Management's Discussion and Analysis of Financial Condition and Results Of Operations.
Loews Corporation reported net income for 2000 of $1,876.7 million or $18.88 per share, compared to $363.2 million or $3.35 per share in 1999.
Net income includes investment gains of $742.5 million in 2000, compared to losses of $136.6 million in 1999. Net investment gains in 2000 resulted principally from the sale of common stock of Global Crossing Ltd. ("Global Crossing") and Canary Wharf Group, plc. ("Canary Wharf") by the CNA subsidiary, and reduced losses from the parent company investment portfolio. Net income for 1999 also reflected a charge of $157.9 million or $1.45 per share, due primarily to the adoption of a change in accounting principles at the CNA subsidiary.
Revenues for 2000 were $21.3 billion, compared to $21.5 billion for 1999. Revenues declined primarily due to the transfer of CNA's personal insurance business to Allstate in October 1999.
Net operating income which excludes net investment gains and losses, was $310.7 million or $3.15 per share for the quarter ended December 31, 2000, compared to a net operating loss of $11.5 million or $.11 per share in 1999.
At year end 2000, Loews Corporation had a book value of $113.48 per share compared to $95.50 per share in 1999.
Underwriting results improved $852.0 million for 2000 as compared with 1999. The combined ratio decreased for the property-casualty segment to 110.3% for 2000 as compared with 117.9% for 1999. This decrease reflects an improvement in the loss ratio to 78.5% in 2000 as compared with 86.2% in 1999 which is primarily attributable to significant rate increases across the entire book of business, favorable catastrophe experience, reduced prior year reserve strengthening and the increased use of reinsurance. After-tax and minority interest catastrophe losses for 2000 improved by $164.0 million, including $54.0 million related to Personal Insurance. In addition to the decrease in the loss ratio was a decrease in the expense ratio to 30.6% in 2000 as compared with 31.4% in 1999 due principally to the absence of restructuring- related charges in 1999. The dividend ratio increased to 1.2% relating to favorable development in dividend reserves in Agency Market Operations in 1999 as compared to 2000.
Net earned premiums for the property-casualty segment for 1999 decreased $260.0 million or approximately 2.9% as compared to 1998. Agency Market Operations' earned premium declined $448.0 million, or 8.5%, due mainly to the transfer of Personal Insurance to Allstate effective October 1, 1999. Reinsurance agreements executed in 1999, as well as rate and underwriting actions taken to improve the core book of business, also contributed to Agency Market Operations' decreased premium. Specialty Operations' premiums decreased $91.0 million due to new reinsurance agreements covering 1999 risks and due to the decision not to pursue certain markets, including the agricultural and entertainment markets. Risk Management's earned premium decreased $22.0 million due to the decision to take advantage of a favorable reinsurance market. Offsetting these declines were increases in CNA Re and Global Operations. CNA Re experienced $232.0 million, or 24.5%, of earned premium growth, which occurred in domestic and foreign markets in the professional and standard lines of business. Global Operations' earned premium increased $69.0 million, due to the effects of 1998 acquisitions, and increased surety and warranty sales stemming from the favorable domestic economic environment.
Underwriting results declined by $201.0 million, or 15.0%, in 1999 and include approximately $558.0 million in loss and allocated loss adjustment expense reserve strengthening for prior years. Agency Market
Group Operations provides a broad array of group life and health insurance products and services to employers, affinity groups and other entities that purchase insurance as a group. In addition, Group Operations provides health insurance to federal employees, retirees and their families ("Federal Markets"); managed care and self-funded medical excess insurance; medical provider network management and administration services; and reinsurance for life and health insurers.
Net operating income increased $36.3 million in 2000 as compared with 1999. This increase relates to a $20.9 million improvement in Federal Markets due to the 1999 exit of unprofitable medical lines, a $29.6 million improvement in Provider Markets, and a $3.5 million improvement in Life Reinsurance. These improvements were partially offset by a $15.7 million decline in Group Benefits due to favorable 1999 loss experience in the group life line of business. The improvement associated with Provider Markets relates to adverse experience and loss development for the personal accident business recorded in 1999, which exceeded $7.0 million of exit costs incurred from the Management Services Organization business and $13.0 million of adverse development on the medical stop loss business in 2000.
Net earned premiums declined in 1999 by $162.0 million, or 4.3%, to $3,571.0 million as compared with 1998. Federal Markets' net earned premiums declined $274.0 million, almost entirely due to the exit of selected medical markets in late 1998. This decline was partially offset by growth in Life Reinsurance and Group Benefits of $60.0 and $53.0 million, respectively.
Net operating results in 1999 improved by $36.1 million as compared with 1998. Key components of the improvement include better underwriting results in
Life Operations provides financial protection to individuals through a full product line of term life insurance, universal life insurance, long term care insurance, annuities and other products. Life Operations also provides retirement services products to institutions in the form of various investment products and administration services. Life Operations has several distribution relationships and partnerships including managing general agencies, other independent agencies working with CNA life sales offices, a network of brokers and dealers and various other independent insurance consultants.
Net operating income increased to $123.7 million in 1999 as compared with $89.0 million in 1998. The 1999 improvement in net operating income was due primarily to favorable investment performance in the portfolio supporting Retirement Services' Index 500 product, improved mortality experience in the individual life market, and expense reductions across virtually all of the other principal groups.
The Other insurance segment contains CNA's corporate interest expense, certain run-off insurance operations, asbestos claims related to Fibreboard Corporation, financial guarantee insurance contracts and certain non-insurance operations, including eBusiness initiatives.
Net operating loss increased to $178.5 million for 2000 as compared with a loss of $169.6 million in 1999 primarily as a result of expenses in 2000 for CNA's eBusiness initiatives.
During 2000, Lorillard increased the wholesale price of its cigarettes by an aggregate of $16.50 per thousand cigarettes ($0.33 per pack of 20 cigarettes). Federal excise taxes included in the price of cigarettes are $17.00 per thousand cigarettes ($0.34 per pack of 20 cigarettes). The federal excise tax on cigarettes is scheduled to increase by $2.50 per thousand cigarettes in 2002. All of the states also levy excise taxes on cigarettes. Various states have proposed, and certain states have recently passed, increases in their state tobacco excise taxes. Such actions may adversely affect Lorillard's volume, operating revenues and operating income.
The Company believes that the implementation of the State Settlement Agreements will materially adversely affect its consolidated results of operations and cash flows in future periods. The degree of the adverse impact will depend, among other things, on the rates of decline in United States cigarette sales in the full price and discount segments, Lorillard's share of the domestic full price and discount segments, and the effect of any resulting cost advantage of manufacturers not subject to payments under the Master Settlement Agreement.
Lorillard's unit sales volume decreased by 7.2% as compared to 1999. Newport, a full price brand, which accounted for approximately 80% of Lorillard's unit sales in 2000, increased by 1.5% as compared to 1999. Newport's increase in unit sales volume reflects increased promotional activities to the extent practicable in light of existing limitations due to competitive conditions. The decrease in Lorillard's overall unit sales volume reflects lower unit sales of its Maverick and Old Gold brands in the discount market segment. Discount brand sales have remained relatively constant at 26.3%, 26.4% and 26.2% as a percentage of industry sales for 2000, 1999 and 1998, respectively.
Newport's market share remained at 7.7% in 2000, as compared to 1999. Overall industry unit sales volume is up by .2% in 2000, as compared to 1999.
Net income increased due primarily to the increased revenues discussed above, partially offset by higher charges for tobacco litigation settlements ($637.3 million in 1999 compared to $346.5 million in 1998) and higher sales promotion expenses.
Lorillard's unit sales volume increased by 4.0% as compared to 1998. Newport, a full price brand which accounted for approximately 73% of Lorillard's unit sales in 1999, decreased by 1.8% as compared to 1998. The increase in Lorillard's unit sales volume reflects higher unit sales of its Maverick and Old Gold brands in the discount market segment, and increased sales promotion activities, relative to the state of the competitive marketplace in early 1999, for these brands.
Newport's decline in unit sales volume reflects the effects of various price increases since November 1998 that followed the Master Settlement Agreement (see Note 17 of the Notes to Consolidated Financial Statements). While Newport's unit sales volume has declined, its market share has increased to 7.7% at December 31, 1999, as compared to 7.1% at December 31, 1998. Overall industry unit sales volume is down by 10.0% in 1999, as compared to 1998.
Loews Hotels Holding Corporation and subsidiaries ("Loews Hotels"). Loews Hotels Holding Corporation is a wholly owned subsidiary of the Company.
Revenues and income before cumulative effect of changes in accounting principles increased due primarily to increased overall average room rates and the addition of two luxury properties to the Loews Hotels portfolio, offsetting the 1999 sale of the two franchised properties. Overall occupancy rates remained at approximately 78%, essentially unchanged from 1999. Income also benefited from improved operating results from an unconsolidated joint venture whose operations commenced in 1999.
Revenues and income before cumulative effect of changes in accounting principles increased by $109.8 and $37.7 million, respectively, in 1999 as compared to 1998, and includes a gain of $85.1 and $14.7 million ($52.0 and $8.4 million after taxes) from the sale of two franchised properties in 1999 and the sale of the Loews Monte Carlo Hotel in 1998. Excluding this gain, revenues increased by $39.4 million, or 17.3%, and income before cumulative effect of changes in accounting principles decreased by $5.9 million, or 24.2%. Revenues increased due primarily to the operations of the Loews Miami Beach Hotel which opened in December 1998 and an approximately 8.4% increase in overall average room rates. These increases were partially offset by the sale of the Loews Monte Carlo Hotel in November 1998. Overall occupancy rates remained at approximately 78%, essentially unchanged from 1998.
Net income includes a charge of $7.1 million to reflect the cumulative effect of a change in accounting principles requiring current write-off of preopening expenses. Income before cumulative effect of changes in accounting principles decreased due to costs incurred with respect to preopening activities in 1999 and losses recorded from an unconsolidated joint venture which commenced operations that year. These declines were partially offset by the increased revenues discussed above.
Net income declined due primarily to the lower revenues discussed above and increased depreciation expense, partially offset by lower contract drilling costs.
lower watch prices in 1999 as compared to 1998. Watch prices declined due primarily to a change in sales mix.
The principal operating cash flow sources of CNA's property-casualty and life insurance subsidiaries are premiums and investment income. The primary operating cash flow uses are payments for claims, policy benefits and operating expenses.
On February 15, 2000, Standard & Poor's lowered CNA's senior debt rating from A- to BBB and lowered CNA's preferred stock rating from BBB to BB+. As a result of these actions, the facility fee payable on the aggregate amount of CNA's $795.0 million revolving credit facility ("Facility") was increased to 12.5 basis points per annum from 9.0 basis points per annum and the interest rate was increased to London Interbank Offered Rate ("LIBOR") plus 27.5 basis points from LIBOR plus 16.0 basis points. Subsequently, CNA repurchased and retired the outstanding money market preferred stock ($150.0 million) in early 2000.
CNA has selected a financial institution to lead the syndication process for its new credit facility to replace its current $750.0 million revolving credit facility that terminates in May 2001.
During 2000, CNA purchased a portion of its notes when opportunities arose. CNA may purchase additional securities in the future. These repurchases included approximately $38.0 million of senior notes.
CNA is separated into three intercompany reinsurance pools: the Continental Casualty Company Pool ("CCC Pool"), the Continental Insurance Company Pool ("CIC Pool") and the Continental Assurance Company Pool ("CAC Pool"). The CCC Pool, CIC Pool and CAC Pool are comprised of 9, 15 and 2 legal insurance entities, respectively, domiciled in a total of 13 states and doing business in 50 states and Canada (the "Pool Companies"). To the extent a Pool Company's currently due claim liabilities may exceed its readily available liquid assets, CNA may be called upon to contribute capital to that company. Furthermore, such capital would likely be obtained in the form of a dividend from another Pool Company, possibly in a different pool, which may or may not require the approval of insurance regulators in the jurisdiction of the dividend-paying company. Accordingly, management must continuously monitor the capital allocation among the pools and the liquidity and capital resources of the individual Pool Companies.
The table below presents ratings issued by A.M. Best, Fitch, Moody's and Standard & Poor's for the CCC Pool, the CIC Pool and the CAC Pool. Also rated were CNA's senior debt and commercial paper and The Continental Corporation's ("Continental") senior debt.
Funds from operations continue to exceed operating requirements. Funds for other capital expenditures and working capital requirements are expected to be provided from existing cash balances and operations.
During 2000, oil and gas prices remained significantly above historical averages. However, market recovery for various classes of equipment within the offshore drilling industry was inconsistent. Diamond Offshore believes that current expectations are for higher than average product prices to persist as world energy demand is increasing and short-term oil supplies are below historical averages. The growth in the offshore drilling industry, anticipated because of these favorable market fundamentals, is dependent on confidence by Diamond Offshore's customers that current levels of oil and gas prices will be sustained.
Utilization and dayrates for Diamond Offshore's domestic jack-up market improved significantly in 2000 as independent producers acted quickly to take advantage of the high natural gas prices which prevailed throughout the year. Although the improvement in the jack-up market leveled off during the fourth quarter of 2000, it remains strong. Diamond Offshore's outlook for this market is for continued strength, especially if the recovery of the international jack-up market creates a tight supply of jack-ups in the Gulf of Mexico.
During 2000, there was increased interest for Diamond Offshore's deepwater high specification rig fleet with both utilization and dayrates increasing. Diamond Offshore believes that prospects are good for further improvement in this market, as most recent dayrates are greater than rates under current contracts. Most of the existing contracts are for short-term, well-to-well work and Diamond Offshore anticipates upward pressure on rates as these existing contracts are renewed or replaced.
For Diamond Offshore's other semisubmersible rig fleet, the market began to experience growth in the latter half of 2000 with both dayrates and utilization increasing. Currently, all of the domestic marketed rigs in this class are working or have commitments. If the backlog for these rigs continues to increase, Diamond Offshore expects further increases in dayrates.
Diamond Offshore believes that the international markets are also strengthening for all classes of equipment. Dayrates are increasing and that trend is expected to continue into the second half of the year. All three of Diamond Offshore's rigs located in the North Sea have recently committed for work at dayrates that are well above their previously contracted dayrates. Five of Diamond Offshore's six rigs operating in Brazil are committed under long-term contracts ranging from 18 months to approximately three years.
3.5%, and are convertible into 8.6075 shares of Diamond Offshore common stock per $1,000 debenture. On March 7, 2001 Diamond Offshore called for redemption its 3.75% convertible subordinated notes due 2007 at a redemption price of 102.1%. Approximately $400.0 million of these notes are outstanding. These notes are convertible into Diamond Offshore common stock at a conversion price of $40.50 per share until the day prior to the April 6, 2001 redemption date.
The conversion of the Ocean Confidence from an accommodation vessel to a semisubmersible drilling unit was completed and the rig was accepted by the customer on January 5, 2001 at which time it began a five-year drilling program in the Gulf of Mexico. The net cost of conversion for this rig was approximately $450.0 million. Future revenues to be generated by the Ocean Confidence under its five-year contract are estimated to be $311.5 million including the effect of an $8.1 million reduction that resulted from the late delivery of the rig. Additional revenue reductions could occur during the first two wells under the drilling contract based on the nature of any downtime.
The significant upgrade of Diamond Offshore's semisubmersible, the Ocean Baroness, to high specification capabilities will be an enhanced version of Diamond Offshore's Victory-class upgrades. The initial estimated cost for the deepwater upgrade of the Ocean Baroness is approximately $180.0 million and is anticipated to take approximately 18 months, with an expected delivery date of February 2002. During the year ended December 31, 2000, Diamond Offshore expended $21.9 million for the deepwater upgrade of the Ocean Baroness.
During the year ended December 31, 2000, Diamond Offshore expended $73.0 million for its continuing rig enhancement program and other corporate requirements. Diamond Offshore has budgeted $106.0 million for 2001 capital expenditures associated with these items.
Bulova For the year ended December 31, 2000, net cash used for operating activities was $15.9 million as compared with net cash inflows of $8.6 million in 1999. Bulova's cash and cash equivalents, and investments amounted to $16.9 million at December 31, 2000, compared to $34.1 million in 1999. The decrease is primarily the result of an increase in inventory purchases to meet Bulova's spring 2001 sales forecast. Funds for capital expenditures and working
capital requirements are expected to be provided from operations and existing cash balances. No material capital expenditures are anticipated during 2001.
During 2000, the Company purchased 5,866,600 shares of its outstanding Common Stock at an aggregate cost of $305.7 million. Depending on market conditions, the Company from time to time purchases shares of its, and its subsidiaries', outstanding common stock in the open market or otherwise.
The general account portfolio consists primarily of high quality (rated BBB or higher) bonds, 93.0% and 94.2% of which are rated as investment-grade at December 31, 2000 and 1999, respectively.
The following table summarizes the ratings of CNA's general account fixed maturity bond portfolio at fair value:
The following table summarizes the bond ratings of the investments supporting CNA's Separate Accounts products which guarantee principal and a specified rate of interest:
At December 31, 2000 and 1999, approximately 98.0% and 95.4% of the general account bond portfolio, and 99.0% and 96.9% of the guaranteed investment contract bond portfolio, respectively, were U.S. government agency securities or were rated by Standard & Poor's or Moody's Investors Service. The remaining bonds were rated by other rating agencies, outside brokers or CNA's management.
High yield securities are bonds rated as below investment-grade (below BBB) by bond rating agencies and other unrated securities that, in the opinion of management, are below investment grade. High yield securities generally involve a greater degree of risk than investment-grade securities. However, expected returns should compensate for the added risk. This risk is also considered in the interest rate assumptions in the underlying insurance products.
Total Separate Accounts investments at fair value were approximately $4.1 and $4.5 billion at December 31, 2000 and 1999, respectively, with taxable fixed maturities representing approximately 65.2% and 72.4% of the totals, respectively. Approximately 57.0% and 63.0% of Separate Accounts investments at December 31, 2000 and 1999, respectively, are used to fund guaranteed investment contracts for which Continental Assurance Company and Valley Forge Life Insurance Company guarantee principal and a specified return to the contract holders (guaranteed investment contracts). The duration of fixed maturity securities included in the guaranteed investment contract portfolio is matched approximately with the corresponding payout pattern of the liabilities of the guaranteed investment contracts.
CNA's second largest equity holding is Canary Wharf. During 2000, CNA experienced a net decrease in unrealized gains of $334.0 million on its position in Canary Wharf, which was valued at $291.0 million on December 31, 2000. The majority of this decline was due to the sale of 60.1 million shares, resulting in a pre-tax realized gain of $444.0 million.
In June 2000, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." This statement addresses a limited number of issues causing implementation difficulties for entities applying SFAS No. 133. SFAS No. 133, as amended and interpreted, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. SFAS No. 133 requires that an entity recognize all derivative instruments as either assets or liabilities in the balance sheet and measure those instruments at fair value. A derivative may be specifically designated as a hedge of the exposures to changes in the fair value, cash flows or foreign currencies. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.
The Company is required to adopt SFAS No. 133 effective January 1, 2001. The transition adjustment resulting from adoption must be reported in net income or other comprehensive income, as appropriate, as the cumulative effect of a change in accounting principle. The Company estimates that the initial adoption of SFAS No. 133 will not have a material impact on the Company's shareholders' equity; however, adoption will result in an estimated decrease to 2001 earnings of $54.0 million, net of taxes and minority interest. Of this estimated transition amount, approximately $50.0 million, net of taxes and minority interest, relates to investments and investment-related derivatives (related primarily to CNA's hedged position in Global Crossing common stock, see Note 2 of the Notes to Consolidated Financial Statements). Because the Company already carries its investment-related derivatives at fair value through other comprehensive income, there is an equal and offsetting favorable adjustment of $50.0 million to shareholders' equity. The remainder of the estimated transition adjustment is attributable to collateralized debt obligation products that are derivatives under SFAS No. 133.
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, the impact of competitive products, policies and pricing; product and policy demand and market responses; development of claims and the effect on loss reserves; the performance of reinsurance companies under reinsurance contracts; general economic and business conditions; changes in financial markets (interest rate, credit, currency, commodities and equities) or in the value of specific investments; changes in foreign, political, social and economic conditions; regulatory initiatives and compliance with governmental regulations; changes in foreign and domestic oil and gas exploration and production activity, and expenditures related to rig conversion and upgrade; changes in rating agency policies and practices, the results of financing efforts; and agreements and various other matters and risks, many of which are beyond the Company's control.
Condensed Statements of Income Information Loews Corporation and Subsidiaries (Including CNA and Diamond Offshore on the Equity Method)
Accounting changes - In the first quarter of 2000, the Company adopted the American Institute of Certified Public Accountants ("AICPA") Statement of Position ("SOP") 98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." Adoption of SOP 98-7 did not have a material impact on the financial position or results of operations of the Company.
Common stock split - On February 20, 2001, the Board of Directors declared a two-for-one stock split, by way of a stock dividend, effective March 21, 2001. All share and per share data has not been restated to retroactively reflect the stock split.
Investments - Investments in securities, which are held principally by insurance subsidiaries of CNA Financial Corporation ("CNA"), an 87% owned subsidiary, are carried as follows:
The Company classifies fixed maturity securities (bonds and redeemable preferred stocks) and its equity securities held by insurance subsidiaries as available-for-sale, and are carried at fair value. Changes in fair value are recorded as a component of accumulated other comprehensive income in shareholders' equity, net of applicable deferred income taxes and participating policyholders' and minority interest. The amortized cost of fixed maturity securities is adjusted for amortization of premiums and accretion of discounts to maturity, and amortization and accretion are
Derivative instruments are generally held for trading purposes and, as such, are marked to market. Changes in fair value are included in investment gains or losses in the income statement. Derivatives used to hedge the fair value of assets or liabilities are classified with the related hedged item in the consolidated balance sheets. Interest rate swaps which are used to manage the Company's exposure to variable rate long-term debt are not considered held for trading purposes. Such swaps are accounted for on an accrual basis and are included in the income statement as an adjustment to interest expense.
Securities sold under agreements to repurchase - The Company lends securities to unrelated parties, primarily major brokerage firms. Borrowers of these securities must deposit collateral with the Company equal to 100% of the fair value of these securities if the collateral is cash, or 102% of the fair value of the securities, if the collateral is securities. Cash deposits from these transactions are invested in short-term investments (primarily U.S. government securities and commercial paper) and a liability is recognized for the obligation to return the collateral. The fair value of collateral held and included in short-term investments was $885.0 and $1,300.0 at December 31, 2000 and 1999, respectively. The Company continues to receive the interest on loaned debt securities, as beneficial owner, and accordingly, loaned debt securities are included in fixed maturity securities.
Claim and claim adjustment expense reserves - Claim and claim adjustment expense reserves, except reserves for structured settlements, workers' compensation lifetime claims and accident and health disability claims, are not discounted and are based on (i) case basis estimates for losses reported on direct business, adjusted in the aggregate for ultimate loss expectations, (ii) estimates of unreported losses, (iii) estimates of losses on assumed reinsurance, (iv) estimates of future expenses to be incurred in settlement of claims, and (v) estimates of claim recoveries, exclusive of reinsurance recoveries, which are reported as an asset. Management considers current conditions and trends as well as past company and industry experience in establishing these estimates. The effects of inflation, which can be significant, are implicitly considered in the reserving process and are part of the recorded reserve balance.
Structured settlements have been negotiated for claims on certain property and casualty insurance claims. Structured settlements are agreements to provide fixed periodic payments to claimants. Certain structured settlements are funded by annuities purchased from CNA's life insurance subsidiary for which the related annuity obligations are recorded in future policy benefits reserves. Obligations for structured settlements not funded by annuities are included in claim and claim adjustment expense reserves and carried at present values determined using interest rates ranging from 6.0% to 7.5%. At December 31, 2000 and 1999, the discounted reserves for unfunded structured settlements were $884.0 and $883.0, respectively (net of discounts of $1,473.0 and $1,483.0, respectively).
Workers' compensation lifetime claim reserves and accident and health disability claim reserves are calculated using mortality and morbidity assumptions based on CNA's and industry experience, and are discounted at interest rates allowed by insurance regulators that range from 3.5% to 6.5%. At December 31, 2000 and 1999, such discounted reserves totaled $2,205.0 and $2,174.0, respectively (net of discounts of $940.0 and $893.0, respectively).
Insurance-related assessments - CNA's participation in involuntary risk pools is mandatory and generally a function of its proportionate share of the voluntary market, by line of insurance, in each state in which it does business. Effective January 1, 1999, in accordance with SOP 97-3, CNA records liabilities for insurance-related assessments when an assessment is probable, when it can be reasonably estimated, and when the event obligating the entity to pay an imposed or probable assessment has occurred on or before the date of the financial statements. Insurance-related assessment liabilities are not discounted or recorded net of premium taxes. These liabilities are included as part of other liabilities in the Consolidated Balance Sheets.
Reinsurance - Amounts recoverable from reinsurers are estimated in a manner consistent with claim and claim adjustment expense reserves or future policy benefits reserves, and reported as a receivable in the Consolidated Balance Sheets. Reinsurance contracts that do not meet the criteria for risk transfer are recorded in accordance with SOP No. 98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." The related deposit assets are recorded as reinsurance receivables in the Consolidated Balance Sheets.
Life insurance business acquisition costs are deferred and amortized based on assumptions consistent with those used for computing future policy benefits reserves. Deferred acquisition costs on traditional life business are amortized over the assumed premium paying periods. The amortization of deferred acquisition costs for universal life and annuity contracts is matched to the recognition of gross profits on these contracts. To the extent that unrealized gains or losses on available-for-sale securities would result in an adjustment of deferred acquisition costs, had those gains or losses actually been realized, an adjustment is recorded to deferred acquisition costs and to unrealized investment gains or losses which are included in accumulated other comprehensive income and reported as a component of shareholders' equity.
Separate Account business - CNA's life insurance subsidiaries, Continental Assurance Company ("CAC") and
Valley Forge Life Insurance Company ("VFL"), write investment and annuity contracts. The supporting assets and liabilities of certain of these contracts are legally segregated and reported in the accompanying Consolidated Balance Sheets as assets and liabilities of Separate Account business. CAC and VFL guarantee principal and a specified return to the contract holders on approximately 57% and 63% of the Separate Account business at December 31, 2000 and 1999, respectively. Substantially all assets of the Separate Account business are carried at fair value. Separate Account liabilities are carried at contract values.
Tobacco product inventories - These inventories, aggregating $269.3 and $230.6 at December 31, 2000 and 1999, respectively, are stated at the lower of cost or market, using the last-in, first-out (LIFO) method and primarily consist of leaf tobacco. If the average cost method of accounting had been used for tobacco inventories instead of the LIFO method, such inventories would have been $205.7 and $212.6 higher at December 31, 2000 and 1999, respectively.
Watch and clock inventories - These inventories, aggregating $56.1 and $36.8 at December 31, 2000 and 1999, respectively, are stated at the lower of cost or market, using the first-in, first-out (FIFO) method.
Accounting pronouncements - In June 2000, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities." This statement addresses a limited number of issues causing implementation difficulties for entities applying SFAS No. 133. SFAS No. 133, as amended and interpreted, establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and hedging activities. SFAS No. 133 requires that an entity recognize all derivative instruments as either assets or liabilities in the balance sheet and measure those instruments at fair value. A derivative may be specifically designated as a hedge of the exposures to changes in the fair value, cash flows or foreign currencies. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation.
In 2001, the Company is required to implement the provisions of the FASB's Emerging Issues Task Force Issue No. 00-14, "Accounting for Certain Sales Incentives." This Issue addresses the recognition, measurement, and income statement classification for sales incentives offered voluntarily by a vendor without charge to customers that can be used in, or that are exercisable by a customer as a result of, a single exchange transaction. Implementation of the recognition and measurement cri-
teria will not have a material impact to the Company's results of operations or equity. Implementation of this Issue will result in reclassifying certain promotional expenses from Other Operating Expenses to become a reduction of Revenues from Manufactured Products.
(a) Includes losses on short sales, equity index futures and options aggregating $14.5, $533.6 and $584.3 for the years ended December 31, 2000, 1999 and 1998, respectively. The Company has maintained short positions, in the form of futures or options - most recently as put options - since 1996. Substantially all of the index short positions were closed during the second quarter of 2000.
Investment gains of $1,826.3, $854.0 and $1,448.4 and losses of $831.8, $790.9 and $962.4 were realized on securities available for sale for the years ended December 31, 2000, 1999 and 1998, respectively. Investment gains (losses) in 2000, 1999 and 1998 also include $16.5, $306.4 and $159.2 of net unrealized losses on equity securities in the Company's trading portfolio.
As of December 31, 2000, CNA owned 19.3 million shares of Global Crossing common stock valued at $277.0, representing approximately 2.2% of Global Crossing's outstanding common stock. During the first quarter of 2000, CNA entered into option agreements intended to hedge market risk associated with approximately 19.3 million shares of Global Crossing common stock. These option agreements were structured as a collar in which CNA purchased put options and sold call options on Global Crossing common stock. As of December 31, 2000, the average exercise prices were $51.70 and $64.93 on the put options and call options, respectively, subject to adjustments on the call options under certain limited circumstances. The options expire in the first half of 2002 and are only exercisable on their expiration dates. CNA has designated the collar as a hedge of its investment in Global Crossing common stock. Accordingly, the fair value of the collar is presented in equity securities available-for-sale in the accompanying Consolidated Balance Sheets, consistent with the hedged item. Additionally, as of December 31, 2000, CNA holds collateral, included in short-term investments, with a fair value of $462.0. The unrealized gain on CNA's position in Global Crossing common stock, including the fair market value of the related hedge, was $902.0 and $1,764.0 as of December 31, 2000 and 1999, respectively.
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 consisted of discounting cash flows and obtaining quoted market prices of the investments, comparable instruments, or underlying assets of the investments.
The fair value of guaranteed investment contracts and deferred annuities of the Separate Accounts business were estimated using discounted cash flow calculations, based on interest rates currently being offered for similar contracts with similar maturities. The fair value of the liabilities for variable Separate Account business was based on the quoted market values of the underlying assets of each variable Separate Account. The fair value of other Separate Account business liabilities approximates carrying value because of their short-term nature.
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) asset and liability management activities; (ii) income enhancements for its portfolio management strategy; and (iii) to benefit from anticipated future movements in the underlying markets. If such movements do not occur as anticipated, then 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 had entered into interest rate swap agreements to convert the variable rate of its borrowings under a bank credit facility and its commercial paper program to a fixed rate. Since these interest rate swaps are not held for trading purposes, they are not included in the preceding tables. CNA was party to interest rate swap agreements with several banks with an aggregate notional principal amount of $650.0 at December 31, 1999. Those agreements, which terminated December 14, 2000, effectively fixed CNA's interest cost on $650.0 of variable rate debt for 1998, 1999 and most of 2000.
CNA also uses derivatives to mitigate the risk associated with its indexed group annuity contracts (a separate account product) by purchasing Standard & Poor's 500 ("S&P 500") index futures contracts in a notional amount equal to the contract holder liability, which is calculated using the S&P 500 rate of return. The gross notional principal or contractual amounts of these instruments in the Separate Accounts were $1,411.0 and $1,627.0 at December 31, 2000 and 1999, respectively.
In January 2000, the Company sold a jack-up drilling rig for $32.0 resulting in a gain of $13.9 ($4.7 after tax and minority interest).
CNA's property and casualty insurance claim and claim adjustment expense reserves represent the estimated amounts necessary to settle all outstanding claims, including claims that are incurred but not reported, as of the reporting date. The Company's reserve projections are based primarily on detailed analysis of the facts in each case, CNA's experience with similar cases, and various historical development patterns. Consideration is given to such historical patterns as field reserving trends, loss payments, pending levels of unpaid claims and product mix, as well as court decisions, economic conditions and public attitudes. All of these factors can affect the estimation of reserves.
Establishing loss reserves is an estimation process. Many factors can ultimately affect the final settlement of a claim and, therefore, the reserve that is needed. Changes in the law, results of litigation, medical costs, the cost of repair materials and labor rates can all affect ultimate claim costs. In addition, time can be a critical part of reserving determinations since the longer the span between the incidence of a loss and the payment or settlement of the claim, the more variable the ultimate settlement amount can be. Accordingly, short-tail claims, such as property damage claims, tend to be more reasonably estimable than long-tail claims, such as general liability and professional liability claims.
The table below provides a reconciliation between beginning and ending claim and claim adjustment expense reserves for 2000, 1999 and 1998:
(a) Excludes life claim and claim adjustment expense reserves of $554.7, $724.9 and $836.7 as of December 31, 2000, 1999 and 1998, respectively, included in the Consolidated Balance Sheets.
The increase (decrease) in provision for insured events of prior years (reserve development), is comprised of the following components:
CNA's property and casualty insurance companies have potential exposures related to environmental pollution and other mass tort and asbestos claims.
As of December 31, 2000, 1999 and 1998, CNA carried approximately $603.0, $684.0 and $1,456.0, respectively, of claim and claim adjustment expense reserves, net of reinsurance recoverables, for reported and unreported asbestos claims. In 2000, CNA recorded $65.0 of adverse development compared with $560.0 and $243.0 in 1999 and 1998, respectively. The reserve strengthening in 2000 for asbestos claims was a result of management's continuous review of development with respect to these exposures, as well as a review of the results of CNA's annual analysis of these claims, which was completed in conjunction with the study of environmental pollution and other mass tort claims. This analysis indicated continued deterioration in claim counts and asbestos claims similar to the results noted in both 1999 and 1998. The factors that have led to the deterioration in claim counts include intensive advertising campaigns by lawyers for asbestos claimants and the addition of new defendants, such as distributors of asbestos containing products.
Unfavorable claim and claim adjustment expense reserve development for other lines in 2000 was due to unfavorable loss experience in standard commercial lines, assumed reinsurance and accident and health lines. These unfavorable changes were partially offset by favorable development in non-medical professional liability and other casualty lines. The unfavorable development in standard commercial lines can be attributed to adverse claim experience for recent accident years in the commercial auto liability, commercial multi-peril and workers' compensation lines of business. The unfavorable development in the assumed reinsurance and accident and health lines also resulted from adverse claims experience.
CNA's insurance subsidiaries also have exposure to construction defect losses, principally in its general liability and commercial multiple peril lines. This exposure relates to claims involving property damage alleging loss of use, damage, destruction or deterioration of land, buildings and other structures involving new construction or major rehabilitation of real property. Many of these claims involve multiple defects and multiple defendants. The majority of losses have been concentrated in a limited number of states, including California. CNA has taken several underwriting actions to mitigate this exposure in the future. Estimation of construction defect losses is subject to a high level of uncertainty due to the long period of time between the accident date and the reporting of the claim, emerging case law, changing regulatory rules and the allocation of damages to the multiple defendants. Due to the inherent uncertainties noted above, the ultimate liability for construction defect claims may vary substantially from the amount currently recorded.
Gross deferred tax assets amounted to $2,484.7 and $2,869.1 and liabilities amounted to $2,080.7 and $2,095.2 for the years ended December 31, 2000 and 1999, respectively.
CNA has a $750.0 revolving credit facility that expires in May 2001. The amount available is reduced by CNA's outstanding commercial paper borrowing. As of December 31, 2000, there was $122.9 of unused borrowing capacity under the facility. The interest rate on the bank loans is based on the London Interbank Offered Rate ("LIBOR"), plus 27.5 basis points. Additionally, there is an annual facility fee of 12.5 basis points on the entire facility. There were no borrowings under the facility at December 31, 2000. The average interest rate on the borrowings under the credit facility, excluding fees, at December 31, 1999 was 6.7%.
The combined weighted average cost of facility borrowings and commercial paper borrowings, including facility fees, and interest rate swaps, was 7.4%, 6.5% and 6.4% at December 31, 2000, 1999 and 1998, respectively.
CNA repurchased and retired all of its outstanding $150.0 of money market preferred stock in early 2000. In addition, during 2000, CNA repurchased approximately $38.0 of its senior notes.
Payment of dividends by insurance subsidiaries of CNA without prior regulatory approval is limited to certain formula-derived amounts. At December 31, 2000, approximately $5,900.0 of retained earnings was not available for dividends without insurance department pre-approval.
In addition to its common stock, the Company has authorized 100,000,000 shares of preferred stock, $.10 par value.
Companies with complex capital structures are required to present basic and diluted earnings per share. Basic earnings per share excludes dilution and is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock. Earnings per common share-assuming dilution, is the same as basic earnings per share because the impact of securities that could potentially dilute basic earnings per common share is insignificant.
The Company's hotels in some instances are constructed on leased land. Other leases cover office facilities, computer and transportation equipment. Rent expense amounted to $93.7, $94.0 and $151.3 for the years ended December 31, 2000, 1999 and 1998, respectively. The table below presents the future minimum lease payments to be made under non-cancelable operating leases along with lease and sublease minimum receipts to be received on owned and leased properties.
MARC assumed approximately $294.0 of liabilities (primarily future policy benefits and claim reserves) and approximately $209.0 in assets (primarily uncollected premium and deferred policy acquisition costs). The net gain from the reinsurance transaction, which is subject to certain post-closing adjustments, has been recorded as deferred revenue, and will be recognized in income over the next 12 to 18 months as CNA Life Re's assumed contracts are novated to MARC.
The CNA Life Re business contributed net earned premiums of $229.0, $194.0 and $134.0, and pre-tax operating income of $33.0, $28.0 and $12.0 for the years ended December 31, 2000, 1999 and 1998, respectively.
On October 1, 1999, certain subsidiaries of CNA completed a transaction with Allstate, whereby CNA's personal lines insurance business and related employees were transferred to Allstate. Approximately $1,100.0 of cash and $1,100.0 of additional assets (primarily premium receivables and deferred policy acquisition costs) were transferred to Allstate, and Allstate assumed $2,200.0 of claim and claim adjustment expense reserves and unearned premium reserves. Additionally, CNA received $140.0 in cash which consisted of (i) $120.0 in ceding commission for the reinsurance of the CNA personal insurance business by Allstate, and (ii) $20.0 for an option exercisable during 2002 to purchase 100% of the common stock of five CNA insurance subsidiaries at a price equal to GAAP carrying value as of the exercise date. Also, CNA invested $75.0 in a 10 year equity-linked note issued by Allstate.
CNA will continue to write new and renewal personal insurance policies and to reinsure this business with Allstate companies, until such time as Allstate exercises its option to buy the five CNA subsidiaries. Prior to 2002, CNA will concentrate the direct writing of personal lines insurance business into the five optioned companies, such that most, if not all, business related to this transaction will be written by those companies by the date Allstate has the opportunity to exercise its option. CNA continues to have primary liability on policies reinsured by Allstate.
CNA will continue to have an ongoing interest in the profitability of CNA's personal lines insurance business and the related successor business through an agreement licensing the "CNA Personal Insurance" trademark and a portion of CNA's Agency Market Operations distribution system to Allstate for use in Allstate's personal insurance agency business for a period of five years from the transaction date. Under this agreement, CNA will receive a royalty fee based on the business volume of personal insurance policies sold through the CNA agents for a period of six years. In addition, the $75.0 equity-linked note will be redeemed on September 30, 2009 (subject to earlier redemption on stated contingencies) for an amount equal to the face amount, subject to adjustment in an amount not exceeding $10.0 depending on the underwriting profitability of the CNA Personal Insurance business.
The retroactive portion of the reinsurance transaction, consisting primarily of the cession of claim and claim adjustment expense reserves approximating $1,000.0, was not recognized as reinsurance because the criteria for risk transfer were not met for this portion of the transaction. The related consideration paid was recorded as a deposit and is included in reinsurance receivables in the consolidated balance sheets. The prospective portion of the transaction, which as of the transaction date consisted primarily of the cession of $1,100.0 of unearned premium reserves, has been recorded as reinsurance. The related consideration paid was recorded as prepaid reinsurance premiums. Premiums ceded after the transaction date will follow this same treatment. The $20.0 received from Allstate for the option to purchase the five CNA subsidiaries was deferred and will not be recognized until Allstate exercises its option or the option expires.
CNA recognized an after-tax realized loss of approximately $39.0 in 1999 related to the transaction, consisting primarily of the accrual of lease obligations and the write-down of assets that related specifically to the Personal Insurance lines of business. The $120.0 ceding commission related to the prospective portion of the transaction has been recognized in proportion to the recognition of the unearned premium reserve to which it relates. Ceding commission earned was $69.0 and $51.0 in 2000 and 1999, respectively. Royalty fees earned in 2000 and 1999 were approximately $27.0 and $7.0, respectively.
The Personal Insurance lines transferred to Allstate contributed net earned premiums of $1,354.0 and $1,622.0 and pre-tax operating income of $89.0 and $97.0 for the years ended December 31, 1999 and 1998, respectively.
CNA accrued $220.0 of these restructuring and other related charges in the third quarter of 1998 (the "Initial Accrual"). Other charges such as parallel processing costs, relocation costs and retention bonuses, did not qualify for accrual under generally accepted accounting principles and have been charged to expense as incurred ("Period Costs"). CNA incurred Period Costs of $83.0 and $26.0 during 1999 and the fourth quarter of 1998, respectively.
The 1998 restructuring and other related charges incurred by Agency Market Operations were approximately $96.0. These charges included employee severance and outplacement costs of $43.0 related to the planned net reduction in the workforce of approximately 1,200 employees. Lease termination costs of approximately $29.0 were incurred in connection with the consolidation of four regional offices into two zone offices and a reduction of the number of claim processing offices from 24 to 8. The Agency Market Operations charges also included benefit plan curtailment costs of $12.0, parallel processing charges of $7.0 and $5.0 of fixed asset writedowns. Through December 31, 1998, approximately 364 Agency Market Operations employees, the majority of whom were loss adjusters and office support staff, had been released.
The 1999 Period Costs incurred by Agency Market Operations were approximately $60.0. These charges included employee-related expenses (outplacement, retention bonuses and relocation costs) of $23.0, parallel processing costs of $16.0 and consulting expenses of $10.0. Other charges, including technology and facility charges, were approximately $15.0. Additionally, Agency Market Operations reduced its estimate for lease termination cost by $4.0 during 1999. During 1999, approximately 1,000 Agency Market Operations employees, the majority of whom were office support staff, were released.
The 1998 restructuring and other related charges incurred by Risk Management were approximately $88.0. These charges included lease termination costs of approximately $8.0 associated with the consolidation of claim offices in 36 market territories. In addition, employee severance and outplacement costs relating to the planned net reduction in workforce of approximately 200 employees were approximately $10.0 and the writedown of fixed and intangible assets was approximately $64.0. Parallel processing and other charges were approximately $6.0. Through December 31, 1998, approximately 152 Risk Management employees had been released, the majority of whom were claim adjusters and office support staff.
The charges related to fixed and intangible assets were due primarily to a writedown of an intangible asset ("goodwill") related to Alexsis, Inc., a wholly owned subsidiary acquired by CNA in 1995 that provided claims administration services for unrelated parties. As part of CNA's periodic reviews of asset recoverability and as a result of several adverse events, CNA concluded, based on an undiscounted cash flow analysis completed in the third quarter of 1998, that an impairment existed. Based on a discounted cash flow analysis, a $59.0 write-off was necessary. The adverse events contributing to this conclusion included operating losses from the business, the loss of several significant customers whose business volume with this operation constituted a large portion of the revenue base, and substantial changes in the overall market demand for the services offered by this operation, which, in turn, had negative effects on the prospects for achieving the profitability levels necessary to recover the intangible asset.
The 1999 Period Costs incurred by Risk Management were approximately $10.0. These charges included employee-related expenses of $3.0 and parallel processing charges of $3.0. Other charges, including consulting and facility charges, were approximately $7.0. Additionally, Risk Management reduced its estimate for lease termination costs by $2.0 and its estimate of employee severance costs
by $1.0 during 1999. During 1999, approximately 136 Risk Management employees were released, the majority of whom were claims adjusters and office support staff.
No restructuring-related charges related to the Plan were incurred during 2000; however, payments were made during 2000 related to amounts accrued under the Plan as of December 31, 1999.
In 1999, CNA amended certain plans to change, among other things, early retirement eligibility and the level of employer contributions. These actions resulted in a reduction in pension and postretirement benefit obligations of approximately $10.0 and $48.0, respectively.
The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for pension plans with an accumulated benefit obligation in excess of plan assets were $2,019.4, $1,788.4 and $1,779.4, respectively, at December 31, 2000 and $1,940.2, $1,687.9 and $1,539.0, respectively, at December 31, 1999.
The aggregate number of shares of Common Stock for which options may be granted under the Plan is 1,000,000; and the maximum number of shares of Common Stock with respect to which options may be granted to any individual in any calendar year is 200,000. The exercise price per share may not be less than the fair market value of the Common Stock on the date of grant. Pursuant to the Plan, options were granted for a total of 132,000 shares of Common Stock at an exercise price of $60.28 per share, the fair market value on the date of grant. These options vest ratably over a four-year period and expire in ten years. The Company has elected to follow Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for its employee stock options and awards.
A summary of the status of the Company's stock option plan as of December 31, 2000, and changes during the year then ending, follows:
CNA assumes and cedes reinsurance with other insurers and reinsurers and members of various reinsurance pools and associations. CNA utilizes reinsurance arrangements to limit its maximum loss, provide greater diversification of risk, minimize exposures on larger risks, and to exit certain lines of business. Reinsurance coverages are tailored to the specific risk characteristics of each product line and CNA's retained amount varies by type of coverage. Generally, property risks are reinsured on an excess of loss, per risk basis. Liability coverages are generally reinsured on a quota share basis in excess of CNA's retained risk. CNA's life reinsurance includes coinsurance, yearly renewable term and facultative programs.
Written premiums were $11,244.0, $12,215.0 and $13,728.0 at December 31, 2000, 1999 and 1998, respectively. The ceding of insurance does not discharge the primary liability of CNA. Therefore, a credit exposure exits with respect to property, liability and life reinsurance ceded to the extent that any reinsurer is unable to meet the obligations assumed under reinsurance agreements. CNA holds substantial collateral in the form of funds and bank letters of credit. CNA places reinsurance with carriers only after careful review of the nature of the contract and a thorough assessment of the reinsurers' credit quality and claims settlement practices. Such collateral was approximately $1,566.0 and $1,306.0 at December 31, 2000 and 1999, respectively. CNA's largest recoverables from reinsurers, including prepaid reinsurance premiums, were approximately $1,176.0, $776.0 and $402.0 at December 31, 2000, from The Allstate Corporation ("Allstate"), American Reinsurance Company and National Indemnity Insurance Company, respectively.
Tobacco Litigation - Four insurance subsidiaries of CNA are defendants in a lawsuit arising out of policies allegedly issued to Liggett Group, Inc. ("Liggett"). The lawsuit was filed by Liggett and its current parent, Brooke Group Holding Inc., in the Delaware Superior Court, New Castle County on January 26, 2000. The lawsuit, which involves numerous insurers, concerns coverage issues relating to a number of tobacco-related claims (currently over 1,100 pending) asserted against Liggett over the past twenty years. However, Liggett only began submitting claims for coverage under the policies in January 2000. CNA believes its coverage defenses are strong. Based on facts and circumstances currently known, management believes that the ultimate outcome of the pending litigation should not materially affect the financial condition or results of operations of the Company.
will also be reduced. Moreover, based on information known at this time, CNA reasonably believes it has strong grounds for avoiding a substantial portion of its United States workers' compensation carve-out exposure through legal action.
As noted, CNA arranged substantial reinsurance protection to manage its exposures under the IGI Program. CNA believes it has valid and enforceable reinsurance contracts with the AAHRU Facility and other reinsurers with respect to the IGI Program, including the United States workers' compensation carve-out business. It is likely that certain reinsurers will dispute their liabilities to CNA; however, CNA is unable to predict the extent of such potential disputes at this time. Legal actions could result, and the resolution of any such actions could take years.
Lawsuits continue to be filed with increasing frequency against Lorillard and other manufacturers of tobacco products. Approximately 4,900 product liability cases are pending against cigarette manufacturers in the United States. Of these, approximately 1,225 cases are pending in a West Virginia court and approximately 3,050 cases are brought by flight attendants alleging injury from exposure to environmental tobacco smoke in the cabins of aircraft. Lorillard is a defendant in all of the flight attendant suits served to date and is a defendant in most of the cases pending in West Virginia.
Tobacco litigation includes various types of claims. In these actions, plaintiffs claim substantial compensatory, statutory and punitive damages, as well as equitable and injunctive relief, in amounts ranging into the billions of dollars. These claims are based on a number of legal theories including, among other things, theories of negligence, fraud, misrepresentation, strict liability, breach of warranty, enterprise liability, civil conspiracy, intentional infliction of harm, violation of consumer protection statutes, violation of antitrust statutes, and failure to warn of the allegedly harmful and/or addictive nature of tobacco products.
Some cases have been brought by individual plaintiffs who allege cancer and/or other health effects claimed to have resulted from an individual's use of cigarettes and/or smokeless tobacco products, addiction to smoking, or exposure to environmental tobacco smoke ("Conventional Product Liability Cases"). Approximately 4,375 such actions are pending against Lorillard, including most of the cases filed in West Virginia and each of the pending flight attendant cases. In other cases, plaintiffs have brought claims as purported class actions on behalf of large numbers of individuals for damages allegedly caused by smoking ("Class Actions"). Approximately 35 such cases are pending against Lorillard. In other cases, plaintiffs are governmental entities or entities such as labor unions, private companies, Indian Tribes, or private citizens suing on behalf of taxpayers. Plaintiffs in these cases seek reimbursement of health care costs allegedly incurred as a result of smoking, as well as other alleged damages ("Reimbursement Cases"). Approximately 50 such cases are pending, including suits brought by the U.S. federal government and the governments of several foreign nations or states of foreign nations. In addition, there are claims for contribution and/or indemnity in relation to asbestos claims filed by asbestos manufacturers or the insurers of asbestos manufacturers ("Claims for Contribution"). Approximately nine such actions are pending against Lorillard, and a tenth case has been served on some of the defendants but not Lorillard.
In addition to the above, claims have been brought against Lorillard seeking damages resulting from alleged exposure to asbestos fibers which were incorporated, for a limited period of time, ending more than forty years ago, into filter material used in one brand of cigarettes manufactured by Lorillard ("Filter Cases"); approximately 20 such actions are pending.
The State Settlement Agreements require that the domestic tobacco industry make annual payments in the following amounts, subject to adjustment for several factors, including inflation, market share and industry volume: 2001, $9,900.0; 2002, $11,300.0; 2003, $10,900.0; 2004 through 2007, $8,400.0; and thereafter, $9,400.0. In addition, the domestic tobacco industry is required to pay settling plaintiffs' attorneys' fees, subject to an annual cap of $500.0, as well as additional amounts of $250.0 per annum for 2001 through 2003. These payment obligations are the several and not joint obligations of each settling defendant.
The Original Participating Manufacturers have also, as part of the Master Settlement Agreement, committed to work cooperatively with the tobacco grower community to address concerns about the potential adverse economic impact on that community. On January 21, 1999, the Original Participating Manufacturers reached an agreement in principle to establish a $5,150.0 trust fund payable over 12 years to compensate the tobacco growing communities in 11 states. Payments to the trust fund are to be allocated among the Original Participating Manufacturers according to their relative market share of domestic cigarette shipments, except that Philip Morris will pay more than its market share in the first year of the agreement but will have its payment obligations reduced in years 11 and 12 to make up for the overpayment. Lorillard's payments under the agreement will total approximately $515.0. All payments will be adjusted for inflation, changes in the unit volume of domestic cigarette shipments, and for the effect of any new increases in state or federal excise taxes on tobacco products which benefits the growing community.
The Company believes that the State Settlement Agreements will materially adversely affect its cash flows and operating income in future years. The degree of the adverse impact will depend, among other things, on the rates of decline in United States cigarette sales in the full price and discount segments, Lorillard's share of the domestic full price and discount cigarette segments, and the effect of
CONVENTIONAL PRODUCT LIABILITY CASES - There are approximately 4,750 cases pending against manufacturers of tobacco products in United States federal and state courts in which individuals allege they or their decedents have been injured due to smoking cigarettes, due to exposure to environmental tobacco smoke, due to use of smokeless tobacco products, or due to nicotine dependence. Approximately 1,225 of these are individual cases pending in West Virginia. Approximately 3,050 of these cases have been filed by flight attendants purportedly injured by their exposure to environmental tobacco smoke in the aircraft cabin. Lorillard is a defendant in approximately 4,375 of these cases, including most of the cases pending in West Virginia, as well as all of the pending flight attendant cases. The Company is a defendant in 13 of the cases filed by individuals, although nine of them have not been served on the Company. The Company is not a defendant in any of the flight attendant suits or in any of the conventional cases pending in West Virginia.
Since January 1, 1999, a total of twelve trials have been held involving fifteen cases filed by individual plaintiffs. Lorillard was a defendant in three of the cases. The Company was not a defendant in any of the cases tried to date since January 1, 1999. Juries returned verdicts in favor of the defendants in the three cases tried against Lorillard. In the twelve remaining cases, verdicts were returned in favor of the defendants in eight of the matters. Juries found in plaintiffs' favor in the remaining four cases. In these four verdicts, juries awarded plaintiffs a total of $153.2 in actual damages and punitive damages. One of the four verdicts was vacated when the trial court granted defendant's motion for new trial. Plaintiff in that action had been awarded $.2 in actual damages. In two of the four cases, the courts have reduced the verdicts to $26.5 (from $51.5) and $32.8 (from $80.3), respectively. In the fourth case, the jury awarded $21.2. Appeals are pending in each of these actions. To date during 2001, juries have returned verdicts in favor of the defendants in two cases. The time for plaintiffs to seek review of these verdicts has not expired. Lorillard is a defendant in one of the two cases tried to date during 2001. Trial is proceeding in another matter in which neither the Company nor Lorillard are parties. Several additional cases are scheduled for trial against Lorillard during 2001, including a consolidated trial scheduled to begin during June 2001, in the cases brought by the approximately 1,225 West Virginia smokers or users of smokeless tobacco products. These cases are presently scheduled to be tried pursuant to a multi- part trial plan.
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.
Theories of liability asserted in the purported class actions include a broad range of product liability theories, including those based on consumer protection statutes and fraud and misrepresentation. Plaintiffs seek damages in each case that range from unspecified amounts to the billions of dollars. Most plaintiffs seek punitive damages and some seek treble damages. Plaintiffs in many of the cases seek medical monitoring. Plaintiffs in several of the purported class actions are represented by a well-funded and coordinated consortium of approximately 60 law firms from throughout the United States.
By order dated July 30, 1999 and supplemented on August 2, 1999 (together, the "order"), the trial judge amended the trial plan in respect to the manner of determining punitive damages. The order provided that the jury will determine punitive damages, if any, on a lump-sum dollar amount basis for the entire qualified class. The Third District of the Florida Court of Appeal rejected as premature defendants' appeals from these rulings, and the Florida Supreme Court declined to review the orders at this time.
The first portion of Phase Two of the trial began on November 1, 1999 before the same jury that returned the verdict in Phase One. In the first part of Phase Two, the jury determined issues of specific causation, reliance, affirmative defenses, and other individual-specific issues related to the claims of three named plaintiffs and their entitlement to damages, if any.
On November 6, 2000, the Circuit Court of Dade County, Florida, entered a purported final judgment in favor of the plaintiffs that reflects the jury's three verdicts in favor of the plaintiffs. The court's purported final judgment also denied various of defendants' post-trial motions, which included a motion for new trial and a motion seeking reduction of the punitive damages award. Lorillard has noticed an appeal from the purported final judgment to the Third District of the Florida Court of Appeal and has posted its appellate bond in the amount of $104.0 pursuant to recent Florida legislation limiting the amount of an appellate bond required to be posted in order to stay execution of a judgment for punitive damages in a certified class action. Although this legislation is intended to apply to the Engle case, Lorillard cannot predict the outcome of any challenges to the possible application or constitutionality of this legislation. In the event this legislation is challenged and found to be invalid, Lorillard could be required to post a bond in an amount not capable of being bonded, resulting in execution of the judgment before it could be set aside on appeal. Lorillard believes that such a result would be unconstitutional and would also violate Florida law. Lorillard intends to take all appropriate steps to prevent this scenario from occurring and believes these efforts should be successful.
Now that the jury has awarded punitive damages and a purported final judgment has been entered, it is unclear how the August 2, 1999 order will be implemented. The August 2, 1999 order provides that the lump-sum punitive damage amount, if any, will be allocated equally to each class member and acknowledges that the actual size of the class will not be known until the last case has withstood appeal, i.e., the punitive damage amount, if any, determined for the entire qualified class, would be divided equally among those plaintiffs who are ultimately successful. The order does not address whether defendants would be required to pay the punitive damage award, if any, prior to a determination of claims of all class members, which is Phase Three of the trial plan, a process that could take years to conclude. The purported final judgment entered by the court on November 6, 2000 directs that the amounts awarded by the jury are to be paid immediately. Phase Three would address potentially hundreds of thousands of other class members' claims, including issues of specific causation, reliance, affirmative defenses and other individual-specific issues regarding entitlement to damages, in individual trials before separate juries.
Lorillard remains of the view that the Engle case should not have been certified as a class action. That certification is inconsistent with the overwhelming majority of federal and state court decisions which have held that mass smoking and health claims are inappropriate for class treatment. Lorillard has challenged class certification, as well as other numerous legal errors that it believes occurred during the trial. The Company and Lorillard believe that an appeal of these issues on the merits should prevail.
Trial began during January 2001 in the case of Blankenship v. R.J. Reynolds Tobacco Company, et al. (Circuit Court, Ohio County, West Virginia) but a mistrial was declared while plaintiffs were presenting their evidence. A date for retrial has not been set. Shortly before trial began the court granted class certification on behalf of West Virginia residents who desire to participate in a medical monitoring plan. The West Virginia Supreme Court declined to review defendants' writ from the class certification ruling. Lorillard is a defendant in the action. The case is to be tried under a multi- part trial plan.
During December 2000, the Superior Court of San Diego County, California issued an order in the case of Daniels v. Philip Morris, Incorporated, et al. that granted plaintiffs'
motion for class certification on behalf of California residents who, while minors, smoked at least one cigarette between April 1994 and December 31, 1999. Defendants have filed a petition for writ or prohibition from the class certification ruling. Trial in this matter is scheduled to begin during March 2002. Lorillard is a defendant in this action.
U.S. Federal Government Action - The federal government of the United States filed a reimbursement suit on September 22, 1999 in the United States District Court for the District of Columbia against Lorillard, other U.S. cigarette manufacturers, some parent companies (but not the Company) and two trade associations. Plaintiff asserts claims under the Medical Care Recovery Act, the Medicare Secondary Payer provisions of the Social Security Act, and the Racketeer Influenced and Corrupt Organizations Act. The government alleges in the complaint that it has incurred costs of more than $20,000.0 annually in providing health care costs under certain federal programs, including Medicare, military and veterans' benefits programs, and the Federal Employee Health Benefits Program. The federal government seeks to recover an unspecified amount of health care costs, and various types of declaratory relief, including disgorgement of profits, injunctive relief and declaratory relief that defendants are liable for the government's future costs of providing health care resulting from the defendants' alleged wrongful conduct. During September 2000, the court granted in part and denied in part defendants' motion to dismiss the complaint. The court dismissed plaintiff's claims asserted under the Medical Care Recovery Act as well as those under Medicare as Secondary Payer Act. The court denied the motion as to plaintiff's claims under the Racketeering Influenced and Corrupt
Organizations Act. Plaintiff is seeking modification of the trial court's order as it relates to the dismissal of the Medical Care Recovery Act claim. In an amended complaint filed during February 2001, plaintiff attempted to plead with greater specificity the claims dismissed by the court in the September 2000 ruling.
Reimbursement Cases by Indian Tribes - Indian Tribes are the plaintiffs in six pending reimbursement suits. Most of these cases have been filed in tribal courts. Lorillard is a defendant in each of the cases. The Company is not named as a defendant in any of the pending tribal cases. Each of the pending cases is in the pre-trial, discovery stage.
issued an order that consolidates, for settlement purposes only, ten pending cases involving Lorillard as well as other industry defendants. These cases include three contribution cases (Falise v. The American Tobacco Company, et al., H.K. Porter Company, Inc. v. The American Tobacco Company, Inc., et al. and Raymark Industries, Inc. v. The American Tobacco Company, Inc., et al.), two union cases (Bergeron, et al. v. Philip Morris, Inc., et al. and The National Asbestos Workers Medical Fund, et al. v. Philip Morris Incorporated, et al.), one private company case (Blue Cross and Blue Shield of New Jersey, Inc., et al. v. Philip Morris, Incorporated, et al.), two smoking and health class actions that have been served on defendants (Decie v. The American Tobacco Company, Inc., et al. and Simon v. Philip Morris Incorporated, et al.), one smoking and health class action in which none of the defendants have received service of process (Ebert v. Philip Morris, Incorporated, et al.) and one case that contains elements of both a smoking and health class action and a private citizen reimbursement case (Mason v. The American Tobacco Company, Inc., et al.). The judge's order directed the parties to select a mediator or special master in order to facilitate settlement discussions and also invited the federal government to join in the settlement discussions. On July 31, 2000, the federal judge orally proposed the formation of a national punitive damages class action for the purposes of settlement. Pursuant to the judge's proposal, Lorillard entered into discussions with a committee of counsel representing a broad-based group of plaintiffs in an effort to arrive at a comprehensive settlement of all exemplary and punitive damage claims, including claims involved in the Engle class action in Florida described above. The parties have been unable to reach an understanding and the negotiations have been suspended.
Approximately 30 suits are pending in various state courts alleging violations of state antitrust laws which permit indirect purchasers, such as retailers and consumers, to sue under price fixing or consumer fraud statutes. Approximately 18 states permit such suits. Lorillard is a defendant in each of these indirect purchaser cases. The Company was also named as a defendant in most of these indirect purchaser cases but has been voluntarily dismissed without prejudice from all of them.
may enter into discussions in an attempt to settle particular cases if it believes it is appropriate to do so.
OTHER LITIGATION - The Company and its subsidiaries are also parties to other litigation arising in the ordinary course of business. The outcome of this other litigation will not, in the opinion of management, materially affect the Company's results of operations or equity.