits to former or inactive employees after employment but before retirement (postemployment benefits). Postemployment benefits include salary continuation, supplemental unemployment benefits, severance benefits, disability-related benefits, job training and counseling and continuation of benefits such as health care benefits and life insurance coverage. This Statement applies to financial statements for fiscal years beginning after December 15, 1993. This Statement will not have a significant impact on the Company. In May 1993, the FASB issued SFAS No. 114, "Accounting by Creditors for Impairment of a Loan." This Statement addresses the accounting by creditors for impairment of certain loans. It is applicable to all creditors and to all loans, uncollateralized as well as collateralized, except large groups of smaller- balance homogeneous loans that are collectively evaluated for impairment, loans that are measured at fair value or at the lower of cost or fair value, leases, and debt securities. The Statement requires that applicable loans be treated as impaired when it is probable that a creditor will be unable to collect all amounts (both principal and interest) contractually due. It requires that impaired loans be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate. Impairment may be measured at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. In early 1994, the FASB began deliberating certain amendments to this Statement. This Statement applies to financial statements for fiscal years beginning after December 15, 1994. This Statement will not have a significant impact on the Company.
Principles of Consolidation-The consolidated financial statements include all significant subsidiaries and all material intercompany accounts and transactions have been eliminated. The equity method of accounting is used for investments in associated companies in which the Company has an interest of 20% to 50%.
Insurance Operations-Premium revenue-Insurance premiums on property/casualty and health insurance contracts (included in life premiums) are earned ratably over the terms of the policies after provision for estimated adjustments on retrospectively rated policies and deductions for ceded insurance. Revenues on universal life-type contracts are comprised of contract charges and fees which are recognized over the coverage period when assessed against the policyholders' account balances. Other life insurance premiums are recognized as revenue when due after deductions for ceded insurance. Claims and claims expense reserves-Claims and claims expense reserves, except reserves for structured settlements, workers' compensation lifetime claims and accident and health disability claims, are based on (a) case basis estimates for losses reported on direct business, adjusted in the aggregate for ultimate loss expectations, (b) estimates of unreported losses based upon past experience, (c) estimates of assumed insurance, (d) estimates of future expenses to be incurred in settlement of claims, and (e) estimates of claim recoveries. In establishing these estimates, consideration is given to current conditions and trends as well as past company and industry experience. Structured settlements have been negotiated for claims on certain property/casualty insurance policies. Structured settlements are agreements to provide periodic payments to claimants, which are fixed and determinable as to the amount and time of payment. Certain structured settlements are funded by annuities purchased from CNA's life insurance subsidiary. Related annuity obligations are carried in future policy benefits reserves. Obligations for structured settlements not funded by annuities are carried at discounted values which approximate the alternative cost of annuity purchases. Such reserves, discounted at interest rates ranging from 6.3 % to 7.5 %, totaled $748,900,000 and $662,600,000 at December 31, 1993 and 1992, respectively. Workers' compensation lifetime claims and accident and health disability claim reserves are discounted at interest rates ranging from 3.5% to 5.5% with mortality and morbidity assumptions reflecting current industry experience. Such discounted reserves totaled $969,800,000 and $911,100,000 at December 31, 1993 and 1992 respectively. Amounts assuming the changes in accounting for discounting certain workers' compensation and disability claims were applied retroactively to the year ended December 31, 1991, in thousands of dollars except per share data, are as follows:
Statutory capital and surplus-Statutory capital and surplus and net income (loss), determined in accordance with accounting practice prescribed or permitted by the Illinois Insurance Department, for property/casualty and life insurance subsidiaries are as follows:
Research and Development Costs-Research and development costs are charged to expense as incurred and amounted to $11,866,000, $11,521,000 and $11,476,000 for the years ended December 31, 1993, 1992 and 1991, respectively.
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: The carrying amounts reported in the balance sheet for short-term investments and securities sold under repurchase agreements approximates fair value, because of the short maturity of those investments. As such, these financial instruments are not shown in the table above. 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 and (c) underlying assets of the investments. The fair value of certain assets contained above approximates their carrying value.
The estimated fair values approximate carrying values and are generally equivalent to the gains or losses on these financial instruments. Fair values are based on quoted market prices, where available. For securities not actively traded, fair values are estimated using values obtained from independent pricing services, quoted market prices of comparable instruments or present value models. Through August 1, 1989, CNA's property/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, 1993 and 1992, gross exposure of financial guarantee insurance amounted to $792,000,000 and $1,000,000,000, respectively. The degree of risk attached to this exposure is substantially reduced through reinsurance, collateral requirements and diversification of exposures. At December 31, 1993 and 1992, collateral consisting of letters of credit and debt service reserves amounted to $48,000,000 and $60,000,000, respectively. In addition, security interests in real estate are also obtained. Approximately 38% of the risks were ceded to reinsurers at December 31, 1993 and 1992. Total exposure, net of reinsurance, amounted to $492,000,000 and $603,000,000 at December 31, 1993 and 1992, respectively. Gross unearned premium reserves for financial guarantee contracts were $33,000,000 and $51,000,000 at December 31, 1993 and 1992, respectively. Gross claims and claims expense reserves totaled $320,000,000 and $197,000,000 at December 31, 1993 and 1992, respectively. The fair values of the liability for financial guarantee contracts were $350,000,000 and $235,000,000 at December 31, 1993 and 1992, respectively. Fair values are based on discounted cash flows utilizing interest rates currently being offered for similar contracts and spot interest rates.
Depreciation and amortization expense and capital expenditures, by business segment, are as follows:
Federal, foreign, state and local income tax payments, net of refunds, amounted to approximately $10,263,000, $355,853,000 and $346,856,000 for the years ended December 31, 1993, 1992 and 1991, respectively. The Tax Reform Act of 1986 enacted a new separate parallel tax system referred to as the Alternative Minimum Tax ("AMT") system. AMT is based on a flat rate applied to a broader tax base. It is calculated separately from the regular federal income tax and the higher of the two taxes is paid. The excess of the AMT over regular tax is a tax credit, which can be carried forward indefinitely to reduce regular tax liabilities of future years. As a result of a carryback of 1992 tax losses, the Company received a tax refund of approximately $32,000,000. At December 31, 1993 the AMT credit totaled approximately $165,200,000.
(b) Redeemable in whole or in part at January 15, 1997 at 104%, and decreasing percentages thereafter. (c) Redeemable in whole or in part at June 1, 2003 at 104%, and decreasing percentages thereafter. (d) Redeemable in whole or in part at October 15, 2003 at 102%, and decreasing percentages thereafter.
The aggregate of long-term debt maturing in each of the next five years is approximately as follows: $8,541,000 in 1994, $6,815,000 in 1995, $282,499,000 in 1996, $21,512,000 in 1997 and $273,283,000 in 1998. The Company paid interest expenses of approximately $219,099,000, $127,689,000 and $146,659,000 for the years ended December 31, 1993, 1992 and 1991, respectively. Payment of dividends by insurance subsidiaries of CNA without prior regulatory agency approval is limited to certain formula-derived amounts. At December 31, 1993, $2,089,629,000 of retained earnings of subsidiaries was not available for dividends to the Company.
In addition to its common stock, the Company has authorized 25,000,000 shares of preferred stock, $.10 par value. Earnings per share, assuming no dilution, are based on the weighted average number of shares outstanding during each year (64,108,000, 65,659,000 and 68,807,000 for the years ended December 31, 1993, 1992 and 1991, respectively). Fully diluted earnings per share assumes conversion of the zero coupon convertible subordinated notes and elimination of the related interest charges, net of taxes. Fully diluted earnings per share are not presented for the years ended December 31, 1992 and 1991 since such dilution is not material.
CNA assumes and cedes insurance with other insurers and reinsurers and members of various reinsurance pools and associations. CNA utilizes reinsurance arrangements to limit its maximum loss, to provide greater diversification of risk and to minimize exposures on larger risks. The reinsurance coverages are tailored to the specific risk characteristics of each product line with CNA's retained amount varying by type of coverage. Generally, reinsurance coverage for property risks is on excess of loss, per risk basis. Liability coverages are generally reinsured on a quota share basis in excess of CNA's retained risk. In addition, CNA has catastrophe coverage for certain types of losses over stipulated amounts arising from any one occurrence or event. 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. At December 31, 1993, such collateral totaled approximately $155,000,000. CNA's largest recoverable, including prepaid reinsurance premiums, at December 31, 1993 was approximately $484,000,000 with Lloyd's of London. The recoverable from Lloyd's of London is dispersed among thousands of individual reinsurers and other names who have unlimited liability.
The effects of reinsurance on written premiums and earned premiums are as follows:
The Company's hotels in some instances are constructed on leased land or are leased. Other leases cover central office facilities, computer equipment and operating service offices. Rent expense amounted to $84,946,000, $85,400,000 and $84,429,000 for the years ended December 31, 1993, 1992 and 1991, respectively. It is expected, in the normal course of business, that leases which expire will be renewed or replaced by leases on other properties; therefore, it is believed that future minimum annual rental commitments will not be less than the amount of rental expense incurred in 1993. At December 31, 1993 future aggregate minimum rental payments approximated $282,805,000.
Pending litigation includes claims seeking damages for cancer and other health effects claimed to have resulted from use of tobacco products. It is not possible to predict the outcome of pending litigation; however, on the basis of the facts presently known to it, management does not believe the actions pending will have a material adverse effect upon the financial condition or results of operations of the Company. Should additional facts arise in the future indicating a probable adverse determination of any such actions, such ultimate determination might have a material adverse effect upon the Company's financial condition.
Fibreboard Litigation--CNA's primary property/casualty subsidiary, Continental Casualty Company ("Continental"), is party to litigation with Fibreboard Corporation ("Fibreboard") involving coverage for certain asbestos-related claims and defense costs (San Francisco Superior Court, Judicial Council Coordination Proceeding 1072). As described below, Continental, Fibreboard, another insurer ("Pacific Indemnity"), a subsidiary of the Chubb Corporation, and a negotiating committee of asbestos claimant attorneys have reached a Global Settlement (the "Global Settlement") to resolve all future asbestos-related bodily injury claims involving Fibreboard. Continental, Fibreboard and Pacific Indemnity have also reached an agreement, which is subject to court approval, (the "Trilateral Agreement") on a settlement to resolve the coverage litigation in the event the Global Settlement does not obtain final court approval. The implementation of the Global Settlement or the Trilateral Agreement would have the effect of settling Continental's litigation with Fibreboard. Pending final court approval of either the Global Settlement or the Trilateral Agreement, at the request of Continental, Fibreboard and Pacific Indemnity, the California Court of Appeal withheld its ruling on the issues discrete to Continental and Pacific Indemnity in the appeal in that litigation.
Interim Agreement--While the state court action in regard to the coverage issues was pending, Continental and Fibreboard entered into an Interim Agreement in 1988 under which Continental agreed to fund Fibreboard's defense costs and certain settlements up to specified dollar limits through 1992. Continental funded approximately $96 million in defense costs under the Interim Agreement.
Settlement Negotiations--Based on the facts and circumstances of the Fibreboard case prior to the fourth quarter of 1992, including the strength of Continental's legal arguments, a material loss to Continental was not known or believed to be probable. Significant fourth quarter developments, including the assignments noted above, and the continuing trend for court decisions to expand liability of policies beyond their original intent, led management to consider negotiation of an all-inclusive settlement of Continental's asbestos-related bodily injury litigation with Fibreboard. On April 9, 1993, Continental 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, 1993, Continental, Fibreboard and plaintiff attorneys had reached settlements with respect to approximately 95,000 claims, subject to resolution of the coverage issues, for a maximum settlement amount of approximately $1.2 billion. If neither the Global Settlement nor the Trilateral Agreement receive final court approval, Continental's obligation to pay under all settlements will be partially subject to the results of the pending appeal in the coverage litigation. Minimum amounts payable under all such agreements, regardless of the outcome of coverage litigation, total approximately $560 million, of which $193 million was paid through December 31, 1993. Continental may negotiate other agreements with various classes of claimants including groups who may have previously reached agreement with Fibreboard. Continental will continue to pursue its appeals in respect of the coverage litigation and all other litigation involving Fibreboard if a Global Settlement or the Trilateral Agreement cannot be implemented.
Global Settlement--On August 27, 1993, Continental, Pacific Indemnity, Fibreboard and a negotiating committee of asbestos claimant attorneys reached an agreement in principle for an omnibus settlement to resolve all future asbestos- related bodily injury claims involving Fibreboard. The Global Settlement was executed on December 23, 1993. The agreement calls for contribution by Continental and Pacific Indemnity of an aggregate of $1.525 billion to a trust fund for a class of all future asbestos claimants, defined generally as those persons whose claims against Fibreboard were neither filed nor settled on or before August 27, 1993. An additional $10 million is to be contributed to the fund by Fibreboard. The Global Settlement is subject to court approval and possible appeals. As noted below, there is limited precedent with settlements which determine the rights of future claimants to seek relief. Subsequent to the announcement of the agreement in principle, Continental, Fibreboard and Pacific entered into the Trilateral Agreement which sets forth the parties' obligations in the event the Global Settlement is not approved by the court. In such case, Continental and Pacific would contribute to a settlement fund an aggregate of $2 billion, less certain adjustments. Such fund would be devoted to the payment of Fibreboard's asbestos liabilities other than liabilities in respect of previously settled claims. Continental's share of such fund would be $1.46 billion, reduced by a portion of the additional payment of $635 million, which Pacific Indemnity has agreed to pay in respect of unsettled present claims and previously settled claims. Continental has agreed that if either the Global Settlement or the Trilateral Agreement is approved, it will assume responsibility for the claims that had been settled and paid on or before August 27, 1993. A portion of the additional $635 million payment by Pacific Indemnity would be applied to the payment of such claims as well. As a part of the Global Settlement and the Trilateral Agreement, Continental would be released by Fibreboard from any further liability under the comprehensive general liability policy written for Fibreboard by Continental, including but not limited to liability for asbestos-related claims against Fibreboard. The Trilateral Agreement is subject to court approval and possible appeals. Continental and Fibreboard have entered into a supplemental agreement (the "Supplemental Agreement") which governs the interim arrangements and obligations between the parties until such time as the Global Settlement is either approved or disapproved by the court and also governs certain obligations between the parties in the event the Global Settlement is approved, including the payment of present claims which have been filed or settled and not included in the Global Settlement. 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 interest and expenses 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. 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.
Environmental Pollution-Potential exposures exist for claims involving environmental pollution, including toxic waste clean-up. Environmental pollution clean-up is the subject of both federal and state regulation. By some estimates, there are thousands of potential waste sites subject to clean-up. The insurance industry is involved in extensive litigation regarding coverage issues. Judicial interpretations in many cases have expanded the scope of coverage and liability beyond the original intent of the policies. Under federal regulation, the Comprehensive Environmental Response Compensation and Liability Act of 1980 ("Superfund") governs the clean-up and restoration of abandoned toxic waste sites and formalizes the concept of legal liability for clean-up and restoration by "Potentially Responsible Parties" ("PRP's"). Superfund establishes a mechanism to pay for clean-up of waste sites if PRP's fail to do so, and to assign liability to PRP's. The extent of liability to be allocated to a PRP is dependent on a variety of factors. Further, the number of waste sites subject to clean-up is unknown. To date, approximately 1,300 clean-up sites have been identified by the Environmental Protection Agency ("EPA"). On the other hand, the Congressional Budget Office is estimating that there will be 4,500 National Priority List sites and other estimates run as high as 30,000 sites that will require clean-up. Very few sites have been subject to clean-up to date. The extent of clean-up necessary and the assignment of liability has not been established. CNA and the insurance industry are disputing coverage for many such claims. Key coverage issues include whether Superfund response cost are considered damages under the policies, trigger of coverage, applicability of pollution exclusions, the potential for joint and several liability and definition of an occurrence. Similar coverage issues exist for clean-up of waste sites not covered under Superfund. To date, courts have been inconsistent in their rulings on these issues. The Superfund legislation must be reauthorized in 1994. A number of proposals to reform Superfund have been made by various parties including the EPA, the Treasury Department, congressional delegates and the Keystone Commission, a broad based national coalition which includes community, industry and insurance representatives. It is too early to determine the future impact of these proposals on CNA and the insurance industry. 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, the exposure to CNA for environmental pollution claims cannot be meaningfully quantified. Prior to 1993, no specific allocation of reserves was made for unreported claims or for litigation expenses. CNA identified reserves only for reported environmental pollution claims. In 1993, CNA allocated approximately $340 million of claims and claims expense reserves for unreported environmental pollution claims in addition to the $94 million of reserves recorded for reported claims. Claims and claims expense reserves represent management's estimates of ultimate liabilities based on currently available facts and law. However, in addition to the uncertainties previously discussed, additional issues related to, among other things, specific policy provisions, multiple insurers and allocation of liability among insurers, consequences of conduct by the insured, missing policies and proof of coverage make quantification of liabilities exceptionally difficult. The number of claims filed for environmental pollution coverage continues to increase. Approximately 2,700 claims were reported in 1993 and approximately 19,200 claims have been reported to date. Pending claims total approximately 10,600, 10,800, and 9,300 at December 31, 1993, 1992 and 1991, respectively. Approximately 8,600 claims were closed through December 31, 1993, of which approximately 7,800 claims were settled without payment, except for claim expenses of $18 million. Settlements for the remaining 800 claims totaled $76 million, plus claim expenses of $21 million. Reserve development for environmental claims totaled $446, $48, and $47 million in 1993, 1992 and 1991, respectively, including litigation costs of $28, $25 and $21 million. As noted above, adverse development for 1993 primarily resulted from the allocation of $339 million of reserves for unreported claims. The results of operations in future years may continue to be adversely affected by environmental pollution claims and claims expenses. Management will continue to monitor potential liabilities and make further adjustments as warranted.
(b) Includes $1,700,000, $1,600,000 and $1,500,000 under contracts covering U.S. government employees and their dependents for the respective periods.
(c) 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.