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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 1-6541
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LOEWS CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 13-2646102
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
667 MADISON AVENUE, NEW YORK, N.Y. 10021-8087
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(Address of principal executive offices) (Zip Code)
(212) 521-2000
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(Registrant's telephone number, including area code)
NOT APPLICABLE
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
--------- ---------
Class Outstanding at November 1, 2002
- ------------------------------------ -------------------------------
Common Stock, $1.00 par value 185,441,200 shares
Carolina Group Stock, $.01 par value 39,910,000 shares
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1
INDEX
Part I. Financial Information Page No.
--------
Item 1. Financial Statements
Consolidated Condensed Balance Sheets--
September 30, 2002 and December 31, 2001 . . . . . . . . . 3
Consolidated Condensed Statements of Operations--
Three and nine months ended September 30, 2002 and 2001 . . 4
Consolidated Condensed Statements of Cash Flows--
Nine months ended September 30, 2002 and 2001 . . . . . . . 6
Notes to Consolidated Condensed Financial Statements . . . . 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . . . 61
Item 3. Quantitative and Qualitative Disclosures about Market
Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106
Item 4. Controls and Procedures . . . . . . . . . . . . . . . . 109
Part II. Other Information
Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . 110
Item 5. Other Information . . . . . . . . . . . . . . . . . . . 115
Item 6. Exhibits and Reports on Form 8-K . . . . . . . . . . . 116
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
--------------------
Loews Corporation and Subsidiaries
Consolidated Condensed Balance Sheets
- ------------------------------------------------------------------------------------------------
(In millions) September 30, December 31,
2002 2001
--------------------------
Assets:
Investments:
Fixed maturities, amortized cost of $28,447.7 and $31,004.1 . . $29,093.0 $31,191.0
Equity securities, cost of $1,460.4 and $1,457.3 . . . . . . . 1,393.4 1,646.0
Other investments . . . . . . . . . . . . . . . . . . . . . . . 1,694.4 1,587.3
Short-term investments . . . . . . . . . . . . . . . . . . . . 10,509.3 6,734.8
--------------------------
Total investments . . . . . . . . . . . . . . . . . . . . . 42,690.1 41,159.1
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 308.8 181.3
Receivables-net . . . . . . . . . . . . . . . . . . . . . . . . . 18,416.7 19,452.8
Property, plant and equipment-net . . . . . . . . . . . . . . . . 3,042.8 3,075.3
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . 595.0 607.0
Goodwill and other intangible assets-net . . . . . . . . . . . . 202.3 323.8
Other assets . . . . . . . . . . . . . . . . . . . . . . . . . . 4,558.5 4,229.8
Deferred acquisition costs of insurance subsidiaries . . . . . . 2,547.8 2,423.9
Separate account business . . . . . . . . . . . . . . . . . . . . 3,147.3 3,798.1
--------------------------
Total assets . . . . . . . . . . . . . . . . . . . . . . . . $75,509.3 $75,251.1
==========================
Liabilities and Shareholders' Equity:
Insurance reserves:
Claim and claim adjustment expense . . . . . . . . . . . . . . $29,724.8 $31,266.2
Future policy benefits . . . . . . . . . . . . . . . . . . . . 7,285.7 7,306.4
Unearned premiums . . . . . . . . . . . . . . . . . . . . . . . 5,002.3 4,505.3
Policyholders' funds . . . . . . . . . . . . . . . . . . . . . 567.3 546.0
-------------------------
Total insurance reserves . . . . . . . . . . . . . . . . . 42,580.1 43,623.9
Payable for securities purchased . . . . . . . . . . . . . . . . 1,733.1 1,365.6
Securities sold under agreements to repurchase . . . . . . . . . 1,211.7 1,602.4
Long-term debt, less unamortized discount . . . . . . . . . . . . 5,914.9 5,920.3
Reinsurance balances payable . . . . . . . . . . . . . . . . . . 3,031.9 2,722.9
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . . 4,892.0 4,595.2
Separate account business . . . . . . . . . . . . . . . . . . . . 3,147.3 3,798.1
--------------------------
Total liabilities . . . . . . . . . . . . . . . . . . . . . 62,511.0 63,628.4
Minority interest . . . . . . . . . . . . . . . . . . . . . . . . 1,891.3 1,973.4
Shareholders' equity . . . . . . . . . . . . . . . . . . . . . . 11,107.0 9,649.3
--------------------------
Total liabilities and shareholders' equity . . . . . . . . . $75,509.3 $75,251.1
==========================
See accompanying Notes to Consolidated Condensed Financial Statements.
3
Loews Corporation and Subsidiaries
Consolidated Condensed Statements of Operations
- ------------------------------------------------------------------------------------------------
(In millions, except per share data) Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -------------------------
2002 2001 2002 2001
---------------------------------------------------
Revenues:
Insurance premiums . . . . . . . . . . $ 2,261.4 $ 2,514.5 $ 7,922.9 $ 6,598.1
Investment income, net of expenses . . 396.8 515.4 1,399.7 1,563.0
Investment gains (losses) . . . . . . . 26.5 72.2 (145.0) 1,063.8
Manufactured products (including excise
taxes of $161.5, $165.3, $518.0 and
$476.4). . . . . . . . . . . . . . . . 1,004.1 1,093.6 3,076.4 3,052.7
Other . . . . . . . . . . . . . . . . . 388.7 471.7 1,258.5 1,458.9
---------------------------------------------------
Total . . . . . . . . . . . . . . . 4,077.5 4,667.4 13,512.5 13,736.5
---------------------------------------------------
Expenses:
Insurance claims and policyholders'
benefits . . . . . . . . . . . . . . . 1,850.1 2,420.3 6,542.4 8,765.9
Amortization of deferred acquisition
costs . . . . . . . . . . . . . . . . 447.9 423.1 1,349.9 1,297.2
Cost of manufactured products sold . . 552.7 612.0 1,760.0 1,765.4
Other operating expenses . . . . . . . 734.7 848.8 2,388.9 2,768.1
Restructuring and other related charges 62.1
Interest . . . . . . . . . . . . . . . 77.1 77.1 231.8 256.1
---------------------------------------------------
Total . . . . . . . . . . . . . . . 3,662.5 4,381.3 12,273.0 14,914.8
---------------------------------------------------
415.0 286.1 1,239.5 (1,178.3)
---------------------------------------------------
Income tax expense (benefit) . . . . . 157.6 113.7 453.6 (326.2)
Minority interest . . . . . . . . . . . 17.0 11.3 59.7 (121.5)
---------------------------------------------------
Total . . . . . . . . . . . . . . . 174.6 125.0 513.3 (447.7)
---------------------------------------------------
Income (loss) from continuing operations 240.4 161.1 726.2 (730.6)
Discontinued operations-net . . . . . . . 4.6 (31.0) 6.7
Cumulative effect of changes in
accounting principles-net . . . . . . . (39.6) (53.3)
---------------------------------------------------
Net income (loss) . . . . . . . . . $ 240.4 $ 165.7 $ 655.6 $ (777.2)
===================================================
4
Loews Corporation and Subsidiaries
Consolidated Condensed Statements of Operations
- ------------------------------------------------------------------------------------------------
(In millions, except per share data) Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -------------------------
2002 2001 2002 2001
---------------------------------------------------
Net income (loss) attributable to:
Loews Common Stock:
Income (loss) from continuing
operations . . . . . . . . . . . . . $ 196.0 $ 161.1 $ 622.4 $ (730.6)
Discontinued operations-net . . . . . 4.6 (31.0) 6.7
Cumulative effect of changes in
accounting principles-net . . . . . (39.6) (53.3)
---------------------------------------------------
Loews Common Stock . . . . . . . . . . 196.0 165.7 551.8 (777.2)
Carolina Group Stock . . . . . . . . . 44.4 103.8
---------------------------------------------------
Total . . . . . . . . . . . . . . . $ 240.4 $ 165.7 $ 655.6 $ (777.2)
===================================================
Income (loss) per Loews common share:
Income (loss) from continuing
operations . . . . . . . . . . . . . . $ 1.06 $ 0.83 $ 3.30 $ (3.71)
Discontinued operations . . . . . . . . 0.02 (0.16) 0.03
Cumulative effect of changes in
accounting principles . . . . . . . . (0.21) (0.27)
---------------------------------------------------
Net income (loss) . . . . . . . . . $ 1.06 $ 0.85 $ 2.93 $ (3.95)
===================================================
Net income per Carolina Group common
share . . . . . . . . . . . . . . . . . $ 1.10 $ 2.58
===================================================
Weighted average number of shares
outstanding:
Loews Common Stock . . . . . . . . . . 185.71 195.41 188.31 196.62
Carolina Group Stock . . . . . . . . . 40.19 40.23
See accompanying Notes to Consolidated Condensed Financial Statements.
5
Loews Corporation and Subsidiaries
Consolidated Condensed Statements of Cash Flows
- ------------------------------------------------------------------------------------------------
(In millions) Nine Months Ended September 30,
2002 2001
-------------------------------
Operating Activities:
Net income (loss) . . . . . . . . . . . . . . . . . . . . $ 655.6 $ (777.2)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities-net . . . . . . . . . . 300.4 (1,406.8)
Loss on disposal of discontinued operations . . . . . . . 32.8
Cumulative effect of changes in accounting principles . . 39.6 53.3
Changes in assets and liabilities-net:
Reinsurance receivable . . . . . . . . . . . . . . . . . 167.3 (3,914.2)
Other receivables . . . . . . . . . . . . . . . . . . . 540.4 1,214.8
Federal income taxes . . . . . . . . . . . . . . . . . . 845.7 (813.4)
Prepaid reinsurance premiums . . . . . . . . . . . . . . (196.1) 95.7
Deferred acquisition costs . . . . . . . . . . . . . . . (129.7) (54.4)
Insurance reserves and claims . . . . . . . . . . . . . (664.3) 4,339.1
Reinsurance balances payable . . . . . . . . . . . . . . 309.0 1,302.7
Other liabilities . . . . . . . . . . . . . . . . . . . 56.4 602.3
Trading securities . . . . . . . . . . . . . . . . . . . (529.1) 108.5
Other-net . . . . . . . . . . . . . . . . . . . . . . . (28.7) (309.3)
----------------------------
1,399.3 441.1
----------------------------
Investing Activities:
Purchases of fixed maturities . . . . . . . . . . . . . . (61,756.9) (56,344.3)
Proceeds from sales of fixed maturities . . . . . . . . . 59,354.8 52,665.8
Proceeds from maturities of fixed maturities . . . . . . . 4,520.8 2,834.7
Securities sold under agreements to repurchase . . . . . . (390.7) (293.1)
Purchase of equity securities . . . . . . . . . . . . . . (746.1) (1,065.8)
Proceeds from sales of equity securities . . . . . . . . . 816.4 1,928.8
Change in short-term investments . . . . . . . . . . . . . (3,102.3) 1,119.8
Purchases of property, plant and equipment . . . . . . . . (325.8) (347.4)
Proceeds from sales of property, plant and equipment . . . 102.2 287.4
Change in other investments . . . . . . . . . . . . . . . (234.3) (235.6)
----------------------------
(1,761.9) 550.3
----------------------------
Financing Activities:
Dividends paid to Loews shareholders . . . . . . . . . . . (120.8) (83.8)
Dividends paid to minority interests . . . . . . . . . . . (30.1) (30.6)
Issuance of Loews Common Stock . . . . . . . . . . . . . . 0.5
Issuance of Carolina Group Stock . . . . . . . . . . . . . 1,069.6
Issuance of common stock by subsidiary . . . . . . . . . . 50.2
Purchases of Loews treasury shares . . . . . . . . . . . . (351.2) (279.6)
Purchases of treasury shares by subsidiaries . . . . . . . (30.6) (24.3)
Issuance of long-term debt . . . . . . . . . . . . . . . . 65.0 449.1
Principal payments on long-term debt . . . . . . . . . . . (85.4) (1,060.2)
Receipts credited to policyholders . . . . . . . . . . . . 0.4 1.5
Withdrawals of policyholders account balances . . . . . . (36.4) (50.4)
Other . . . . . . . . . . . . . . . . . . . . . . . . . . 9.1
----------------------------
490.1 (1,028.1)
----------------------------
Net change in cash . . . . . . . . . . . . . . . . . . . . . 127.5 (36.7)
Cash, beginning of period . . . . . . . . . . . . . . . . . 181.3 195.2
----------------------------
Cash, end of period . . . . . . . . . . . . . . . . . . . . $ 308.8 $ 158.5
============================
See accompanying Notes to Consolidated Condensed Financial Statements.
6
Loews Corporation and Subsidiaries
Notes to Consolidated Condensed Financial Statements
- ------------------------------------------------------------------------------
(Dollars in millions, except per share data)
1. Basis of Presentation:
Loews Corporation is a holding company. Its subsidiaries are engaged in
the following lines of business: property, casualty and life insurance
(CNA Financial Corporation ("CNA"), a 90% owned subsidiary); the
production and sale of cigarettes (Lorillard, Inc. ("Lorillard"), a wholly
owned subsidiary); the operation of hotels (Loews Hotels Holding
Corporation ("Loews Hotels"), a wholly owned subsidiary); the operation of
offshore oil and gas drilling rigs (Diamond Offshore Drilling, Inc.
("Diamond Offshore"), a 54% owned subsidiary); and the distribution and
sale of watches and clocks (Bulova Corporation ("Bulova"), a 97% owned
subsidiary).
Unless the context otherwise requires, the terms "Company" and
"Registrant" as used herein mean Loews Corporation excluding its
subsidiaries.
On February 6, 2002, the Company sold 40,250,000 shares of a new class
of its common stock, referred to as Carolina Group Stock, for net proceeds
of $1,069.6. This stock is designed to track the performance of the
Carolina Group, which consists of: the Company's ownership interest in
Lorillard; $2,500.0 of notional, intergroup debt owed by the Carolina
Group to the Loews Group, bearing interest at the annual rate of 8.0% and,
subject to optional prepayment, due December 31, 2021; any and all
liabilities, costs and expenses of the Company and Lorillard arising out
of the past, present or future business of Lorillard, and all net income
or net losses from the assets and liabilities attributed to the Carolina
Group. Each outstanding share of Carolina Group stock has 1/10 of a vote
per share. Holders of Carolina Group stock are common stockholders of the
Company.
The issuance of Carolina Group Stock has resulted in a two class common
stock structure for the Company. During the three months ended September
30, 2002, the Company purchased, for the account of the Carolina Group,
340,000 shares of Carolina Group Stock. As of September 30, 2002, the
outstanding Carolina Group Stock represents a 23.01% economic interest in
the economic performance of the Carolina Group. The Loews Group consists
of all of the Company's assets and liabilities other than the assets and
liabilities attributable to the Carolina Group, and includes as an asset
the notional, intergroup debt of the Carolina Group, and a 76.99%
intergroup interest in the Carolina Group.
Reference is made to the Notes to Consolidated Financial Statements in
the 2001 Annual Report to Shareholders which should be read in conjunction
with these consolidated condensed financial statements.
Accounting Changes
In 2002, the Company implemented the provisions of the Financial
Accounting Standards Board ("FASB") Emerging Issues Task Force ("EITF")
Issue No. 00-14, "Accounting for Certain Sales Incentives" and EITF Issue
No. 00-25, "Vendor Income Statement Characterization of Consideration from
a Vendor to a Retailer." EITF Issue No. 00-14 addresses the recognition,
measurement, and income statement characterization of sales incentives,
7
including rebates, coupons and free products or services, offered
voluntarily by a vendor without charge to the customer that can be used
in, or that are exercisable by a customer as a result of, a single
exchange transaction. EITF Issue No. 00-25 addresses whether consideration
from a vendor to a reseller of the vendor's products is (i) an adjustment
of the selling prices of the vendor's products and, therefore, should be
deducted from revenue when recognized in the vendor's income statement or
(ii) a cost incurred by the vendor for assets or services received from
the reseller and, therefore, should be included as a cost or an expense
when recognized in the vendor's income statement. As a result of both
issues, promotional expenses historically included in other operating
expenses were reclassified to cost of manufactured products sold, or as
reductions of revenues from manufactured products. Prior period amounts
were reclassified for comparative purposes. Adoption of these provisions
did not have a material impact on the financial position or results of
operations of the Company.
In June of 2001, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS
No. 142 changed the accounting for goodwill and intangible assets with
indefinite lives from an amortization method to an impairment-only
approach. Amortization of goodwill and intangible assets with indefinite
lives recorded in past business combinations ceased effective January 1,
2002 upon adoption of SFAS No. 142. Net income for the nine months ended
September 30, 2002 does not include amortization expense on goodwill. Had
the Company not amortized goodwill in 2001, pro forma net income (loss)
and the related basic and diluted earnings per share amounts for Loews
Common Stock would have been as follows:
September 30, 2001
------------------------------------------------
(In millions, except per share data) Three Months Ended Nine Months Ended
- -------------------------------------------------------------------------------------------
Net income Per share Net income Per share
- -------------------------------------------------------------------------------------------
Results as reported in prior year . . . . . $165.7 $0.85 $(777.2) $(3.95)
Add goodwill amortization, after tax
and minority interest . . . . . . . . . . 4.0 0.02 14.1 0.07
- -------------------------------------------------------------------------------------------
Adjusted reported results to include the
impact of the non-amortization provisions
of SFAS No. 142 . . . . . . . . . . . . . $169.7 $0.87 $(763.1) $(3.88)
===========================================================================================
During the third quarter of 2002, the Company completed its initial
goodwill impairment testing and recorded a $39.6 impairment charge, as
adjusted to reflect purchase accounting adjustments, net of income taxes
and minority interest of $5.8 and $6.4, respectively. In accordance with
SFAS No. 142, the impairment charge, which primarily relates to CNA's
Specialty Lines and Life Operations, was recorded as a cumulative effect
of a change in accounting principle as of January 1, 2002. Any impairment
losses incurred after the initial application of this standard will be
reported in operating results.
The impact of the goodwill impairment charge on net income and the
related basic and diluted per share amounts for Loews Common Stock for the
8
three months ended March 31, 2002 and the six months ended June 30, 2002,
is presented in the following table.
Restatement of 2002 Prior Period Results in Accordance with SFAS No. 142
Three Months Ended Six Months Ended
(In millions, except per share amounts) March 31, 2002 June 30, 2002
- -------------------------------------------------------------------------------------------
Net income Per share Net income Per share
- -------------------------------------------------------------------------------------------
Results as reported in prior periods . . . $234.9 $1.23 $395.4 $2.09
Less cumulative effect of adopting
SFAS No. 142, net of tax and minority
interest . . . . . . . . . . . . . . . . (39.6) (0.21) (39.6) (0.21)
- -------------------------------------------------------------------------------------------
Results as restated . . . . . . . . . . . $195.3 $1.02 $355.8 $1.88
===========================================================================================
Effective January 1, 2002, the Company adopted SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144
essentially applies one accounting model for long-lived assets to be
disposed of by sale, whether previously held and used or newly acquired,
and broadens the presentation of discontinued operations to include more
disposal transactions. Adoption of these provisions did not have a
material impact on the equity or results of operations of the Company;
however, it did impact the income statement presentation of certain
operations sold in 2002.
In June of 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 addresses
financial accounting and reporting for costs associated with exit or
disposal activities and supercedes EITF No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)". The
Company adopted the provisions of SFAS No. 146 for all disposal activities
initiated after June 30, 2002. The adoption of SFAS No. 146 did not have a
significant impact on the results of operations or equity of the Company.
In the first quarter of 2001, the Company adopted SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities" and SFAS
No. 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activities" (collectively referred to as SFAS No. 133). The
initial adoption of SFAS No. 133 did not have a significant impact on the
equity of the Company; however, adoption of SFAS No. 133 resulted in a
charge to 2001 earnings of $53.3, net of income taxes and minority
interest of $33.0 and $8.0, respectively, to reflect the change in
accounting principle. Of this transition amount, approximately $50.5, net
of income taxes and minority interest, related to CNA's investments and
investment-related derivatives. Because CNA already carried its investment
and investment-related derivatives at fair value through other
comprehensive income, there was an equal and offsetting favorable
adjustment of $50.5 to shareholders' equity (accumulated other
comprehensive income). The remainder of the transition adjustment is
attributable to collateralized debt obligation products that are
derivatives under SFAS No. 133. See Note 4 of the Notes to Consolidated
Financial Statements in the Company's 2001 Annual Report on Form 10-K.
9
In June of 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 applies to the accounting and
reporting obligations associated with the retirement of tangible long-
lived assets and the associated asset retirement costs. This Statement
applies to legal obligations associated with the retirement of long-lived
assets that result from the acquisition, construction, development and/or
the normal operation of a long-lived asset, except for certain obligations
of lessees. Adoption of this Statement is required for fiscal years
beginning after June 15, 2002. Adoption of these provisions will not have
a material impact on the equity or results of operations of the Company.
Comprehensive Income (Loss)
Comprehensive income (loss) includes all changes to shareholders'
equity, except those resulting from investments by shareholders and
distributions to shareholders. For the three and nine months ended
September 30, 2002 and 2001, comprehensive income (loss) totaled $438.5,
$338.7, $861.7 and $(1,118.8), respectively. Comprehensive income (loss)
includes net income (loss), unrealized appreciation (depreciation) of
investments and foreign currency translation gains or losses.
Reclassifications
Certain amounts applicable to prior periods have been reclassified to
conform to the classifications followed in 2002.
2. Earnings Per Share Attributable to Loews Common Stock and Carolina Group
Stock:
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 (loss) attributable to each class
of common stock by the weighted average number of common shares of each
class of common stock 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. For the three and nine months ended September 30, 2002 and
2001, income (loss) per common share assuming dilution is the same as
basic income (loss) per share because the impact of securities that could
potentially dilute basic income (loss) per common share is insignificant
or antidilutive for the periods presented.
10
The attribution of income to each class of common stock, for the three
and nine months ended September 30, 2002, was as follows:
September 30, 2002
-----------------------------
Three Months, Nine Months
Ended Ended
-----------------------------
Loews Common Stock:
Consolidated net income . . . . . . . . . . . . . $240.4 $ 655.6
Less income attributable to Carolina Group Stock (44.4) (103.8)
-----------------------------
Income attributable to Loews Common Stock . . . . $196.0 $ 551.8
=============================
Carolina Group Stock:
Carolina Group net income . . . . . . . . . . . . $191.7 $521.2
Less net income for January 2002 . . . . . . . . 73.1
-----------------------------
Income available to Carolina Group Stock . . . . 191.7 448.1
Weighted average economic interest of the
Carolina Group Stock . . . . . . . . . . . . . . 23.14% 23.16%
-----------------------------
Income attributable to Carolina Group Stock . . . $ 44.4 $103.8
=============================
11
3. Consolidating Financial Information:
The Consolidating Condensed Balance Sheets of Loews Corporation as of
September 30, 2002 and December 31, 2001 and the Consolidating Statements
of Operations for the three and nine months ended September 30, 2002 and
2001 and Cash Flows for the nine months ended September 30, 2002 and 2001,
are as follows:
CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS
Adjustments Consolidated
Carolina Loews and Loews
Three Months Ended September 30, 2002 Group Group Eliminations Corporation
- ------------------------------------------------------------------------------------------
Revenues:
Insurance premiums . . . . . . . . $ 2,261.4 $ 2,261.4
Investment income, net of expenses $ 13.8 433.0 $ (50.0) (a) 396.8
Investment gains . . . . . . . . . 22.1 4.4 26.5
Manufactured products . . . . . . 963.4 40.7 1,004.1
Other . . . . . . . . . . . . . . 1.2 387.5 388.7
- ------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . 1,000.5 3,127.0 (50.0) 4,077.5
- ------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits . . . . . 1,850.1 1,850.1
Amortization of deferred
acquisition costs . . . . . . . . 447.9 447.9
Cost of manufactured products sold 534.1 18.6 552.7
Other operating expenses . . . . . 98.3 636.4 734.7
Interest . . . . . . . . . . . . . 50.0 77.1 (50.0)(a) 77.1
- ------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . 682.4 3,030.1 (50.0) 3,662.5
- ------------------------------------------------------------------------------------------
318.1 96.9 415.0
- ------------------------------------------------------------------------------------------
Income taxes . . . . . . . . . . . 126.4 31.2 157.6
Minority interest . . . . . . . . 17.0 17.0
- ------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . 126.4 48.2 174.6
- ------------------------------------------------------------------------------------------
Income from operations . . . . . . 191.7 48.7 240.4
Equity in earnings of the Carolina
Group . . . . . . . . . . . . . . 147.3 (147.3)(b)
- ------------------------------------------------------------------------------------------
Net income . . . . . . . . . $ 191.7 $ 196.0 $ (147.3) $ 240.4
==========================================================================================
(a) To eliminate interest on the intergroup notional debt.
(b) To eliminate the Loews Group's intergroup interest in the earnings of the Carolina
Group.
12
CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS
Adjustments Consolidated
Carolina Loews and Loews
Nine Months Ended September 30, 2002 Group Group Eliminations Corporation
- ------------------------------------------------------------------------------------------
Revenues:
Insurance premiums . . . . . . . . $ 7,922.9 $ 7,922.9
Investment income, net of expenses $ 35.6 1,493.1 $(129.0)(a) 1,399.7
Investment (losses) gains. . . . . 32.7 (177.7) (145.0)
Manufactured products . . . . . . 2,963.4 113.0 3,076.4
Other . . . . . . . . . . . . . . 1.9 1,256.6 1,258.5
- ------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . 3,033.6 10,607.9 (129.0) 13,512.5
- ------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits . . . . . 6,542.4 6,542.4
Amortization of deferred
acquisition costs . . . . . . . . 1,349.9 1,349.9
Cost of manufactured products sold 1,707.0 53.0 1,760.0
Other operating expenses (b) . . . 337.3 2,051.6 2,388.9
Interest . . . . . . . . . . . . . 129.0 231.8 (129.0)(a) 231.8
- ------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . 2,173.3 10,228.7 (129.0) 12,273.0
- ------------------------------------------------------------------------------------------
860.3 379.2 1,239.5
- ------------------------------------------------------------------------------------------
Income taxes . . . . . . . . . . . 339.1 114.5 453.6
Minority interest . . . . . . . . 59.7 59.7
- ------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . 339.1 174.2 513.3
- ------------------------------------------------------------------------------------------
Income from operations . . . . . . 521.2 205.0 726.2
Equity in earnings of the Carolina
Group . . . . . . . . . . . . . . 417.4 (417.4)(c)
- ------------------------------------------------------------------------------------------
Income from continuing operations 521.2 622.4 (417.4) 726.2
Discontinued operations-net . . . (31.0) (31.0)
Cumulative effect of changes in
accounting principles-net . . . . (39.6) (39.6)
- ------------------------------------------------------------------------------------------
Net income . . . . . . . . . $ 521.2 $ 551.8 $(417.4) $ 655.6
==========================================================================================
(a) To eliminate interest on the intergroup notional debt.
(b) Includes $0.2 of expenses allocated by the Carolina Group to the Loews Group for
computer related charges and $0.2 of expenses allocated by Loews Group to the Carolina
Group for services provided pursuant to a services agreement, which eliminate in these
consolidating statements.
(c) To eliminate the Loews Group's intergroup interest in the earnings of the Carolina
Group.
13
CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS
Adjustments Consolidated
Carolina Loews and Loews
Three Months Ended September 30, 2001 Group Group Eliminations Corporation
- ------------------------------------------------------------------------------------------
Revenues:
Insurance premiums . . . . . . . . $ 2,514.5 $ 2,514.5
Investment income, net of expenses $ 18.3 497.1 515.4
Investment gains . . . . . . . . . 72.2 72.2
Manufactured products . . . . . . 1,058.9 34.7 1,093.6
Other . . . . . . . . . . . . . . 1.2 470.5 471.7
- ------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . 1,078.4 3,589.0 4,667.4
- ------------------------------------------------------------------------------------------
Expenses:
Insurance claims and policyholders'
benefits . . . . . . . . . . . . 2,420.3 2,420.3
Amortization of deferred
acquisition costs . . . . . . . . 423.1 423.1
Cost of manufactured products sold 595.8 16.2 612.0
Other operating expenses (a) . . . 106.0 742.8 848.8
Interest . . . . . . . . . . . . . 0.3 76.8 77.1
- ------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . 702.1 3,679.2 4,381.3
- ------------------------------------------------------------------------------------------
376.3 (90.2) 286.1
- ------------------------------------------------------------------------------------------
Income taxes (benefit) . . . . . . 146.7 (33.0) 113.7
Minority interest . . . . . . . . 11.3 11.3
- ------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . 146.7 (21.7) 125.0
- ------------------------------------------------------------------------------------------
Income (loss) from operations . . 229.6 (68.5) 161.1
Equity in earnings of the Carolina
Group . . . . . . . . . . . . . . 229.6 $(229.6)(b)
- ------------------------------------------------------------------------------------------
Income from continuing operations 161.1 161.1
Discontinued operations-net . . . 4.6 4.6
- ------------------------------------------------------------------------------------------
Net income . . . . . . . . . $ 229.6 $ 165.7 $(229.6) $ 165.7
==========================================================================================
(a) Includes $0.2 of expenses allocated by the Carolina Group to the Loews Group for
computer related charges and $0.1 expenses allocated by Loews Group to the Carolina
Group for services provided pursuant to a service agreement, which eliminate in these
consolidating statements.
(b) To eliminate the Loews Group's intergroup interest in the earnings of the Carolina
Group.
14
CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS
Adjustments Consolidated
Carolina Loews and Loews
Nine Months Ended September 30, 2001 Group Group Eliminations Corporation
- ------------------------------------------------------------------------------------------
Revenues:
Insurance premiums . . . . . . . . $ 6,598.1 $ 6,598.1
Investment income, net of expenses $ 64.9 1,498.1 1,563.0
Investment gains . . . . . . . . . 2.1 1,061.7 1,063.8
Manufactured products . . . . . . 2,955.2 97.5 3,052.7
Other . . . . . . . . . . . . . . 6.9 1,452.0 1,458.9
- ------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . 3,029.1 10,707.4 13,736.5
- ------------------------------------------------------------------------------------------
Expenses:
Insurance claims and policyholders'
benefits . . . . . . . . . . . . 8,765.9 8,765.9
Amortization of deferred
acquisition costs . . . . . . . . 1,297.2 1,297.2
Cost of manufactured products sold 1,719.7 45.7 1,765.4
Other operating expenses (a) . . . 526.0 2,242.1 2,768.1
Restructuring and other related
charges . . . . . . . . . . . . . 62.1 62.1
Interest . . . . . . . . . . . . . 0.6 255.5 256.1
- ------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . 2,246.3 12,668.5 14,914.8
- ------------------------------------------------------------------------------------------
782.8 (1,961.1) (1,178.3)
- ------------------------------------------------------------------------------------------
Income taxes (benefit) . . . . . . 307.4 (633.6) (326.2)
Minority interest . . . . . . . . (121.5) (121.5)
- ------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . 307.4 (755.1) (447.7)
- ------------------------------------------------------------------------------------------
Income (loss) from operations . . 475.4 (1,206.0) (730.6)
Equity in earnings of the Carolina
Group . . . . . . . . . . . . . . 475.4 $(475.4) (b)
- ------------------------------------------------------------------------------------------
Income (loss) from continuing
operations . . . . . . . . . . . 475.4 (730.6) (475.4) (730.6)
Discontinued operations-net . . . 6.7 6.7
Cumulative effect of changes in
accounting principles-net . . . . (53.3) (53.3)
- ------------------------------------------------------------------------------------------
Net income (loss) . . . . . . $ 475.4 $ (777.2) $(475.4) $ (777.2)
==========================================================================================
(a) Includes $0.6 of expenses allocated by the Carolina Group to the Loews Group for
computer related charges and $0.2 of expenses allocated by Loews Group to the Carolina
Group for services provided pursuant to a service agreement, which eliminate in these
consolidating statements.
(b) To eliminate the Loews Group's intergroup interest in the earnings of the Carolina
Group.
15
CONSOLIDATING CONDENSED BALANCE SHEET
Adjustments Consolidated
Carolina Loews and Loews
September 30, 2002 Group Group Eliminations Corporation
- ------------------------------------------------------------------------------------------
Assets:
Investments . . . . . . . . . . . $ 2,055.0 $40,635.1 $42,690.1
Cash . . . . . . . . . . . . . . 1.3 307.5 308.8
Receivables-net . . . . . . . . . 42.9 18,407.4 $ (33.6)(a) 18,416.7
Property, plant and equipment-net 191.0 2,851.8 3,042.8
Deferred income taxes . . . . . . 451.1 143.9 595.0
Goodwill and other intangible
assets-net . . . . . . . . . . . 202.3 202.3
Other assets . . . . . . . . . . 467.4 4,091.1 4,558.5
Investment in combined attributed
net assets of the Carolina Group 1,756.5 (2,500.0)(a)
743.5 (b)
Deferred acquisition costs of
insurance subsidiaries . . . . . 2,547.8 2,547.8
Separate account business . . . . 3,147.3 3,147.3
- ------------------------------------------------------------------------------------------
Total assets . . . . . . . . $ 3,208.7 $74,090.7 $(1,790.1) $75,509.3
==========================================================================================
Liabilities and Shareholders' Equity:
Insurance reserves . . . . . . . $42,580.1 $42,580.1
Payable for securities purchased 1,733.1 1,733.1
Securities sold under agreements
to repurchase . . . . . . . . . 1,211.7 1,211.7
Long-term debt, less unamortized
discount . . . . . . . . . . . . $ 2,500.0 5,914.9 $(2,500.0)(a) 5,914.9
Reinsurance balances payable . . 3,031.9 3,031.9
Other liabilities . . . . . . . . 1,674.5 3,251.1 (33.6)(a) 4,892.0
Separate account business . . . . 3,147.3 3,147.3
- ------------------------------------------------------------------------------------------
Total liabilities . . . . . 4,174.5 60,870.1 (2,533.6) 62,511.0
- ------------------------------------------------------------------------------------------
Minority interest . . . . . . . . 1,891.3 1,891.3
- ------------------------------------------------------------------------------------------
Shareholders' equity:
Loews Common stock, $1.00 par
value . . . . . . . . . . . . . 191.5 (c) 191.5
Carolina Group Stock, $0.01 par
value . . . . . . . . . . . . . 0.4 (c) 0.4
Additional paid-in capital . . . 1,115.7 (c) 1,115.7
Earnings retained in the
business . . . . . . . . . . . 9,749.8 (c) 9,749.8
Accumulated other comprehensive
income . . . . . . . . . . . . 400.8 (c) 400.8
Combined attributed net assets . (965.8) 11,329.3 743.5 (b)
(11,107.0)(c)
- ------------------------------------------------------------------------------------------
(965.8) 11,329.3 1,094.7 11,458.2
Less treasury stock, at cost . . (351.2)(c) (351.2)
- ------------------------------------------------------------------------------------------
Total shareholders' equity . (965.8) 11,329.3 743.5 11,107.0
- ------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity . . . $ 3,208.7 $74,090.7 $(1,790.1) $75,509.3
==========================================================================================
(a) To eliminate the intergroup notional debt and interest payable/receivable.
(b) To eliminate the Loews Group's 76.99% equity interest in the combined attributed net
assets of the Carolina Group.
(c) To record the Loews Corporation consolidated equity accounts at the balance
sheet date.
16
CONSOLIDATING CONDENSED BALANCE SHEET
Adjustments Consolidated
Carolina Loews and Loews
December 31, 2001 Group Group Eliminations Corporation
- ------------------------------------------------------------------------------------------
Assets:
Investments . . . . . . . . . . . $1,628.9 $39,530.2 $41,159.1
Cash . . . . . . . . . . . . . . 1.7 179.6 181.3
Receivables-net . . . . . . . . . 45.9 19,406.9 19,452.8
Property, plant and equipment-net 181.2 2,894.1 3,075.3
Deferred income taxes . . . . . . 426.6 180.4 607.0
Goodwill and other intangible
assets-net . . . . . . . . . . . 323.8 323.8
Other assets . . . . . . . . . . 485.1 3,744.7 4,229.8
Investment in combined attributed
net assets of the Carolina Group 1,274.5 $ (1,274.5)(a)
Deferred acquisition costs of
insurance subsidiaries . . . . . 2,423.9 2,423.9
Separate account business . . . . 3,798.1 3,798.1
- ------------------------------------------------------------------------------------------
Total assets . . . . . . . . $2,769.4 $73,756.2 $ (1,274.5) $75,251.1
==========================================================================================
Liabilities and Shareholders' Equity:
Insurance reserves . . . . . . . $43,623.9 $43,623.9
Payable for securities purchased 1,365.6 1,365.6
Securities sold under agreements
to repurchase . . . . . . . . . 1,602.4 1,602.4
Long-term debt, less unamortized
discount . . . . . . . . . . . . 5,920.3 5,920.3
Reinsurance balances payable . . 2,722.9 2,722.9
Other liabilities . . . . . . . . $1,494.9 3,100.3 4,595.2
Separate account business . . . . 3,798.1 3,798.1
- ------------------------------------------------------------------------------------------
Total liabilities . . . . . 1,494.9 62,133.5 63,628.4
- ------------------------------------------------------------------------------------------
Minority interest . . . . . . . . 1,973.4 1,973.4
- ------------------------------------------------------------------------------------------
Shareholders' equity:
Loews Common stock, $1.00 par
value . . . . . . . . . . . . . $ 191.5 (b) 191.5
Additional paid-in capital . . . 48.2 (b) 48.2
Earnings retained in the business 9,214.9 (b) 9,214.9
Accumulated other comprehensive
income . . . . . . . . . . . . 194.7 (b) 194.7
Combined attributed net assets . 1,274.5 9,649.3 (1,274.5)(a)
(9,649.3)(b)
- ------------------------------------------------------------------------------------------
Total shareholders' equity . 1,274.5 9,649.3 (1,274.5) 9,649.3
- ------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity . . . $2,769.4 $73,756.2 $ (1,274.5) $75,251.1
==========================================================================================
(a) To eliminate the Loews Group's 100% equity interest in the combined attributed net
assets of the Carolina Group.
(b) To record the Loews Corporation consolidated equity accounts at the balance
sheet date.
17
CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS
Adjustments Consolidated
Carolina Loews and Loews
Nine Months Ended September 30, 2002 Group Group Eliminations Corporation
- ------------------------------------------------------------------------------------------
Net cash provided by operating
activities . . . . . . . . . . . . $ 624.0 $ 994.1 $ (218.8) $ 1,399.3
- -----------------------------------------------------------------------------------------
Investing activities:
Purchases of property and equipment (40.3) (285.5) (325.8)
Proceeds from sales of property
and equipment . . . . . . . . . . 6.0 96.2 102.2
Change in short-term investments (327.9) (2,774.4) (3,102.3)
Other investing activities . . . . 1,564.0 1,564.0
- -----------------------------------------------------------------------------------------
(362.2) (1,399.7) (1,761.9)
- -----------------------------------------------------------------------------------------
Financing activities:
Dividends paid to shareholders . . (254.6) (85.0) 218.8 (120.8)
Other financing activities . . . . (7.6) 618.5 610.9
- -----------------------------------------------------------------------------------------
(262.2) 533.5 218.8 490.1
- -----------------------------------------------------------------------------------------
Net change in cash . . . . . . . . (0.4) 127.9 127.5
Cash, beginning of period . . . . . 1.7 179.6 181.3
- -----------------------------------------------------------------------------------------
Cash, end of period . . . . . . . . $ 1.3 $ 307.5 $ 308.8
=========================================================================================
Nine Months Ended September 30, 2001
- ------------------------------------------------------------------------------------------
Net cash provided by operating
activities . . . . . . . . . . . . . $1,015.9 $ (74.8) $ (500.0) $ 441.1
- -----------------------------------------------------------------------------------------
Investing activities:
Purchases of property and equipment (25.6) (321.8) (347.4)
Proceeds from sales of property
and equipment . . . . . . . . . . 9.1 278.3 287.4
Change in short-term investments . (498.9) 1,618.7 1,119.8
Other investing activities . . . . (509.5) (509.5)
- -----------------------------------------------------------------------------------------
(515.4) 1,065.7 550.3
- -----------------------------------------------------------------------------------------
Financing activities:
Dividends paid to shareholders . . (500.0) (83.8) 500.0 (83.8)
Other financing activities . . . . (944.3) (944.3)
- -----------------------------------------------------------------------------------------
(500.0) (1,028.1) 500.0 (1,028.1)
- -----------------------------------------------------------------------------------------
Net change in cash . . . . . . . . . 0.5 (37.2) (36.7)
Cash, beginning of period . . . . . 1.4 193.8 195.2
- -----------------------------------------------------------------------------------------
Cash, end of period . . . . . . . . $ 1.9 $ 156.6 $ 158.5
=========================================================================================
18
4. Reinsurance:
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.
CNA's overall reinsurance program includes certain property and casualty
contracts, such as the corporate aggregate reinsurance treaties discussed
in more detail later in this section, that are entered into and accounted
for on a "funds withheld" basis. Under the funds withheld basis, CNA
records the cash remitted to the reinsurer for the reinsurer's margin, or
cost of the reinsurance contract, as ceded premiums. The remainder of the
premiums ceded under the reinsurance contract is recorded as funds
withheld liability. CNA is required to increase the funds withheld balance
at stated interest crediting rates applied to the funds withheld balance
or as otherwise specified under the terms of the contract. The funds
withheld liability is reduced by any cumulative claim payments made by CNA
in excess of CNA's retention under the reinsurance contract. If the funds
withheld liability is exhausted, interest crediting will cease and
additional claim payments are recoverable from the reinsurer. The funds
withheld liability is recorded in reinsurance balances payable in the
Consolidated Condensed Balance Sheets.
Interest cost on these contracts is credited during all periods in which
a funds withheld liability exists. Interest cost, which is included in
investment income, net of expenses was $53.0 and $84.0 for the three
months ended September 30, 2002 and 2001 and $168.0 and $206.0 for the
nine months ended September 30, 2002 and 2001. The amount subject to
interest crediting rates on such contracts was $2,904.0 and $2,724.0 at
September 30, 2002 and December 31, 2001.
The amount subject to interest crediting on these funds withheld
contracts will vary over time based on a number of factors, including the
timing of loss payments and ultimate gross losses incurred. CNA expects
that it will continue to incur significant interest costs on these
contracts for several years.
The ceding of insurance does not discharge the primary liability of CNA.
Therefore, a credit exposure exists with respect to property and casualty
and life reinsurance ceded to the extent that any reinsurer is unable to
meet the obligations assumed under reinsurance agreements.
19
The effects of reinsurance on earned premiums are shown in the following
table:
Direct Assumed Ceded Net
-------------------------------------------
Nine Months Ended September 30, 2002
-------------------------------------------
Property and casualty . . . . . . . . . . . . $ 7,243.0 $ 872.0 $3,022.0 $ 5,093.0
Accident and health . . . . . . . . . . . . . 2,225.0 166.0 61.0 2,330.0
Life . . . . . . . . . . . . . . . . . . . . 804.0 (10.0) 294.0 500.0
-------------------------------------------
Total . . . . . . . . . . . . . . . . . $10,272.0 $1,028.0 $3,377.0 $ 7,923.0
===========================================
Nine Months Ended September 30, 2001
-------------------------------------------
Property and casualty . . . . . . . . . . . . $ 6,188.0 $ 937.0 $3,781.0 $ 3,344.0
Accident and health . . . . . . . . . . . . . 2,727.0 121.0 104.0 2,744.0
Life . . . . . . . . . . . . . . . . . . . . 865.0 155.0 510.0 510.0
-------------------------------------------
Total . . . . . . . . . . . . . . . . . $ 9,780.0 $1,213.0 $4,395.0 $ 6,598.0
===========================================
For 2002, CNA has entered into an aggregate reinsurance treaty covering
substantially all of CNA's property and casualty lines of business (the
"2002 Cover"). The loss protection provided by the 2002 Cover is dependent
on the level of subject premium, but there is a maximum aggregate limit of
$1,125.0 of ceded losses. Maximum ceded premium under the contract is
$683.0, and premiums, claims recoveries and interest charges other than
the reinsurer's margin and related fees are made on a funds withheld
basis. Interest is credited on funds withheld at 8.0% per annum, and all
premiums are deemed to have been paid as of January 1, 2002. Ceded premium
related to the reinsurer's margin in the amount of $2.5 and $7.5 was
recorded for the 2002 Cover for the three and nine months ended September
30, 2002.
The aggregate reinsurance protection from the 2002 Cover attaches at a
defined accident year loss and allocated loss adjustment expense
(collectively, losses) ratio. Under the contract, CNA has the right to
elect to cede losses to the 2002 Cover when its recorded accident year
losses exceed the attachment point. This election period expires March 31,
2004. If no losses are ceded by this date, the contract is considered to
be commuted. If CNA elects to cede any losses to the 2002 Cover, it must
continue to cede all losses subject to the terms of the contract. As of
September 30, 2002, CNA has not recorded any ceded losses related to this
cover.
In 1999, CNA entered into an aggregate reinsurance treaty related to the
1999 through 2001 accident years covering substantially all of CNA's
property and casualty lines of business (the "Aggregate Cover"). CNA has
two sections of coverage under the terms of the Aggregate Cover. These
coverages attach at defined loss ratios for each accident year. Coverage
under the first section of the Aggregate Cover, which is available for all
accident years covered by the contract, has annual limits of $500.0 of
ceded losses with an aggregate limit of $1,000.0 of ceded losses for the
20
three year period. The ceded premiums are a percentage of ceded losses and
for each $500.0 of limit the ceded premium is $230.0. The second section
of the Aggregate Cover, which was only utilized for accident year 2001,
provides additional coverage of up to $510.0 of ceded losses for a maximum
ceded premium of $310.0. Under the Aggregate Cover, interest charges on
the funds withheld accrue at 8.0% per annum. If the aggregate loss ratio
for the three-year period exceeds certain thresholds, additional premiums
may be payable and the rate at which interest charges are accrued would
increase to 8.25% per annum commencing in 2006.
The coverage under the second section of the Aggregate Cover was
triggered for the 2001 accident year. As a result of losses related to the
September 11, 2001 World Trade Center disaster and related events ("WTC
event"), the limit under this section was exhausted. Additionally, as a
result of the significant reserve additions recorded in the second quarter
of 2001, the $500.0 limit on the 1999 accident year under the first
section was also fully utilized. No losses have been ceded to the
remaining $500.0 of aggregate limit on accident years 2000 and 2001 under
the first section of the Aggregate Cover.
The impact of the Aggregate Cover on pretax operating results was as
follows:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------------
2002 2001 2002 2001
- -------------------------------------------------------------------------------------------
Ceded earned premiums . . . . . . . . . . . . $ (83.0) $ (543.0)
Ceded claim and claim adjustment expenses . . 288.0 1,010.0
Interest charges (included in investment
income, net of expenses) . . . . . . . . . . $(13.0) (11.0) $(38.0) (70.0)
- -------------------------------------------------------------------------------------------
Pretax impact on operating results . . . . . $(13.0) $ 194.0 $(38.0) $ 397.0
===========================================================================================
In 2001, CNA entered into a one-year aggregate reinsurance treaty
related to the 2001 accident year covering substantially all property and
casualty lines of business in the Continental Casualty Company pool (the
"CCC Cover"). The loss protection provided by the CCC Cover has an
aggregate limit of approximately $760.0 of ceded losses. The ceded
premiums are a percentage of ceded losses. The ceded premium related to
full utilization of the $760.0 limit is $456.0. The CCC Cover provides
continuous coverage in excess of the second section of the Aggregate Cover
discussed above. Under the CCC Cover, interest charges on the funds
withheld generally accrue at 8.0% per annum. The interest rate increases
to 10.0% per annum if the aggregate loss ratio exceeds certain thresholds.
Losses of $618.0 have been ceded under the CCC Cover through September 30,
2002.
21
The impact of the CCC Cover on pretax operating results was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------------
2002 2001 2002 2001
- -------------------------------------------------------------------------------------------
Ceded earned premiums . . . . . . . . . . . . $(39.0) $(232.0) $(100.0) $(234.0)
Ceded claim and claim adjustment expenses . . 55.0 427.0 148.0 427.0
Interest charges (included in investment
income, net of expenses) . . . . . . . . . . (11.0) (15.0) (27.0) (15.0)
- -------------------------------------------------------------------------------------------
Pretax impact on operating results . . . . . $ 5.0 $ 180.0 $ 21.0 $ 178.0
===========================================================================================
5. Other Investments:
Other invested assets include investments in limited partnerships and
certain derivative securities. The Company's limited partnership
investments are recorded at fair value, typically reflecting a reporting
lag of up to three months, with changes in fair value reported in
investment income, net of expenses. Fair value of the Company's limited
partnership investments represents the Company's equity in the
partnership's net assets as determined by the general partner. The
carrying value of the Company's limited partnership investments was
$1,430.3 and $1,307.0 as of September 30, 2002 and December 31, 2001.
Limited partnerships are a relatively small portion of the Company's
overall investment portfolio. The majority of the limited partnerships
invest in a substantial number of securities that are readily marketable.
The Company is a passive investor in such partnerships and does not have
influence over the partnerships' management, who are committed to operate
them according to established guidelines and strategies. These strategies
may include the use of leverage and hedging techniques that potentially
introduce more volatility and risk to the partnerships.
As of September 30, 2002, the Company had committed approximately $157.0
for future capital calls from various third-party limited partnership
investments in exchange for an ownership interest in the related
partnerships.
22
6. Receivables:
September 30, December 31,
2002 2001
- --------------------------------------------------------------------------
Reinsurance . . . . . . . . . . . . . . . . . $13,656.1 $13,823.4
Other insurance . . . . . . . . . . . . . . . 3,546.5 4,006.4
Security sales . . . . . . . . . . . . . . . 911.1 648.1
Accrued investment income . . . . . . . . . . 392.2 398.3
Federal income taxes . . . . . . . . . . . . 586.6
Other . . . . . . . . . . . . . . . . . . . . 291.6 353.7
- --------------------------------------------------------------------------
Total . . . . . . . . . . . . . . . . . 18,797.5 19,816.5
Less allowance for doubtful accounts and cash
discounts . . . . . . . . . . . . . . . . . 380.8 363.7
- --------------------------------------------------------------------------
Receivables-net . . . . . . . . . . . . $18,416.7 $19,452.8
==========================================================================
7. Claim and Claim Adjustment Expense Reserves:
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. CNA'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 and claims
settlement practices, 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, including loss reserves for catastrophic
events that have occurred, is an estimation process. Many factors can
ultimately affect the final settlement of a claim and, therefore, the
necessary reserve. 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. Adjustments to prior year reserve estimates, if necessary, are
reflected in the operating results in the period that the need for such
adjustments is determined.
Catastrophes are an inherent risk of the property and casualty insurance
business, which have contributed to material period-to-period fluctuations
in the Company's results of operations and equity. The level of
catastrophe losses experienced in any period cannot be predicted and can
be material to the results of operations and equity.
23
During the third quarter of 2001, CNA experienced a severe catastrophe
loss estimated at $468.0 pretax, net of reinsurance, related to the WTC
event. The loss estimate is based on a total industry loss of $50,000.0
and includes all lines of insurance. The estimate takes into account CNA's
substantial reinsurance agreements, including its catastrophe reinsurance
program and corporate reinsurance programs. CNA has closely monitored
reported losses as well as the collection of reinsurance on WTC event
claims. Based on experience to-date, CNA believes its recorded reserves
are adequate.
During the first quarter of 2002, CNA Re revised its estimate of
premiums and losses related to the WTC event. In estimating CNA Re's WTC
event losses, CNA performed a treaty-by-treaty analysis of exposure. CNA's
loss estimate was based on a number of assumptions including the loss to
the industry, the loss to individual lines of business and the market
share of CNA Re's cedants. Information available in the first quarter of
2002 resulted in CNA Re increasing its estimate of WTC event related
premiums and losses on its property facultative and property catastrophe
business. The impact of increasing the estimate of gross WTC event losses
by $144.0 was fully offset on a net of reinsurance basis (before the
impact of the CCC Cover) by higher reinstatement premiums and a reduction
of return premiums.
The following table provides management's estimate of pretax losses
related to this catastrophe on a gross basis (before reinsurance) and a
net basis (after reinsurance) by line of business for the three and nine
months ended September 30, 2001.
Gross Net
Basis Basis
- -------------------------------------------------------------------------------------------
Property and casualty reinsurance . . . . . . . . . . . . . . . $662.0 $ 465.0
Property . . . . . . . . . . . . . . . . . . . . . . . . . . . 282.0 159.0
Workers compensation . . . . . . . . . . . . . . . . . . . . . 112.0 25.0
Airline hull . . . . . . . . . . . . . . . . . . . . . . . . . 194.0 6.0
Commercial auto . . . . . . . . . . . . . . . . . . . . . . . . 1.0 1.0
- -------------------------------------------------------------------------------------------
Total property and casualty . . . . . . . . . . . . . . . . . 1,251.0 656.0
- ------------------------------------------------------------------------------------------
Group . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 322.0 60.0
Life . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75.0 22.0
- ------------------------------------------------------------------------------------------
Total group and life . . . . . . . . . . . . . . . . . . . . . 397.0 82.0
- ------------------------------------------------------------------------------------------
Total loss before corporate aggregate reinsurance treaties
and reinstatement and additional premiums and other . . . . . 1,648.0 738.0
==========================================================================
Reinstatement and additional premiums and other . . . . . . . . (11.0)
Corporate aggregate reinsurance treaties . . . . . . . . . . . (259.0)
- -------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 468.0
===========================================================================================
Environmental Pollution and Mass Tort and Asbestos Reserves ("APMT")
CNA's property and casualty insurance subsidiaries have actual and
potential exposures related to environmental pollution and mass tort and
24
asbestos claims. The following table provides data related to CNA's
environmental pollution and mass tort and asbestos claim and claim
adjustment expense reserves.
September 30, 2002 December 31, 2001
-------------------------------------------------------------------------------------------
Environmental Environmental
Pollution Pollution
and Mass and Mass
Tort Asbestos Tort Asbestos
-------------------------------------------------------------------------------------------
Gross reserves . . . . . . . . . . . $ 730.0 $1,536.0 $ 820.0 $1,590.0
Less ceded reserves . . . . . . . . (204.0) (320.0) (203.0) (386.0)
-------------------------------------------------------------------------------------------
Net reserves . . . . . . . . . . . . $ 526.0 $1,216.0 $ 617.0 $1,204.0
===========================================================================================
Environmental pollution cleanup is the subject of both federal and state
regulation. By some estimates, there are thousands of potential waste
sites subject to cleanup. 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. The Comprehensive Environmental Response
Compensation and Liability Act of 1980 ("Superfund") and comparable state
statutes ("mini-Superfunds") govern the cleanup and restoration of toxic
waste sites and formalize the concept of legal liability for cleanup and
restoration by Potentially Responsible Parties ("PRPs"). Superfund and the
mini-Superfunds establish mechanisms to pay for cleanup of waste sites if
PRPs fail to do so, and to assign liability to PRPs. The extent of
liability to be allocated to a PRP is dependent upon a variety of factors.
Further, the number of waste sites subject to cleanup is unknown. To date,
approximately 1,500 cleanup sites have been identified by the
Environmental Protection Agency ("EPA") and included on its National
Priorities List ("NPL"). State authorities have designated many cleanup
sites as well.
Many policyholders have made claims against various CNA insurance
subsidiaries for defense costs and indemnification in connection with
environmental pollution matters. The vast majority of these claims relate
to accident years 1989 and prior, which coincides with CNA's adoption of
the Simplified Commercial General Liability coverage form, which includes
what is referred to in the industry as an "absolute pollution exclusion."
CNA and the insurance industry are disputing coverage for many such
claims. Key coverage issues include whether cleanup costs are considered
damages under the policies, trigger of coverage, allocation of liability
among triggered policies, applicability of pollution exclusions and owned
property exclusions, the potential for joint and several liability and the
definition of an occurrence. To date, courts have been inconsistent in
their rulings on these issues.
A number of proposals to reform Superfund have been made by various
parties. However, no reforms were enacted by Congress during 2001 or the
first nine months of 2002, and it is unclear what positions Congress or
the administration will take and what legislation, if any, will result in
the future. If there is legislation, and in some circumstances even if
there is no legislation, the federal role in environmental cleanup may be
significantly reduced in favor of state action. Substantial changes in the
25
federal statute or the activity of the EPA may cause states to reconsider
their environmental cleanup statutes and regulations. There can be no
meaningful prediction of the pattern of regulation that would result or
the effect upon the Company's results of operations and/or equity.
Due to the inherent uncertainties described above, including the
inconsistency of court decisions, the number of waste sites subject to
cleanup, and the standards for cleanup and liability, the ultimate
liability of CNA for environmental pollution claims may vary substantially
from the amount currently recorded.
As of September 30, 2002 and December 31, 2001, CNA carried
approximately $526.0 and $617.0 of claim and claim adjustment expense
reserves, net of reinsurance recoverables, for reported and unreported
environmental pollution and mass tort claims. There was no environmental
pollution and mass tort net development for the three and nine months
ended September 30, 2002 and the three months ended September 30, 2001.
Unfavorable environmental pollution and mass tort development for the nine
months ended September 30, 2001 amounted to $453.0. CNA paid environmental
pollution related claims and other mass tort related claims, net of
reinsurance recoveries, of $91.0 and $153.0 for the nine months ended
September 30, 2002 and 2001.
CNA's property and casualty insurance subsidiaries also have exposure to
asbestos-related claims. Estimation of asbestos-related claim and claim
adjustment expense reserves involves many of the same limitations
discussed above for environmental pollution claims, such as inconsistency
of court decisions, specific policy provisions, allocation of liability
among insurers and insureds, and additional factors such as missing
policies and proof of coverage. Furthermore, estimation of asbestos-
related claims is difficult due to, among other reasons, the proliferation
of bankruptcy proceedings and attendant uncertainties, the targeting of a
broader range of businesses and entities as defendants, the uncertainty as
to which other insureds may be targeted in the future, and the
uncertainties inherent in predicting the number of future claims.
As of September 30, 2002 and December 31, 2001, CNA carried
approximately $1,216.0 and $1,204.0 of claim and claim adjustment expense
reserves, net of reinsurance recoverables, for reported and unreported
asbestos-related claims. There was no asbestos net claim and claim
adjustment expense development for the three and nine months ended
September 30, 2002 and the three months ended September 30, 2001.
Unfavorable asbestos net claim and claim adjustment reserve development
for the nine months ended September 30, 2001 amounted to $769.0. CNA had a
net $12.0 receipt of cash related to asbestos in the first nine months of
2002 as reinsurance recoveries collected exceeded claim payments. CNA made
asbestos-related claim payments, net of reinsurance recoveries, of $78.0
for the nine months ended September 30, 2001.
In the past several years, CNA has experienced significant increases in
claim counts for asbestos-related claims. The factors that led to these
increases included, among other things, intensive advertising campaigns by
lawyers for asbestos claimants, mass medical screening programs sponsored
by plaintiff lawyers, and the addition of new defendants such as the
distributors and installers of products containing asbestos. Currently,
the majority of asbestos bodily injury claims are filed by persons
exhibiting few, if any, disease symptoms. It is estimated that
approximately 90.0% of the current non-malignant asbestos claimants do not
meet the American Medical Association's definition of impairment. Some
26
courts, including the federal district court responsible for pre-trial
proceedings in all federal asbestos bodily injury actions, have ordered
that so-called "unimpaired" claimants may not recover unless at some point
the claimant's condition worsens to the point of impairment.
Since 1982, at least sixty-two companies that mined asbestos, or
manufactured or used asbestos-containing products, have filed for
bankruptcy. Of these sixty-two companies, twenty-six companies have filed
bankruptcy since January 1, 2000. This phenomenon has prompted plaintiff
attorneys to file claims against companies that had only peripheral
involvement with asbestos. Many of these defendants were users or
distributors of asbestos-containing products, or manufacturers of products
in which asbestos was encapsulated. These defendants include equipment
manufacturers, brake, gasket, and sealant manufacturers, and general
construction contractors. According to a comprehensive report on asbestos
litigation recently released by the Rand Corporation, over 6,000 companies
have been named as defendants in asbestos lawsuits, with 75 out of 83
different types of industries in the United States impacted by asbestos
litigation. The study found that a typical claimant names 70 to 80
defendants, up from an average of 20 in the early years of asbestos
litigation.
Some asbestos-related defendants have asserted that their claims for
insurance are not subject to aggregate limits on coverage. CNA has such
claims from a number of insureds. Some of these claims involve insureds
facing exhaustion of products liability aggregate limits in their
policies, who have asserted that their asbestos-related claims fall within
so-called "non-products" liability coverage contained within their
policies rather than products liability coverage, and that the claimed
"non-products" coverage is not subject to any aggregate limit. It is
difficult to predict the ultimate size of any of the claims for coverage
purportedly not subject to aggregate limits or predict to what extent, if
any, the attempts to assert "non-products" claims outside the products
liability aggregate will succeed. CNA is currently attempting to achieve
settlements of several of these claims for coverage purportedly not
subject to aggregate limits. Nevertheless, there can be no assurance any
of these settlement efforts will be successful, or that any such claims
can be settled on terms acceptable to CNA. Adverse developments with
respect to such matters discussed in this paragraph could have a material
adverse effect on the Company's results of operations and/or equity.
Policyholders have also initiated litigation directly against CNA and
other insurers. CNA has been named in Adams v. Aetna, Inc., et. al.
(Circuit Court of Kanhwha County, West Virginia), a purported class action
against CNA and other insurers, alleging that the defendants violated West
Virginia's Unfair Trade Practices Act in handling and resolving asbestos
claims against their policyholders. In addition, lawsuits have been filed
in Texas against CNA and other insurers and non-insurer corporate
defendants asserting liability for failing to warn of the dangers of
asbestos. (Boston v. Union Carbide Corp., et al., (District Court of
Nueces County, Texas)). It is difficult to predict the outcome or
financial exposure represented by this type of litigation in light of the
broad nature of the relief requested and the novel theories asserted.
Due to the uncertainties created by volatility in claim numbers and
settlement demands, the effect of bankruptcies, the extent to which non-
impaired claimants can be precluded from making claims and the efforts by
insureds to obtain coverage not subject to aggregate limits, the ultimate
liability of CNA for asbestos-related claims may vary substantially from
27
the amount currently recorded. Other variables that will influence CNA's
ultimate exposure to asbestos-related claims will be medical inflation
trends, jury attitudes, the strategies of plaintiff attorneys to broaden
the scope of defendants, the mix of asbestos-related diseases presented,
CNA's abilities to recover reinsurance, future court decisions and the
possibility of legislative reform. Adverse developments with respect to
such matters discussed in this paragraph could have a material adverse
effect on the Company's results of operations and/or equity.
CNA reviews each active asbestos account every six months to determine
whether changes in reserves may be warranted. CNA considers input from its
analyst professionals with direct responsibility for the claims, inside
and outside counsel with responsibility for representation of CNA, and its
actuarial staff. These professionals review, among many factors, the
policyholder's present and future exposures (including such factors as
claims volume, disease mix, trial conditions, settlement demands and
defense costs); the policies issued by CNA (including such factors as
aggregate or per occurrence limits, whether the policy is primary,
umbrella or excess, and the existence of policyholder retentions and/or
deductibles); the existence of other insurance; and reinsurance
arrangements.
The results of operations and equity of the Company in future years may
be adversely affected by environmental pollution and mass tort and
asbestos claim and claim adjustment expenses. Management will continue to
review and monitor these liabilities and make further adjustments,
including the potential for further reserve strengthening, as warranted.
Second Quarter 2001 Prior Year Reserve Strengthening
During the second quarter of 2001, CNA noted the continued emergence of
adverse loss experience across several lines of business related to prior
years, which are discussed in further detail below. CNA completed a number
of reserve studies during the second quarter of 2001 for many of its lines
of business, including those in which these adverse trends were noted.
28
The second quarter 2001 prior year reserve strengthening and related
items comprising the amounts noted above, for the three months ended June
30, 2001, are detailed in the following table.
Net reserve strengthening, excluding the impact
of the corporate aggregate reinsurance treaty
APMT . . . . . . . . . . . . . . . . . . . . . $1,197.0
Non-APMT . . . . . . . . . . . . . . . . . . . 1,594.0
--------
Total . . . . . . . . . . . . . . . . . . . 2,791.0
Pretax benefit from corporate aggregate
reinsurance treaty on accident year 1999 (1) . . (223.0)
Accrual for insurance-related assessments . . . . 48.0
--------
Net reserve strengthening and related accruals 2,616.0
--------
Change in estimate of premium accruals . . . . . 616.0
Reduction of related commission accruals. . . . . (50.0)
--------
Net premium and related accrual reductions. . . 566.0
--------
Total reserve strengthening and related accruals $3,182.0
========
(1) $500.0 of ceded losses reduced by $230.0 of ceded premiums and $47.0
of interest charges.
With respect to environmental and mass tort reserves, commencing in 2000
and continuing into the first and second quarters of 2001, CNA received a
number of new reported claims, some of which involved declaratory judgment
actions premised on court decisions purporting to expand insurance
coverage for pollution claims. In these decisions, several courts adopted
rules of insurance policy interpretation which established joint and
several liability for insurers consecutively on a risk during a period of
alleged property damage; and in other instances adopted interpretations of
the "absolute pollution exclusion," which weakened its effectiveness in
most circumstances. In addition to receiving new claims and declaratory
judgment actions premised upon these unfavorable legal precedents, these
court decisions also impacted CNA's pending pollution and mass tort claims
and coverage litigation. During the spring of 2001, CNA reviewed specific
claims and litigation, as well as general trends, and concluded reserve
strengthening in this area was warranted.
In the area of mass torts, several well-publicized verdicts arising out
of bodily injury cases related to allegedly toxic mold led to a
significant increase in mold-related claims in 2000 and the first half of
2001. CNA's reserve increase in the second quarter of 2001 was caused in
part by this increased area of exposure.
With respect to other court cases and how they might affect CNA's
reserves and reasonable possible losses, the following should be noted.
State and federal courts issue numerous decisions each year, which
potentially impact losses and reserves in both a favorable and unfavorable
manner. Examples of favorable developments include decisions to allocate
29
defense and indemnity payments in a manner so as to limit carriers'
obligations to damages taking place during the effective dates of their
policies; decisions holding that injuries occurring after asbestos
operations are completed are subject to the completed operations aggregate
limits of the policies; and decisions ruling that carriers' loss control
inspections of their insured's premises do not give rise to a duty to warn
third parties to the dangers of asbestos.
Examples of unfavorable developments include decisions limiting the
application of the "absolute pollution exclusion;" and decisions holding
carriers liable for defense and indemnity of asbestos and pollution claims
on a joint and several basis.
Throughout 2000, and into 2001, CNA experienced significant increases in
new asbestos bodily injury claims. In light of this development, CNA
formed the view that payments for asbestos claims could be higher in
future years than previously estimated. Moreover, in late 2000 through
mid-2001, industry sources such as rating agencies and actuarial firms
released analyses and studies commenting on the increase in claim volumes
and other asbestos liability developments. For example, A.M. Best released
a study in May 2001 increasing its ultimate asbestos reserve estimate
63.0% from $40,000.0 to $65,000.0, citing an unfunded insurance industry
reserve shortfall of $33,000.0. In June 2001, Tillinghast raised its
asbestos ultimate exposure from $55,000.0 to $65,000.0 for the insurance
industry and its estimate of the ultimate asbestos liability for all
industries was raised to $200,000.0.
Also in the 2000 to 2001 time period, a number of significant asbestos
defendants filed for bankruptcy, increasing the likelihood that excess
layers of insurance coverage could be called upon to indemnify
policyholders and creating the potential that novel legal doctrines could
be employed which could accelerate the time when such indemnification
payments could be due.
These developments led CNA's claims management to the conclusion that
its asbestos reserves required strengthening.
The non-APMT adverse reserve development was the result of analyses of
several lines of business. This development related principally to
commercial insurance coverages including automobile liability and
multiple-peril, as well as assumed reinsurance and health care related
coverages. A brief summary of these lines of business and the associated
reserve development is discussed below.
Approximately $600.0 of the adverse loss development is a result of
several coverages provided to commercial entities. Reserve analyses
performed during 2001 showed unexpected increases in the size of claims
for several lines, including commercial automobile liability, general
liability and the liability portion of commercial multiple-peril
coverages. In addition, the number of commercial automobile liability
claims was higher than expected and several state-specific factors
resulted in higher than anticipated losses, including developments
associated with commercial automobile liability coverage in Ohio and
general liability coverage provided to contractors in New York.
The commercial automobile liability analysis indicated increased
ultimate loss and allocated loss adjustment expense across several
accident years due to higher paid and reported loss and allocated loss
adjustment expense resulting from several factors. These factors include
30
uninsured/underinsured motorists coverage in Ohio, a change in the rate at
which the average claim size is increasing and a lack of improvement in
the ratio of the number of claims per exposure unit, the frequency. First,
Ohio courts have significantly broadened the population covered through
the uninsured/underinsured motorists' coverage. The broadening of the
population covered by this portion of the policy, and the retrospective
nature of this broadening of coverage, resulted in additional claims for
older years. Second, in recent years, the average claim size has been
increasing at less than a 2.0% annual rate. The most recent available data
indicates that the rate of increase is now closer to 8.0% with only a
portion of this increase explainable by a change in mix of business.
Finally, the review completed during the second quarter of 2001 indicated
that the frequency for the 2000 accident year was 6.0% higher than 1999.
Expectations were that the 2000 frequency would show an improvement from
the 1999 level.
The analyses of general liability and the liability portion of
commercial multiple-peril coverages showed several factors affecting these
lines. Construction defect claims in California and a limited number of
other states have had a significant impact. It was expected that the
number of claims being reported and the average size of those claims would
fall quickly due to the decrease in business exposed to those losses.
However, the number of claims reported during the first six months of 2001
increased from the number of claims reported during the last six months of
2000. In addition to the effects of construction defect claims, the
average claim associated with New York labor law has risen to more than
one hundred twenty five thousand dollars from less than one hundred
thousand dollars, which was significantly greater than previously
expected.
An analysis of assumed reinsurance business showed that the paid and
reported losses for recent accident years were higher than expectations,
which resulted in management recording net unfavorable development on
prior year loss reserves of approximately $560.0. Because of the long and
variable reporting pattern associated with assumed reinsurance as well as
uncertainty regarding possible changes in the reporting methods of the
ceding companies, the carried reserves for assumed reinsurance are based
mainly on the pricing assumptions until experience emerges to show that
the pricing assumptions are no longer valid. The reviews completed during
the second quarter of 2001, including analysis at the individual treaty
level, showed that the pricing assumptions were no longer appropriate. The
classes of business with the most significant changes include excess of
loss liability, professional liability and proportional and retrocessional
property.
Approximately $320.0 of adverse loss development was due to adverse
experience in all other lines, primarily in coverages provided to
healthcare-related entities. The level of paid and reported losses
associated with coverages provided to national long-term care facilities
were higher than expected. The long-term care facility business had
traditionally been limited to local facilities. In recent years, CNA began
to provide coverage to large chains of long-term care facilities. Original
assumptions were that these chains would exhibit loss ratios similar to
the local facilities. The most recent review of these large chains
indicated an overall loss ratio in excess of 500.0% versus approximately
100.0% for the remaining business. In addition, the average size of claims
resulting from coverages provided to physicians and institutions providing
healthcare related services increased more than expected. The most recent
review indicated that the average loss had increased to over three hundred
31
thirty thousand dollars. Prior to this review, the expectation for the
average loss was approximately two hundred fifty thousand dollars.
Concurrent with CNA's review of loss reserves, CNA completed
comprehensive studies of estimated premium receivable accruals on
retrospectively rated insurance policies and involuntary market
facilities. These studies included ground-up reviews of retrospective
premium accruals utilizing a more comprehensive database of
retrospectively rated contracts. This review included application of the
policy retrospective rating parameters to the revised estimate of ultimate
loss ratio and consideration of actual interim cash settlement. This study
resulted in a change in the estimated retrospective premiums receivable
balances.
As a result of this review and changes in premiums associated with the
change in estimates for loss reserves, CNA recorded a pretax reduction in
premium accruals of $566.0. The effect on net earned premiums was $616.0
offset by a reduction of accrued commissions of $50.0. The studies
included the review of all such retrospectively rated insurance policies
and the estimate of ultimate losses.
Approximately $188.0 of this amount resulted from a change in estimate
in premiums related to involuntary market facilities, which had an
offsetting impact on net losses and therefore had no impact on the net
operating results in 2001. Accruals for ceded premiums related to other
reinsurance treaties increased $83.0 due to the reserve strengthening. The
remainder of the decrease in premium accruals relates to the change in
estimate of the amount of retrospective premium receivables as discussed
above.
8. Shareholders' equity:
September 30, December 31,
2002 2001
- --------------------------------------------------------------------------
Preferred stock, $0.10 par value,
Authorized--100,000,000 shares
Common stock:
Loews Common Stock, $1.00 par value:
Authorized--600,000,000 shares
Issued-191,506,800 and 191,493,300 shares $ 191.5 $ 191.5
Carolina Group Stock, $0.01 par value:
Authorized--600,000,000 shares
Issued-40,250,000 shares . . . . . . . . 0.4
Additional paid-in capital . . . . . . . . . 1,115.7 48.2
Earnings retained in the business . . . . . . 9,749.8 9,214.9
Accumulated other comprehensive income . . . 400.8 194.7
- --------------------------------------------------------------------------
11,458.2 9,649.3
Less treasury stock, at cost (6,065,600
shares of Loews Common Stock and 340,000
shares of Carolina Group Stock). . . . . . . 351.2
- --------------------------------------------------------------------------
Total shareholders' equity . . . . . . . . . $11,107.0 $ 9,649.3
==========================================================================
32
Investments in securities, which are held principally by insurance
subsidiaries of CNA are considered 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. Investments are written down to estimated fair values
and impairment losses are recognized in income when a decline in value is
determined to be other than temporary.
Realized investment losses for the three and nine months ended September
30, 2002, included $223.2 and $534.2 of pretax impairment losses as
compared with $41.0 and $124.0 of pretax impairment losses for the same
periods in 2001.
The impairment losses recorded in 2002 and 2001 were primarily the
result of the continued deterioration in the bond and equity markets and
the effects on such markets due to the overall slowing of the economy.
These impairment losses were related principally to corporate bonds in the
taxable securities asset class of fixed maturity securities and in equity
securities.
For the three months ended September 30, 2002, the impairment losses
related primarily to corporate bonds in the communications sector of the
market and equities in the financial industry sector. On an aggregate
basis these impairment losses were more than offset by the realized gains
in the overall investment portfolio.
For the three months ended September 30, 2001, the impairment losses
related to corporate bonds primarily in the internet communications sector
of the market.
For the nine months ended September 30, 2002, the impairment losses
included $130.2 related to debt securities issued by WorldCom Inc., $74.0
related to Adelphia Communications Corporation, and $57.0 for AT&T Canada,
all of which have recently filed for bankruptcy. The remainder of the
impairment losses were primarily in the communications sector. If the
deterioration in this and other industry sectors continues in future
periods and the Company continues to hold these securities, the Company is
likely to have additional impairment losses in the future.
For the nine months ended September 30, 2001 the impairment losses were
primarily in corporate bonds and included $61.0 related to the internet
communications industry sector. The remainder of the impairment losses
were primarily in the equity sector within the medical services industry.
9. Restructuring and Other Related Charges:
2001 Restructuring
In 2001, CNA finalized and approved two separate restructuring plans.
The first plan related to CNA's Information Technology operations (the "IT
Plan"). The second plan related to restructuring the property and casualty
segments and life operations, discontinuation of the variable life and
annuity business and consolidation of real estate locations (the "2001
Plan").
33
IT Plan
The overall goal of the IT Plan was to improve technology for the
underwriting function and throughout CNA and to eliminate inefficiencies
in the deployment of IT resources. The changes facilitate a strong focus
on enterprise-wide system initiatives. The IT Plan had two main
components, which included the reorganization of IT resources into the
Technology and Operations Group with a structure based on centralized,
functional roles and the implementation of an integrated technology
roadmap that included common architecture and platform standards that
directly support CNA's strategies.
For the nine months ended September 30, 2001 CNA incurred $62.0 pretax
of restructuring and other related charges for the IT Plan primarily
related to employee severance charges and the write-off of impaired
assets. There were no charges recorded during the three months ended
September 30, 2001.
No restructuring and other related charges related to the IT Plan have
been incurred in 2002; however, payments were made during the nine months
ended September 30, 2002 related to amounts accrued as of December 31,
2001. The following table summarizes the remaining IT Plan accrual at
September 30, 2002 and the activity in that accrual since inception.
IT Plan Accrual
Employee
Termination Impaired
And Related Asset Other
Benefit Costs Charges Costs Total
- -------------------------------------------------------------------------------------------
IT Plan initial accrual . . . . . . . . . . . . $ 29.0 $ 32.0 $1.0 $ 62.0
Costs that did not require cash in 2001 . . . . (32.0) (32.0)
Payments charged against liability in 2001 . . . (19.0) (19.0)
- -------------------------------------------------------------------------------------------
Accrued costs at December 31, 2001 . . . . . . . 10.0 1.0 11.0
Payments charged against liability in 2002 . . . (1.0) (1.0)
- -------------------------------------------------------------------------------------------
Accrued costs at September 30, 2002 . . . . . . $ 9.0 $1.0 $ 10.0
===========================================================================================
The IT Plan is not expected to result in decreased operating expenses in
the foreseeable future because savings from the workforce reduction have
been used to fund new technology-related initiatives. Employee termination
and related benefit payments will continue through 2004 due to employment
contract obligations.
2001 Plan
The overall goal of the 2001 Plan was to create a simplified and leaner
organization for customers and business partners. The major components of
the plan included a reduction in the number of strategic business units
("SBUs") in the property and casualty operations, changes in the strategic
focus of the Life Operations and consolidation of real estate locations.
The reduction in the number of property and casualty SBUs resulted in
consolidation of SBU functions, including underwriting, claims, marketing
and finance. The strategic changes in Life Operations included a decision
to discontinue writing variable life and annuity business.
34
No restructuring and other related charges related to the 2001 Plan have
been incurred in 2002; however, payments were made during the nine months
ended September 30, 2002 related to amounts accrued as of December 31,
2001. The following table summarizes the remaining 2001 Plan accrual as of
September 30, 2002 and the activity in that accrual since inception.
2001 Plan Accrual
Employee
Termination Lease Impaired
and Related Termination Asset Other
Benefit Costs Costs Charges Costs Total
- -------------------------------------------------------------------------------------------
2001 Plan initial accrual . . . . . . $ 68.0 $ 56.0 $ 30.0 $ 35.0 $189.0
Costs that did not require cash
in 2001 . . . . . . . . . . . . . . (35.0) (35.0)
Payments charged against liability
in 2001 . . . . . . . . . . . . . . (2.0) (2.0)
- -------------------------------------------------------------------------------------------
Accrued costs at December 31, 2001 . 66.0 56.0 30.0 152.0
Costs that did not require cash
in 2002 . . . . . . . . . . . . . . (25.0) (25.0)
Payments charged against liability
in 2002 . . . . . . . . . . . . . . (50.0) (11.0) (1.0) (62.0)
- -------------------------------------------------------------------------------------------
Accrued costs at September 30, 2002 . $ 16.0 $ 45.0 $ 4.0 $ $ 65.0
===========================================================================================
10. Significant Transactions:
National Postal Mail Handlers Union Contract Termination
During the second quarter of 2002, CNA announced the sale of the Claims
Administration Corporation and the transfer of the National Postal Mail
Handlers Union group benefits plan (the "Mail Handlers Plan") to First
Health Group Corporation, effective July 1, 2002. In the third quarter of
2002, CNA recognized a $5.0 pretax realized loss on the sale of the Claims
Administration Corporation and $14.0 pretax of non-recurring fee income
related to the transfer of the Mail Handlers Plan.
The assets and liabilities of the Claims Administration Corporation and
the Mail Handlers Plan were $352.0 and $350.0 at December 31, 2001. The
revenues of the Claims Administration Corporation and the Mail Handlers
Plan were $3.0 and $613.0 for the three months ended September 30, 2002
and 2001 and $1,157.0 and $1,663.0 for the nine months ended September 30,
2002 and 2001.
Net operating income from the Claims Administration Corporation and the
Mail Handlers Plan was $4.5, including the non-recurring fee income, and
$2.6 for the three months ended September 30, 2002 and 2001 and $10.7 and
$7.8 for the nine months ended September 30, 2002 and 2001.
CNA Vida Disposition
In March of 2002, CNA completed the sale of the common stock of CNA
Holdings Limited and its subsidiaries ("CNA Vida"), CNA's life operations
in Chile, to Consorcio Financiero S.A. ("Consorcio"). In connection with
the sale, CNA received proceeds of $73.0 and recorded a loss from
35
discontinued operations of $31.0. This loss is composed of $32.8 realized
loss on the sale of CNA Vida and income of $1.8 from CNA Vida's operations
for 2002.
CNA Vida's assets and liabilities at December 31, 2001 were $442.0 and
$337.0. CNA Vida's net earned premiums were $14.0 for the three months
ended September 30, 2001 and $24.0 and $63.0 for the nine months ended
September 30, 2002 and 2001. Net operating income was $4.6 for the three
months ended September 30, 2001 and $1.8 and $6.7 for the nine months
ended September 30, 2002 and 2001. CNA Vida's results of operations,
including the loss on sale, are presented as discontinued operations in
all periods presented.
Other Dispositions and Planned Dispositions of Certain Businesses
During the second quarter of 2001, CNA announced its intention to sell
certain businesses. The assets being held for disposition included the
U.K. subsidiaries of CNA Re ("CNA Re U.K.") and certain other businesses.
Based upon the impairment analyses performed at that time, CNA anticipated
that it would realize losses in connection with those planned sales. In
determining the anticipated loss from these sales, CNA estimated the net
realizable value of each business being held for sale. An estimated loss
of $278.4 (after-tax and minority interest) was initially recorded in the
second quarter of 2001. This loss was reported as investment losses in the
Statement of Operations.
CNA continues to monitor the impairment losses recorded for these
businesses and perform updated impairment analyses. Based on the analyses,
the impairment loss has been reduced by approximately $170.0, primarily
because the net assets of the businesses had been significantly diminished
by their operating losses, including adverse loss reserve development
recognized by CNA Re U.K. in the fourth quarter of 2001.
In the fourth quarter of 2001, CNA sold certain businesses as planned.
The realized loss after-tax and minority interest applicable to these
businesses, recognized in the second quarter of 2001, was $33.1. Revenues
of these businesses included in the three and nine months ended September
30, 2001 totaled approximately $6.0 and $28.0. These businesses
contributed approximately $2.6 of net operating income and $12.2 of losses
in the three and nine months ended September 30, 2001.
At September 30, 2002, CNA Re U.K. remained held for sale. On October
31, 2002, CNA completed the sale of CNA Re U.K. to Tawa U.K. Limited, a
subsidiary of Artemis Group, a diversified French-based holding company.
The sale includes business underwritten since inception by CNA Re U.K.,
except for certain risks retained by CCC as discussed below. In October,
the sale was approved in the United Kingdom by the Financial Services
Authority ("FSA") and by the Illinois Insurance Department. This sale does
not impact CNA Re's on-going U.S.-based operations.
CNA Re U.K. was sold for one dollar, subject to adjustments that are
primarily driven by certain operating results and changes in interest
rates between January 1, 2002 and October 31, 2002, and realized foreign
currency losses recognized by CNA Re U.K. prior to December 31, 2002. CNA
has also committed to contribute up to $9.6 to CNA Re U.K. over a four-
year period beginning in 2010 should the FSA deem CNA Re U.K. to be
undercapitalized. Due to the various components of the completion
adjustments, which are initially prepared by the buyer, the final
settlement can not yet be determined. However, based upon information
36
currently available to CNA, management believes there will be a reduction
in the previously recognized impairment loss, which will be reflected as a
realized gain when the completion adjustments are finalized.
Concurrent with the sale, several reinsurance agreements under which CCC
had provided retrocessional protection to CNA Re U.K. will be terminated.
As part of the sale, CNA Re U.K.'s net exposure to all IGI Program
liabilities will be ceded to CCC. Further, CCC will provide a $100.0 stop
loss cover attaching at carried reserves on CNA Re U.K.'s 2001
underwriting year exposures for which CCC received premiums of $25.0.
The statutory surplus of CNA Re U.K. was below the required regulatory
minimum surplus level at December 31, 2001. CCC contributed $120.0 of
capital on March 25, 2002 bringing the capital above the regulatory
minimum.
CNA Re U.K. contributed revenues of approximately $14.0 and $57.0 for
the three months ended September 30, 2002 and 2001, and $57.0 and $220.0
for the nine months ended September 30, 2002 and 2001. CNA Re U.K.
contributed net operating income of $8.1 and net operating losses of $94.9
for the three months ended September 30, 2002 and 2001 and net operating
income of $11.6 and net operating losses of $153.2 for the nine months
ended September 30, 2002 and 2001. The assets and liabilities of CNA Re
U.K., including the effects of planned concurrent transactions, were
approximately $2,700.0 and $2,700.0 as of September 30, 2002 and $2,900.0
and $2,900.0 as of December 31, 2001.
The businesses sold in 2002, excluding CNA Vida, Claims Administration
Corporation and the Mail Handlers Plan, and those that continue to be held
for disposition as of September 30, 2002, excluding CNA Re U.K.,
contributed revenues of approximately $6.0 and $28.0 for the three months
ended September 30, 2002 and 2001, and $35.0 and $95.0 for the nine months
ended September 30, 2002 and 2001. Additionally, these businesses
contributed net operating losses of $1.8 and $1.7 for the three months
ended September 30, 2002 and 2001 and $12.5 and $10.4 for the nine months
ended September 30, 2002 and 2001. The assets and liabilities of these
businesses were approximately $96.0 and $83.0 as of September 30, 2002 and
$126.0 and $109.0 as of December 31, 2001. All anticipated sales are
expected to be completed in 2002.
37
11. Discontinued Operations:
The Company reports CNA's net assets of discontinued operations, which
primarily consist of run-off operations discontinued in the mid-1990's, in
other assets in the Consolidated Condensed Balance Sheets. The following
table provides more detailed information regarding those net assets.
September 30, December 31,
2002 2001
- --------------------------------------------------------------------------
Total investments . . . . . . . . . . . . . . $ 471.0 $ 467.0
Other assets . . . . . . . . . . . . . . . . 279.0 264.0
Insurance reserves . . . . . . . . . . . . . (424.0) (412.0)
Other liabilities . . . . . . . . . . . . . . (25.0) (25.0)
- -------------------------------------------------------------------------
Net assets of discontinued operations . . . . $ 301.0 $ 294.0
=========================================================================
12. Business Segments:
CNA's insurance products include property and casualty coverages; life,
accident and health insurance; and retirement products and annuities.
CNA's services include risk management, information services, health care
management and claims administration. CNA's products and services are
marketed through agents, brokers, managing general agents and direct
sales.
During the second quarter of 2002, Group Reinsurance, the business which
assumes reinsurance from unaffiliated entities on group life, accident and
health products as well as excess medical risk coverages for self-funded
employers, was transferred from Group Operations to the Other Insurance
segment to be included as part of run-off insurance operations. Also, CNA
Trust, a limited-operations bank specializing in 401(k) plan
administration, was transferred from Life Operations to Group Operations.
Segment disclosures of prior periods have been restated to conform to the
current period presentation.
The Other Insurance segment is comprised primarily of losses and
expenses related to the centralized adjusting and settlement of APMT
claims, certain run-off insurance operations and other operations. This
segment's results also include interest expense on CNA's corporate
borrowings, eBusiness initiatives and CNA UniSource.
Lorillard's principal products are marketed under the brand names of
Newport, Kent, True, Maverick and Old Gold with substantially all of its
sales in the United States.
Loews Hotels owns and/or operates 18 hotels, 16 of which are in the
United States and two are in Canada. There is also a property in the
United States under development with an opening date scheduled in 2004.
Diamond Offshore's business primarily consists of operating 45 offshore
drilling rigs that are chartered on a contract basis for fixed terms by
companies engaged in exploration and production of hydrocarbons. Offshore
rigs are mobile units that can be relocated based on market demand. As of
38
September 30, 2002, 28 of these rigs were located in the Gulf of Mexico, 5
were located in Brazil and the remaining 12 were located in various other
foreign markets.
Bulova distributes and sells watches and clocks under the brand names of
Bulova, Wittnauer, Caravelle and Accutron with substantially all of its
sales in the United States and Canada. All watches and clocks are
purchased from foreign suppliers.
Each of the Company's operating subsidiaries are headed by a chief
executive officer who is responsible for the operation of its business and
has the duties and authority commensurate with that position.
The accounting policies of the segments are the same as those described
in the summary of significant accounting policies in Note 1 of the Notes
to Consolidated Financial Statements in the Annual Report on Form 10-K for
the year ended December 31, 2001. In addition, CNA does not maintain a
distinct investment portfolio for each of its insurance segments, and
accordingly, allocation of assets to each segment is not performed.
Therefore, investment income and investment gains (losses) are allocated
based on each segment's carried insurance reserves, as adjusted.
The following tables set forth the Company's consolidated revenues and
income by business segment:
Three Months Ended Nine Months Ended
September 30, September 30,
-----------------------------------------------
2002 2001 2002 2001
-----------------------------------------------
Revenues (a):
CNA Financial:
Property and casualty . . . . . . . . $ 1,908.9 $ 1,691.1 $ 5,960.5 $ 5,027.6
Life . . . . . . . . . . . . . . . . 411.8 419.8 1,230.4 1,387.0
Group . . . . . . . . . . . . . . . . 356.8 968.6 2,178.9 2,696.6
Other Insurance . . . . . . . . . . . 113.5 46.1 186.7 291.1
- ------------------------------------------------------------------------------------------
Total CNA Financial . . . . . . . . . 2,791.0 3,125.6 9,556.5 9,402.3
Lorillard . . . . . . . . . . . . . . . 977.8 1,078.4 3,000.0 3,027.1
Loews Hotels . . . . . . . . . . . . . 70.4 71.1 229.6 247.1
Diamond Offshore . . . . . . . . . . . 180.4 244.1 572.3 707.8
Bulova . . . . . . . . . . . . . . . . 40.9 35.4 114.5 100.0
Corporate . . . . . . . . . . . . . . . 17.0 112.8 39.6 252.2
- -------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . . . . . . $ 4,077.5 $ 4,667.4 $13,512.5 $13,736.5
===========================================================================================
39
Three Months Ended Nine Months Ended
September 30, September 30,
-----------------------------------------------
2002 2001 2002 2001
-----------------------------------------------
Income (loss) before taxes, minority
interest, discontinued operations and
cumulative effect of changes in
accounting principles:
CNA Financial:
Property and casualty . . . . . . . . $ (30.0) $ (168.9) $ 202.3 $(1,286.1)
Life . . . . . . . . . . . . . . . . 32.6 14.2 82.5 257.8
Group . . . . . . . . . . . . . . . . 47.4 (16.1) 98.6 36.7
Other Insurance . . . . . . . . . . . 32.0 (64.6) (79.9) (1,302.6)
- -------------------------------------------------------------------------------------------
Total CNA Financial . . . . . . . . . 82.0 (235.4) 303.5 (2,294.2)
Lorillard . . . . . . . . . . . . . . . 345.5 376.8 955.9 781.2
Loews Hotels . . . . . . . . . . . . . (0.4) (0.4) 19.4 23.4
Diamond Offshore . . . . . . . . . . . 8.3 71.4 44.6 175.7
Bulova . . . . . . . . . . . . . . . . 4.5 2.7 12.1 10.3
Corporate . . . . . . . . . . . . . . . (24.9) 71.0 (96.0) 125.3
- -------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . . . . . . $ 415.0 $ 286.1 $ 1,239.5 $(1,178.3)
===========================================================================================
Net income (loss) (a):
CNA Financial:
Property and casualty . . . . . . . $ (14.2) $ (90.2) $ 127.0 $ (761.5)
Life . . . . . . . . . . . . . . . . 18.8 6.5 47.6 144.6
Group . . . . . . . . . . . . . . . 28.2 (9.3) 58.8 23.9
Other Insurance . . . . . . . . . . 18.9 (44.2) (44.2) (763.7)
- -------------------------------------------------------------------------------------------
Total CNA Financial .. . . . . . . . 51.7 (137.2) 189.2 (1,356.7)
Lorillard . . . . . . . . . . . . . . 207.0 229.9 577.6 474.4
Loews Hotels . . . . . . . . . . . . . (0.1) 0.1 12.6 15.2
Diamond Offshore . . . . . . . . . . 2.8 22.7 13.2 55.2
Bulova . . . . . . . . . . . . . . . . 2.3 1.5 6.5 5.7
Corporate . . . . . . . . . . . . . . (23.3) 44.1 (72.9) 75.6
- -------------------------------------------------------------------------------------------
Income from continuing operations . . 240.4 161.1 726.2 (730.6)
Discontinued operations-net . . . . . 4.6 (31.0) 6.7
Cumulative effect of changes in
accounting principles-net . . . . . . (39.6) (53.3)
- -------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . . . . . $ 240.4 $ 165.7 $ 655.6 $ (777.2)
===========================================================================================
40
(a) Investment gains (losses) included in Revenues and Net income (loss) are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
-----------------------------------------------
2002 2001 2002 2001
-----------------------------------------------
Revenues:
CNA Financial:
Property and casualty . . . . . . . $ (47.8) $ (22.7) $ (99.5) $ 590.6
Life . . . . . . . . . . . . . . . . (22.8) 11.4 (83.4) 153.5
Group . . . . . . . . . . . .. . . . 8.4 13.8 9.7 26.8
Other Insurance . . . . . . . . . . 86.1 (2.2) 35.8 167.2
- -------------------------------------------------------------------------------------------
Total CNA Financial . . . . . . . . . 23.9 0.3 (137.4) 938.1
Corporate and other . . . . . . . . . 2.6 71.9 (7.6) 125.7
- -------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . . . . . $ 26.5 $ 72.2 $(145.0) $ 1,063.8
===========================================================================================
Net income (loss):
CNA Financial:
Property and casualty . . . . . . . $ (27.1) $ (13.6) $ (55.4) $ 290.1
Life . . . . . . . . . . . . . . . . (13.2) 6.3 (47.9) 85.0
Group . . . . . . . . . . . . . . . 4.9 7.7 5.7 15.1
Other Insurance . . . . . . . . . . 50.2 (0.3) 20.7 88.5
- -------------------------------------------------------------------------------------------
Total CNA Financial . . . . . . . . . 14.8 0.1 (76.9) 478.7
Corporate and other . . . . . . . . . (5.7) 44.7 (16.1) 75.7
- -------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . . . . . $ 9.1 $ 44.8 $ (93.0) $ 554.4
===========================================================================================
13. Legal Proceedings and Contingent Liabilities:
INSURANCE RELATED
IGI Contingency
In 1997, CNA Reinsurance Company Limited ("CNA Re Ltd.") entered into an
arrangement with IOA Global, Ltd. ("IOA"), an independent managing general
agent based in Philadelphia, Pennsylvania, to develop and manage a book of
accident and health coverages. Pursuant to this arrangement, IGI
Underwriting Agencies, Ltd. ("IGI"), a personal accident reinsurance
managing general underwriter, was appointed to underwrite and market the
book under the supervision of IOA. Between April 1, 1997 and December 1,
1999, IGI underwrote a number of reinsurance arrangements with respect to
personal accident insurance worldwide (the "IGI Program"). Under various
arrangements, CNA Re Ltd. both assumed risks as a reinsurer and also ceded
a substantial portion of those risks to other companies, including other
CNA insurance subsidiaries and ultimately to a group of reinsurers
participating in a reinsurance pool known as the Associated Accident and
Health Reinsurance Underwriters ("AAHRU") Facility. CNA's Group Operations
business unit participated as a pool member in the AAHRU Facility in
varying percentages between 1997 and 1999.
CNA has determined that a portion of the premiums assumed under the IGI
Program related to United States workers compensation "carve-out"
business. Some of these premiums were received from John Hancock Financial
41
Services, Inc. ("John Hancock"). CNA is aware that a number of reinsurers
with workers compensation carve-out insurance exposure, including John
Hancock, have disavowed their obligations under various legal theories. If
one or more such companies are successful in avoiding or reducing their
liabilities, then it is likely that CNA's potential liability will also be
reduced. Moreover, based on information known at this time, CNA believes
it has strong grounds to successfully challenge its alleged exposure on a
substantial portion of its United States workers compensation carve-out
business, including all purported exposure derived from John Hancock,
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. However, certain reinsurers dispute their
liabilities to CNA, and CNA has commenced arbitration proceedings against
such reinsurers.
CNA has established reserves for its estimated exposure under the
program, other than that derived from John Hancock, and an estimate for
recoverables from retrocessionaires. CNA has not established any reserve
for any exposure derived from John Hancock because, as indicated, CNA
believes the contract will be rescinded.
CNA is pursuing a number of loss mitigation strategies with respect to
the entire IGI Program. Although the results of these various actions to
date support the recorded reserves, the estimate of ultimate losses is
subject to considerable uncertainty due to the complexities described
above. As a result of these uncertainties, the results of operations in
future years may be adversely affected by potentially significant reserve
additions. Management does not believe that any such reserve additions
will be material to the equity of the Company, although results of
operations may be adversely affected.
California Wage and Hour Litigation
In Ernestine Samora, et al. v. CCC, Case No. BC 242487, Superior Court
of California, County of Los Angeles, California and Brian Wenzel v.
Galway Insurance Company, Superior Court of California, County of Orange
No. BC01CC08868 (coordinated), two former CNA employees, filed lawsuits in
Los Angeles Superior Court on behalf of purported classes of CNA employees
asserting they worked hours for which they should have been compensated at
a rate of 1 1/2 times their base hourly wage over a four-year period. The
cases were coordinated and an amended complaint was filed which alleges
overtime claims under California law over a four year period. In June
2002, CNA filed a responsive pleading denying the material allegations of
the amended complaint. CNA intends to defend this case vigorously. Due to
the recent commencement of discovery and the uncertainty of California law
as applied to the facts of these cases, the extent of losses beyond any
amounts that may be accrued is not readily determinable at this time.
Based on facts and circumstances currently known, however, in the opinion
of management, the outcome will not materially affect the equity of the
Company, although results of operations may be adversely affected.
Voluntary Market Premium Litigation
CNA, along with dozens of other insurance companies, is a defendant in
sixteen purported class action cases brought by large policyholders, which
42
generally allege that the defendants, as part of an industry-wide
conspiracy, included improper charges in their retrospectively rated and
other loss-sensitive insurance premiums. Fourteen lawsuits were brought as
class actions in state courts and one in federal court. Among the claims
asserted were violations of state antitrust laws, breach of contract,
fraud and unjust enrichment. In two of the cases, the defendants won
dismissals on motions and, in three others, class certification was denied
after hearing. Plaintiffs voluntarily dismissed their claims in three
states. In the federal court case, Sandwich Chef of Texas, Inc., et al. v.
Reliance National Indemnity Insurance Company, et al., Civil Action No. H-
98-1484, United States District Court for the Southern District of Texas,
the district court certified a multi-state class. The U.S. Court of
Appeals for the Fifth Circuit granted leave for an interlocutory appeal.
Due to the uncertainty of how the courts may interpret state and federal
law as applied to the facts of the cases, the extent of potential losses
beyond any amounts that may be accrued is not readily determinable at this
time. Based on facts and circumstances presently known, however, in the
opinion of management, the outcome will not materially affect the equity
of the Company, although the results of operations may be adversely
affected.
Other
See Note 7 for information with respect to claims and litigation
involving CNA related to environmental pollution, asbestos and mass torts.
NON-INSURANCE
TOBACCO RELATED
Approximately 4,575 product liability cases are pending against
cigarette manufacturers in the United States; Lorillard is a defendant in
approximately 4,150 of these cases. Lawsuits continue to be filed against
Lorillard and other manufacturers of tobacco products. Some of the
lawsuits also name the Company as a defendant. Among the 4,575 product
liability cases are approximately 1,200 cases pending in a West Virginia
court. Another group of approximately 2,800 cases has been 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 and is a defendant in most of the cases pending in
West Virginia.
Excluding the flight attendant and West Virginia suits, approximately
575 product liability cases are pending against U.S. cigarette
manufacturers. Of these 575 cases, Lorillard is a defendant in
approximately 250 cases. The Company is a defendant in approximately 40 of
these actions, although it has not received service of process in
approximately 10 of them.
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 theories, theories of negligence, fraud,
misrepresentation, strict liability, breach of warranty, enterprise
liability (including claims asserted under the Racketeering Influenced and
Corrupt Organizations Act), civil conspiracy, intentional infliction of
harm, violation of consumer protection statutes, violation of antitrust
43
statutes, and failure to warn of the harmful and/or addictive nature of
tobacco products.
Some cases have been brought by individual plaintiffs who allege cancer
and/or other health effects resulting from an individual's use of
cigarettes and/or smokeless tobacco products, addiction to smoking or
exposure to environmental tobacco smoke. These cases are generally
referred to as "conventional product liability 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.
These cases are generally referred to as purported "class action cases."
In other cases, plaintiffs are U.S. and foreign governmental entities or
entities such as labor unions, private companies, hospitals or hospital
districts, American 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. These cases are generally referred to as "reimbursement cases."
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. These cases are generally referred to
as "claims for contribution."
In addition to the above, claims have been brought against Lorillard
seeking damages resulting from alleged exposure to asbestos fibers which
were incorporated into filter material used in one brand of cigarettes
manufactured by Lorillard for a limited period of time, ending more than
40 years ago. These cases are generally referred to as "filter cases."
Approximately 50 filter cases are pending against Lorillard. The number of
pending filter cases has approximately doubled during 2002. The Company is
a defendant in three of the pending filter cases.
Lorillard believes that it has valid defenses to the cases pending
against it. Lorillard also believes it has valid bases for appeal of the
adverse verdicts against it. To the extent the Company is a defendant in
any of the lawsuits described in this section, the Company believes that
it is not a proper defendant in these matters and has moved or plans to
move for dismissal of all such claims against it. Litigation is subject to
many uncertainties and it is possible that some of these actions could be
decided unfavorably. Lorillard will continue to maintain a vigorous
defense in all such litigation. Lorillard may enter into discussions in an
attempt to settle particular cases if it believes it is appropriate to do
so.
While Lorillard intends to defend vigorously all smoking and health
related litigation which may be brought against it, it is not possible to
predict the outcome of any of this litigation. Litigation is subject to
many uncertainties, and it is possible that some of these actions could be
decided unfavorably.
In addition, adverse developments in relation to smoking and health,
including the release in 1998 of industry documents, have received
widespread media attention. These developments may reflect adversely on
the tobacco industry and, together with adverse outcomes in pending cases,
could have adverse effects on the ability of Lorillard to prevail in
smoking and health litigation and could prompt the filing of additional
litigation.
Except for the impact of the State Settlement Agreements as described
below, Lorillard is unable to make a meaningful estimate of the amount or
44
range of loss that could result from an unfavorable outcome of pending
litigation. It is possible that the Company's results of operations or
cash flows in a particular quarterly or annual period or its financial
position could be materially affected by an unfavorable outcome of certain
pending litigation.
SIGNIFICANT RECENT DEVELOPMENTS
Conventional Product Liability Cases -
During October of 2002, the California Supreme Court remanded to the
California Court of Appeal the case of Henley v. Philip Morris
Incorporated, a matter in which a California jury awarded damages to a
smoker following a 1999 trial. The Supreme Court directed the Court of
Appeal to vacate its 2001 ruling in which it affirmed the judgment entered
in plaintiff's favor and directed that the Court of Appeal reconsider its
decision in light of the August 2002 order entered by the California
Supreme Court that is discussed below. In its 1999 verdict, the jury
awarded the plaintiff $1.5 in actual damages and $50.0 in punitive
damages, although the trial court reduced the punitive damages award to
$25.0. Neither the Company nor Lorillard is a defendant in this matter.
During September and October of 2002, a jury impaneled by the Superior
Court of California, Los Angeles County, returned verdicts in favor of the
plaintiff and awarded her $0.9 in actual damages and $28,000.0 in punitive
damages in the case of Bullock v. Philip Morris Incorporated. Neither the
Company nor Lorillard are defendants in this matter. The court denied
Philip Morris' motion to stay entry of the judgment based on the
nationwide punitive damages class action certified by the U.S. District
Court for the Eastern District of New York that is discussed below under
"Significant Recent Developments - Class Action Cases." Philip Morris, the
only defendant in the suit at trial, has filed a motion for new trial and
a motion for judgment notwithstanding the verdict. The court had not
issued a ruling as to these two motions as of November 6, 2002.
During September of 2002, a jury impaneled by the U.S. District Court
for the District of Puerto Rico returned a verdict in favor of the
plaintiffs and awarded them $1.0 in actual damages in the case of Figueroa
v. R.J. Reynolds Tobacco Company. Plaintiffs were not permitted to present
evidence as to punitive damages as such claims are not permitted in Puerto
Rico. Neither the Company nor Lorillard were defendants in this matter.
During October of 2002, the U.S. District Judge granted a motion for
judgment as a matter of law that was filed by the only defendant in the
suit, R.J. Reynolds, and entered a final judgment in favor of the
defendant. As of November 6, 2002, plaintiffs had not noticed an appeal
from the final judgment.
During August of 2002, the Florida Second District Court of Appeal
affirmed a ruling that granted the defendant's motion for new trial
following a jury's verdict in favor of the plaintiff in the case of Jones
v. R.J. Reynolds Tobacco Company. The court of appeal subsequently denied
plaintiff's petition for rehearing. Plaintiff has asked the Florida
Supreme Court to review these rulings, but the Supreme Court had not
granted review as of November 6, 2000. In a 2000 trial, a jury awarded the
plaintiff $0.2 in actual damages but declined to award punitive damages.
Neither the Company nor Lorillard are defendants in this suit.
During August of 2002, the California Supreme Court issued two rulings
in separate conventional product liability cases in which it addressed the
45
effect of an amendment to a statute in effect in the state between January
1, 1988, and December 31, 1997 (the "immunity period"). In one of its
rulings, the California Supreme Court held that the amendment conferred
immunity to cigarette manufacturers in product liability actions for
conduct engaged in during the immunity period, regardless of when a
plaintiff may have sustained or discovered an injury allegedly caused by
the cigarette manufacturers. In the second decision issued during August
of 2002, the California Supreme Court held that, within the immunity
period, immunity does not extend to allegations that the cigarette
manufacturers "used additives that exposed smokers to dangers beyond those
commonly known to be associated with cigarette smoking." The California
Supreme Court did not precisely define the term "additives," nor did it
expressly state how the phrase "dangers beyond those commonly known to be
associated with cigarette smoking" should be considered. The California
Supreme Court's rulings are expected to govern future litigation brought
against cigarette manufacturers in California.
During March of 2002, a jury impaneled by the Circuit Court of Multnomah
County, Oregon, returned a verdict in favor of the plaintiff in Schwarz v.
Philip Morris Incorporated. The jury awarded plaintiff approximately one
hundred nineteen thousand dollars in economic damages, fifty thousand
dollars in non-economic damages and $150.0 in punitive damages. Many of
plaintiff's claims were directed to allegations that the defendant had
made false representations regarding the low tar cigarettes smoked by the
decedent. The court granted in part the defendant's motion for elimination
or reduction of the punitive damages award and reduced the punitive
damages verdict to $100.0. The court denied the defendant's motion for new
trial and for judgment notwithstanding the verdict. Philip Morris has
noticed an appeal to the Oregon Court of Appeals. Neither the Company nor
Lorillard are defendants in this matter.
During March of 2002, a jury impaneled by the U.S. District Court for
the District of Rhode Island returned a verdict in favor of the only
defendant in Hyde v. Philip Morris Incorporated. The court denied
plaintiffs' motion for new trial. Plaintiffs did not notice an appeal from
the judgment in favor of Philip Morris Incorporated. Neither the Company
nor Lorillard were defendants in this matter.
During February of 2002, a jury impaneled by the U.S. District Court for
the District of Kansas returned a verdict in favor of the plaintiff in
Burton v. R.J. Reynolds Tobacco Company, et al. The jury awarded plaintiff
approximately $0.2 in actual damages and found that plaintiff had
presented evidence that entitled him to an award of punitive damages from
one of the two defendants in the case. Pursuant to Kansas law, the amount
plaintiff was awarded in punitive damages was set by the court. During
June of 2002, the court awarded plaintiff $15.0 in punitive damages from
R.J. Reynolds. R.J. Reynolds' post-trial motions were denied and it has
noticed an appeal to the U.S. Court of Appeals for the Tenth Circuit.
Neither the Company nor Lorillard are defendants in this matter.
Flight Attendant Cases -
As of November 6, 2002, verdicts had been returned during 2002 in three
flight attendant cases, all of which were tried in the Circuit Court of
Dade County, Florida. Defendants, including Lorillard, prevailed in two of
the matters, Janoff v. Philip Morris Incorporated, et al. and Tucker v.
Philip Morris Incorporated, et al. In the third case, French v. Philip
Morris Incorporated, et al., the jury found in favor of the plaintiff and
awarded her $5.5 in actual damages, but the trial court granted in part
46
defendants' motion for reduction or elimination of the verdict amount and
reduced the award to $0.5. Defendants have noticed an appeal and plaintiff
has filed a cross-appeal to the Florida Third District Court of Appeal.
Class Action Cases -
The Florida Third District Court of Appeal heard argument in defendants'
appeal in the case of Engle v. R.J. Reynolds Tobacco Company, et al. on
November 6, 2002, and took the appeal under advisement. Defendants' appeal
is from the final judgment that reflects the jury's verdicts in favor of
the plaintiffs, including its award of approximately $145.0 billion in
punitive damages.
During October of 2002, the Louisiana Supreme Court stayed trial until
it resolved two writ applications filed by the plaintiffs in the case of
Scott v. The American Tobacco Company, et al. In one of the two
applications, plaintiffs are seeking review of a ruling that reversed the
trial court's decision removing comparative fault from the case. In the
second writ application, the plaintiffs' writ is from a ruling by the
Louisiana Court of Appeals holding that individual issues, such as injury,
reliance, causation and defendants' affirmative defenses, could not be
tried on a class-wide basis. The Supreme Court heard argument of the two
petitions during October of 2002 and had not issued a ruling as of
November 6, 2002. The trial court impaneled a jury during September of
2002 but it had not begun hearing evidence as of November 6, 2002.
The Superior Court of California, San Diego County, issued rulings in
the case of Daniels v. Philip Morris Incorporated, et al. during September
and November of 2002 that granted defendants' motion for summary judgment
and denied plaintiffs' motion for relief from the summary judgment ruling.
As of November 6, 2002, the parties were negotiating the form of the final
judgment to be entered in favor of the defendants.
During September of 2002, a federal judge in the U.S. District Court for
the Eastern District of New York certified the case of In re Simon II as a
nationwide, non-opt out class action of punitive damages claims asserted
by U.S. residents alleging various specific injuries or medical conditions
allegedly caused by smoking cigarettes. Certain individuals were excluded
from the class, including those who allege membership in the class
certified in the case of Engle v. R.J. Reynolds Tobacco Company, et al.,
discussed above. The district judge denied defendants' motion to
reconsider the class certification ruling. Defendants have sought leave to
pursue an interlocutory appeal to the U.S. Court of Appeals for the Second
Circuit from the class certification order. As of November 6, 2002, the
Second Circuit Court of Appeals had not ruled as to whether it would grant
review of the defendants' petition. Trial of this matter has been
scheduled for January of 2003, although the district judge has stayed the
case. Lorillard is a defendant in this matter. The Company is not a named
defendant in plaintiffs' pending amended complaint.
Reimbursement Cases -
During July of 2002, the U.S. District Court for the Eastern District of
New York issued a ruling in a reimbursement suit filed by private
citizens, Mason v. The American Tobacco Company, Inc., et al., that denied
plaintiffs' motion for class certification on behalf of U.S. taxpayers and
granted defendants' motion to dismiss the case. Plaintiffs have noticed an
appeal to the U.S. Court of Appeals for the Second Circuit.
47
During February of 2002, the U.S. District Court for the Eastern
District of New York entered an order in the case of Blue Cross and Blue
Shield of New Jersey, et al. v. Philip Morris Incorporated, et al., a
health plan reimbursement case, that awarded plaintiffs' counsel
approximately $38.0 in attorneys' fees from the defendants, including
Lorillard. The award of attorneys' fees followed from a 2001 verdict in
favor of one of the plan plaintiffs that is asserting claims in the case,
Empire Blue Cross and Blue Shield. Defendants are pursuing a single appeal
from the judgment reflecting the verdict and from the order awarding
attorneys' fees.
Tobacco-Related Antitrust Cases -
During July of 2002, the U.S. District Court for the Northern District
of Georgia granted defendants' motion for summary judgment in a case
brought against Lorillard and other domestic and international cigarette
manufacturers by tobacco product wholesalers for violations of U.S.
antitrust laws. The decision entirely dismissed nine cases that were
consolidated for pre-trial purposes. The plaintiffs have filed a notice of
appeal in the U.S. Court of Appeals for the Eleventh Circuit.
During April of 2002, the U.S. District Court for the Middle District of
North Carolina granted a motion for class certification on behalf of
tobacco farmers in the case of DeLoach v. Philip Morris Inc., et al. The
class members contend that U.S. cigarette manufacturers conspired to set
the prices they offered to U.S. growers for tobacco. An estimated 500,000
farmers are members of the class. Defendants sought permission to appeal
the District Court's class certification decision to the Fourth Circuit
Court of Appeals, and in June of 2002 a three judge panel of that court
declined to accept the appeal. A motion for reconsideration by the full
court was also denied, and discovery is proceeding in the case.
SETTLEMENT OF STATE REIMBURSEMENT LITIGATION - On November 23, 1998,
Lorillard, Philip Morris Incorporated, Brown & Williamson Tobacco
Corporation and R.J. Reynolds Tobacco Company, the "Original Participating
Manufacturers," entered into a Master Settlement Agreement with 46 states,
the District of Columbia, the Commonwealth of Puerto Rico, Guam, the U.S.
Virgin Islands, American Samoa and the Commonwealth of the Northern
Mariana Islands to settle the asserted and unasserted health care cost
recovery and certain other claims of those states. These settling entities
are generally referred to as the "Settling States." The Original
Participating Manufacturers had previously settled similar claims brought
by Mississippi, Florida, Texas and Minnesota, which together with the
Master Settlement Agreement are generally referred to as the "State
Settlement Agreements."
The State Settlement Agreements provide that the agreements are not
admissions, concessions or evidence of any liability or wrongdoing on the
part of any party, and were entered into by the Original Participating
Manufacturers to avoid the further expense, inconvenience, burden and
uncertainty of litigation.
Lorillard recorded pretax charges of $255.2, $309.0, $842.9 and $890.3
million ($153.7, $188.2, $510.6 and $542.2 million after taxes), for the
quarter and nine months ended September 30, 2002 and 2001, respectively,
to accrue its obligations under various settlement agreements. Lorillard's
portion of ongoing adjusted payments and legal fees is based on its share
of domestic cigarette shipments in the year preceding that in which the
payment is due. Accordingly, Lorillard records its portions of ongoing
48
settlement payments as part of cost of manufactured products sold as the
related sales occur.
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: 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 2002 through 2003. These payment obligations are the several and
not joint obligations of each settling defendant.
The State Settlement Agreements also include provisions relating to
significant advertising and marketing restrictions, public disclosure of
certain industry documents, limitations on challenges to tobacco control
and underage use laws, and other provisions.
In addition, as part of the Master Settlement Agreement, the Original
Participating Manufacturers committed to work cooperatively with the
tobacco growing community to address concerns about the potential adverse
economic impact on that community. On January 21, 1999, the Original
Participating Manufacturers reached an agreement to establish a $5,200.0
trust fund payable between 1999 and 2010 to compensate the tobacco growing
communities in 14 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
paid more than its market share in 1999 but will have its payment
obligations reduced in 2009 and 2010 to make up for the overpayment. Of
the total $5,200.0, a total of $1,211.0 was paid since 1999 through
September 30, 2002, of which $113.0 was paid by Lorillard. Lorillard
believes its remaining payments under the agreement will total
approximately $402.0. All payments will be adjusted for inflation, changes
in the unit volume of domestic cigarette shipments, and the effect of new
increases in state or federal excise taxes on tobacco products that
benefit the tobacco 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 U.S. cigarette sales in the premium price and
discount price segments, Lorillard's share of the domestic premium price
and discount price cigarette segments, and the effect of any resulting
cost advantage of manufacturers not subject to significant payment
obligations under the State Settlement Agreements. Almost all domestic
manufacturers have agreed to become subject to the terms of the Master
Settlement Agreement, however, under the terms of the Master Settlement
Agreement, manufacturers other than the Original Participating
Manufacturers retain much of their cost advantage.
CONVENTIONAL PRODUCT LIABILITY CASES - Conventional product liability
cases are cases 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
cigarette or nicotine dependence or addiction. Plaintiffs in most
conventional product liability cases seek unspecified amounts in
compensatory damages and punitive damages. Lorillard is a defendant in
approximately 1,275 of these cases. This total includes approximately
1,100 cases pending in West Virginia that are part of a consolidated
49
proceeding. Additional cases are pending against other cigarette
manufacturers. The Company is a defendant in six of the cases filed by
individuals, although five of the cases have not been served on the
Company. The Company is not a defendant in any of the conventional product
liability cases pending in West Virginia.
Since January 1, 2000, 19 cases filed by individual plaintiffs have been
tried. Lorillard was a defendant in three of the 19 cases, and juries
returned verdicts in favor of the defendants in each of these three
matters. The Company was not a defendant in any of the 19 conventional
product liability cases tried since January 1, 2000. As of November 6,
2002, trial was proceeding in one matter brought by an individual. Neither
the Company nor Lorillard is a defendant in this matter.
Lorillard was not a defendant in 16 of the individual cases tried since
January 1, 2000. Juries have returned verdicts in favor of the defendants
in six of the cases. In another of the suits, a court granted the motion
for directed verdict filed by the defendant at the conclusion of
plaintiff's evidence. Juries have returned verdicts in favor of the
plaintiffs in nine cases since January 1, 2000. See "Significant Recent
Developments - Conventional Product Liability Cases" above for reports on
those cases tried to a verdict during 2002.
In addition to the case of Henley v. Philip Morris Incorporated that is
discussed in "Significant Recent Developments - Conventional Product
Liability Cases" above, an appeal is pending in one case in which an
adverse verdict was returned prior to January 1, 2000. In the case of
Williams v. Philip Morris Incorporated, the Oregon Court of Appeals issued
an order during June of 2002 that affirmed the jury's verdict in favor of
the plaintiff and reinstated the full amount of the $79.5 punitive damages
award. The Oregon Court of Appeals denied the defendant's petition for
rehearing. The defendant has noticed an appeal to the Oregon Supreme
Court. As of November 6, 2002, the Supreme Court had not ruled as to
whether it would grant review of the petition. Neither the Company nor
Lorillard is a defendant in this matter.
Some cases against U.S. cigarette manufacturers and manufacturers of
smokeless tobacco products are scheduled for trial during the remainder of
2002 and beyond. These trials include a consolidated trial of the cases
brought by approximately 1,200 West Virginia smokers or users of smokeless
tobacco products that is scheduled to begin during June of 2003. Lorillard
is a defendant in some of the cases set for trial, including the
consolidated West Virginia trial. The trial dates are subject to change.
FLIGHT ATTENDANT CASES - There are approximately 2,800 cases pending in
the Circuit Court of Dade County, Florida against Lorillard and three
other U.S. cigarette manufacturers in which the plaintiffs are present or
former flight attendants, or the estates of deceased flight attendants,
who allege injury as a result of exposure to environmental tobacco smoke
in aircraft cabins. The Company is not a defendant in any of the flight
attendant cases.
The suits were filed as a result of a settlement agreement on October
10, 1997 by the parties to Broin v. Philip Morris Companies, Inc., et al.
(Circuit Court, Dade County, Florida, filed October 31, 1991), a class
action brought on behalf of flight attendants claiming injury as a result
of exposure to environmental tobacco smoke. The trial court approved the
settlement agreement on February 3, 1998. Pursuant to the settlement
agreement, among other things, Lorillard and three other U.S. cigarette
50
manufacturers paid approximately $300.0 to create and endow a research
institute to study diseases associated with cigarette smoke. In addition,
the settlement agreement permitted the plaintiff class members to file
individual suits. These individuals may not seek punitive damages for
injuries that arose prior to January 15, 1997.
During October of 2000, the Circuit Court of Dade County, Florida
entered an order that may be construed to hold that the flight attendants
are not required to prove the substantive liability elements of their
claims for negligence, strict liability and breach of implied warranty in
order to recover damages. The court further ruled that the trials of these
suits are to address whether the plaintiffs' alleged injuries were caused
by their exposure to environmental tobacco smoke and, if so, the amount of
damages to be awarded. It is not clear how the trial judges will apply
this order. The Florida Third District Court of Appeal and the Florida
Supreme Court rejected defendants' attempts to appeal this ruling without
prejudice as premature. Defendants may seek redress of the October 2000
order in subsequent appeals, including their appeal from the 2002 verdict
in favor of the plaintiff in the cases of French v. Philip Morris
Incorporated, et al.
As of November 6, 2002, approximately 10 flight attendant cases were
scheduled for trial between January of 2003 and April of 2003. It is
possible that several of the flight attendant cases will be tried during
2003 and thereafter.
CLASS ACTION CASES - Certain cases have been filed against cigarette
manufacturers, including Lorillard, in which plaintiffs purport to seek
class certification on behalf of groups of cigarette smokers. Lorillard is
a defendant in approximately 30 of these cases, two of which also name the
Company as a defendant. As of November 6, 2002, three of the purported
class actions were on appeal. The remaining purported class actions are in
the pre-trial, discovery stage, except that trial proceedings are under
way in the case of Scott v. The American Tobacco Company, et al. Most of
the suits seek class certification on behalf of residents of the states in
which the purported class action cases have been filed, although some
suits seek class certification on behalf of residents of multiple states.
Plaintiffs in all but two of the purported class action cases seek class
certification on behalf of individuals who smoked cigarettes or were
exposed to environmental tobacco smoke. In one of the two remaining
purported class action cases, plaintiffs seek class certification on
behalf of individuals who paid insurance premiums. Plaintiffs in the other
remaining suit seek class certification on behalf of U.S. residents under
the age of 22 who purchased cigarettes as minors and who do not have
personal injury claims. Neither Lorillard nor the Company are defendants
in approximately 20 additional class action cases pending against other
cigarette manufacturers, many of which assert claims on behalf of smokers
of "light" cigarettes. Plaintiffs in a few of the reimbursement cases,
which are discussed below, also seek certification of such cases as class
actions.
Various courts have ruled on motions for class certification in smoking
and health-related cases. In 12 state court cases, which were pending in
five states and the District of Columbia, courts have denied plaintiffs'
class certification motions. In another 15 cases, cigarette manufacturers
have defeated motions for class certification before either federal trial
courts or courts of appeal from cases pending in 13 states and the
Commonwealth of Puerto Rico. The denial of class certification in a New
York federal court case, however, was due to the court's interest in
51
preserving judicial resources for a potentially broader class
certification ruling in In re Simon II Litigation. In seven cases in which
Lorillard is a defendant, plaintiffs' motions for class certification have
been granted and appeals either have been rejected at the interlocutory
stage, or, in one case, plaintiffs' claims were resolved through a
settlement agreement. These seven cases are Broin (which is the matter
concluded by a settlement agreement and discussed under "Flight Attendant
Cases"), Engle, Blankenship, Scott, Daniels, Brown and In re Simon II.
Theories of liability asserted in the purported class action cases
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 some of the purported class action cases are
represented by a well-funded and coordinated consortium of law firms from
throughout the United States.
The Engle case: Trial began during July 1998 in the case of Engle v.
R.J. Reynolds Tobacco Co., et al. (Circuit Court, Dade County, Florida,
filed May 5, 1994). The trial court, as amended by the Florida Court of
Appeal, granted class certification on behalf of Florida residents and
citizens, and survivors of such individuals, who have been injured or have
died from medical conditions allegedly caused by their addiction to
cigarettes containing nicotine.
The case is being tried in three phases. The first phase began during
July of 1998 and involved consideration of certain issues claimed to be
common to the members of the class and their asserted causes of action.
On July 7, 1999, the jury returned a verdict against defendants,
including Lorillard, at the conclusion of the first phase. The jury found,
among other things, that cigarette smoking is addictive and causes lung
cancer and a variety of other diseases, that the defendants concealed
information about the health risks of smoking, and that defendants'
conduct rose to a level that would permit a potential award or entitlement
to punitive damages. The verdict permitted the trial to proceed to a
second phase. The jury was not asked to award damages in the Phase One
verdict.
By order dated July 30, 1999 and supplemented on August 2, 1999,
together, the Punitive Damages Order, the trial judge amended the trial
plan with respect to the manner of determining punitive damages. The
Punitive Damages Order provided that the jury would determine punitive
damages, if any, on a lump-sum dollar amount basis for the entire
qualified class. The Florida Third District Court of Appeal rejected as
premature defendants' appeals from the Punitive Damages Order, and the
Florida Supreme Court declined to review the Punitive Damages Order at
that 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.
52
On April 7, 2000, the jury found in favor of the three plaintiffs and
awarded them a total of $12.5 in economic damages, pain and suffering
damages and damages for loss of consortium. After awarding damages to one
of the three plaintiffs, the jury appeared to find that his claims were
barred by the statute of limitations. The final judgment entered by the
trial court on November 6, 2000 reflected the damages award, and held that
only a portion of this plaintiff's claims were barred by the statute of
limitations.
The second part of Phase Two of the trial began on May 22, 2000 and was
heard by the same jury that heard the trial's prior phases and considered
evidence as to the punitive damages to be awarded to the class. On July
14, 2000, the jury awarded approximately $145,000.0 in punitive damages
against all defendants, including $16,250.0 against Lorillard.
On November 6, 2000, the Circuit Court of Dade County, Florida, entered
a final judgment in favor of the plaintiffs. The judgment also provides
that the jury's awards bear interest at the rate of 10% per year. The
court's final judgment 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 final
judgment to the Florida Third District Court of Appeal and has posted its
appellate bond in the amount of $100.0 pursuant to Florida legislation
enacted in May of 2000 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. While Lorillard believes this legislation is
valid and that any challenges to the possible application or
constitutionality of this legislation would fail, during May of 2001,
Lorillard and two other defendants jointly contributed a total of $709.0
to a fund (held for the benefit of the Engle plaintiffs) that will not be
recoverable by them even if challenges to the judgment are resolved in
favor of the defendants. As a result, the class has agreed to a stay of
execution, referred to as the Engle agreement, on its punitive damages
judgment until appellate review is completed, including any review by the
U.S. Supreme Court. Lorillard contributed a total of $200.0 to this fund,
which included the $100.0 that was posted as collateral for its appellate
bond. Accordingly, Lorillard recorded a pretax charge of $200.0 in the
second quarter of the year ended December 31, 2001.
In the event that Lorillard, Inc.'s balance sheet net worth falls below
$921.2 (as determined in accordance with generally accepted accounting
principles in effect as of July 14, 2000), the stay granted in favor of
Lorillard in the Engle agreement would terminate and the class would be
free to challenge the Florida legislation. As of September 30, 2002,
Lorillard, Inc. had a balance sheet net worth of approximately $1,434.2.
In addition, the Engle agreement requires Lorillard to obtain the
written consent of class counsel or the court prior to selling any
trademark of or formula comprising a cigarette brand having a U.S. market
share of 0.5% or more during the preceding calendar year. The Engle
agreement also requires Lorillard to obtain the written consent of the
Engle class counsel or the court to license to a third party the right to
manufacture or sell such a cigarette brand unless the cigarettes to be
manufactured under the license will be sold by Lorillard.
Now that the jury has awarded punitive damages and final judgment has
been entered, Lorillard believes that it is unclear how the Punitive
Damages Order will be implemented. The Punitive Damages Order provides
that the lump-sum punitive damages amount, if any, will be allocated
53
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 damages amount, if any, determined for the entire qualified
class, would be divided equally among those plaintiffs who are ultimately
successful. The Punitive Damages Order does not address whether defendants
would be required to pay the punitive damages 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 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 is a defendant in eight separate lawsuits that are pending in
the Florida courts in which the plaintiffs claim that they are members of
the Engle class, that all liability issues associated with their claims
were resolved in the earlier phases of the Engle proceedings, and that
trials on their claims should proceed immediately. Lorillard is opposing
trials of these actions on the grounds that they should be considered
during Phase Three of the Engle case and should be stayed while the Engle
appeal is proceeding. Trial has been held in one of the cases in which
Lorillard was not a party. During June of 2002, a jury in the Circuit
Court of Dade County, Florida returned a verdict in favor of the
plaintiffs and awarded them $0.5 in economic damages, $24.5 in noneconomic
damages and $12.5 in damages for loss of consortium. No post-trial motions
are scheduled to be filed as a final judgment reflecting the verdict will
not be entered until the Engle appeal is resolved.
Lorillard remains of the view that the Engle case should not have been
certified as a class action. Lorillard believes that class certification
in the Engle case is inconsistent with the majority of federal and state
court decisions which have held that mass smoking and health claims are
inappropriate for class treatment. Lorillard has challenged the class
certification, as well as numerous other legal errors that it believes
occurred during the trial. The Florida Third District Court of Appeal
heard argument in defendants' appeal on November 6, 2002. The Court of
Appeal took the appeal under advisement and it is not known when a ruling
will be issued. Lorillard believes that an appeal of these issues on the
merits should prevail.
Other Class Action Cases - On November 14, 2001, a jury in the Circuit
Court of Ohio County, West Virginia returned a verdict in favor of the
defendants, including Lorillard, in the case of Blankenship v. American
Tobacco Company, et al. (Circuit Court, Ohio County, West Virginia, filed
January 31, 1997). The court denied plaintiffs' motion for new trial.
Plaintiff has noticed an appeal to the Supreme Court of Appeals of West
Virginia. During 2000, the court granted plaintiffs' motion for class
certification. The court ruled that the class consisted of West Virginia
residents who were cigarette smokers on or after January 31, 1995; who had
a minimum of a five pack-year smoking history as of December 4, 2000; who
had not been diagnosed with certain medical conditions; and who had not
received health care funded by the State of West Virginia. The West
Virginia Supreme Court of Appeals declined to review defendants' petition
for a writ of prohibition against the class certification ruling.
Plaintiffs sought the creation of a fund, the purpose of which would be to
pay for class members to receive medical monitoring for chronic
54
obstructive pulmonary disease, emphysema and lung cancer. Lorillard is a
defendant in the case.
In the case of Scott v. The American Tobacco Company, et al. (District
Court, Orleans Parish, Louisiana, filed May 24, 1996), the trial court
certified a class comprised of residents of the State of Louisiana who
desire to participate in medical monitoring or smoking cessation programs
and who began smoking prior to September 1, 1988, or who began smoking
prior to May 24, 1996 and allege that defendants undermined compliance
with the warnings on cigarette packages. Lorillard is a defendant in the
case. Also see "Significant Recent Developments - Class Action Cases"
above.
During December of 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. Also see
"Significant Recent Developments - Class Action Cases" above. Lorillard is
a defendant in the case.
During April of 2001, the Superior Court of San Diego County, California
in the case of Brown v. The American Tobacco Company, Inc., et al.,
granted in part plaintiff's motion for class certification and certified a
class comprised of adult residents of California who smoked at least one
of defendants' cigarettes during the applicable time period and who were
exposed to defendants' marketing and advertising activities in California.
Certification was granted as to plaintiff's claims that defendants
violated California Business and Professions Code sections 17200 and
17500. The court subsequently defined the applicable class period for
plaintiff's claims, pursuant to a stipulation submitted by the parties, as
June 10, 1993 through April 23, 2001. Trial is scheduled to begin during
March of 2003. Lorillard is a defendant in the case.
During September of 2002, the U.S. District Court for the Eastern
District of New York entered an order in the case of In re Simon II that
certified a nationwide non-opt out class comprised of the punitive damages
claims asserted by individuals who allege certain injuries or medical
conditions allegedly caused by smoking. Also see "Significant Recent
Developments - Class Action Cases" above.
REIMBURSEMENT CASES - In addition to the cases settled by the State
Settlement Agreements described above, approximately 45 other suits are
pending, comprised of cases brought by the U.S. federal government, county
governments, city governments, unions, American Indian tribes, hospitals
or hospital districts, private companies and foreign governments filing
suit in U.S. courts, in which plaintiffs seek recovery of funds allegedly
expended by them to provide health care to individuals with injuries or
other health effects allegedly caused by use of tobacco products or
exposure to cigarette smoke. These cases are based on, among other things,
equitable claims, including injunctive relief, indemnity, restitution,
unjust enrichment and public nuisance, and claims based on antitrust laws
and state consumer protection acts. Plaintiffs in some of these actions
seek certification as class actions. 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 some of the cases seek medical monitoring. Lorillard is named as a
defendant in all of the reimbursement cases except for a few of those
filed in U.S. courts by foreign governments. The Company is named as a
55
defendant in approximately 25 of the pending reimbursement cases, although
it has not received service of three of these matters.
U.S. Federal Government Action - The U.S. federal government filed a
reimbursement suit on September 22, 1999 in the U.S. District Court for
the District of Columbia against Lorillard, other U.S. cigarette
manufacturers, some parent companies and two trade associations. The
Company is not a defendant in this action. Plaintiff asserted claims under
the Medical Care Recovery Act, the Medicare as 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 several 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 other 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 of 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 the Medicare as Secondary Payer provisions of the Social
Security Act. The court denied the motion as to plaintiff's claims under
the Racketeering Influenced and Corrupt Organizations Act. Plaintiff
sought modification of the trial court's order as it related to the
dismissal of the Medical Care Recovery Act claim. In an amended complaint
filed during February of 2001, plaintiff attempted to replead the Medicare
as Secondary Payer claim. In a July 2001 decision, the court reaffirmed
its dismissal of the Medical Care Recovery Act claims. The court also
dismissed plaintiff's reasserted claims under the Medicare as Secondary
Payer Act. The court has denied a motion for intervention and a proposed
complaint in intervention filed by the Cherokee Nation Tribe on behalf of
a purported nationwide class of American Indian tribes. Trial in this
matter is schedule to begin during September of 2004.
In June of 2001, the government invited defendants in the lawsuit,
including Lorillard, to meet to discuss the possibility of a settlement of
the government's case. Lorillard participated in one such meeting and no
further meetings are scheduled.
Reimbursement Cases filed by Foreign Governments in U.S. Courts - Cases
have been brought in U.S. courts by 13 nations, 11 Brazilian states, 11
Brazilian cities and one Canadian province. Both the Company and Lorillard
are named as defendants in most of the cases. The Company has not received
service of process of the cases filed by one of the nations and by one of
the Brazilian states. Four of the cases have been voluntarily dismissed.
During 2001, a federal court of appeal affirmed orders dismissing three of
the cases, and the U.S. Supreme Court denied plaintiffs' petitions for
writ of certiorari. During 2001, a Florida court dismissed two of the
suits, and the plaintiff in one of the two actions has noticed an appeal.
During 2002, the appellate court affirmed the dismissal order. During
November 2002, a Texas court dismissed one of the cases filed by a
Brazilian state. In addition, Lorillard and the Company were dismissed
from three suits that remain pending against other defendants.
In 1977, Lorillard sold substantially all of its cigarette trademarks
outside of the United States and the international business associated
56
with those brands. Performance by Lorillard of obligations under the 1977
agreement reflecting the sale was guaranteed by the Company. Lorillard and
the Company have received notice from Brown & Williamson Tobacco
Corporation, which claims to be a successor to the purchaser, that
indemnity will be sought under certain indemnification provisions of the
1977 agreement with respect to suits brought by various of the foregoing
foreign jurisdictions, and in certain cases brought in foreign countries
by individuals concerning periods prior to June 1977 and during portions
of 1978.
Reimbursement Cases by American Indian Tribes - American Indian tribes are
the plaintiffs in three pending reimbursement suits. Each of the 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. The three cases are in the pre-trial discovery stage.
Reimbursement Cases by Private Companies and Health Plans or Hospitals and
Hospital Districts - Two cases are pending against cigarette manufacturers
in which the plaintiffs are not-for-profit insurance companies. Lorillard
is a defendant in both pending cases. The Company is not a defendant in
either matter. In addition, three cases are pending in which plaintiffs
are hospitals or hospital districts. Lorillard is named as a defendant in
each of the cases. The Company is not named as a defendant in any of the
cases filed by hospitals or hospital districts. In one additional suit, a
city governmental entity and several hospitals or hospital districts are
plaintiffs. The Company is a defendant in this case.
On June 4, 2001, the jury in the U.S. District Court for the Eastern
District of New York in the case of Blue Cross and Blue Shield of New
Jersey, Inc., et al. v. Philip Morris, Incorporated, et al., returned a
verdict awarding damages against the defendants, including Lorillard. In
this trial, the jury heard evidence as to the claims of only one of the
plan plaintiffs, Empire Blue Cross and Blue Shield, referred to as
"Empire." In its June 4, 2001 verdict, the jury found in favor of the
defendants on some of Empire's claims. One of the jury's findings
precluded it from considering Empire's claims for punitive damages. The
jury found in favor of Empire on certain other of plaintiff's claims. As a
result of these findings, Empire is entitled to an award of approximately
$17.8 in total actual damages, including approximately $1.5 attributable
to Lorillard. The court denied plaintiff's post-verdict application for
trebling of the damages awarded by the jury. On November 1, 2001, the
court entered a final judgment that reflects the jury's verdict. In the
final judgment, Empire was awarded approximately $1.5 in actual damages
and approximately fifty-five thousand dollars in pre-judgment interest for
a total award against Lorillard of approximately $1.6. The court has
awarded plaintiff's counsel approximately $38.0 in attorneys' fees. The
defendants, including Lorillard, have noticed an appeal to the U.S. Court
of Appeals for the Second Circuit from the final judgment and from the
order awarding plaintiff's counsel attorneys' fees.
In addition to the above, the District Court of Jerusalem, Israel, has
permitted a private insurer in Israel, Clalit Health Services, to attempt
service on the Company and Lorillard with a suit in which Clalit Health
Services seeks damages for providing treatment to individuals allegedly
injured by cigarette smoking. The Company and Lorillard have separately
moved to set aside the order that permitted plaintiff to attempt service
of the summonses. As of November 6, 2002, the court had not ruled on the
motions to set aside the service.
57
Reimbursement Cases by Labor Unions - One case is pending in which the
plaintiffs are the trust funds of several labor unions. The Company is not
a defendant in this action. Approximately 75 union cases have been
dismissed in recent years. Some of these cases were dismissed voluntarily,
while others were dismissed as a result of defendants' motions. Appeals
were sought from some of these dismissal rulings and defendants have
prevailed in each of these appeals. The Second, Third, Fifth, Seventh,
Eighth, Ninth and Eleventh Circuit Courts of Appeal have found in favor of
the defendants in each of the appeals from dismissal orders entered by the
federal trial courts that were submitted to them, and the U.S. Supreme
Court has denied petitions for writ of certiorari that sought review of
some of these decisions. In addition, the Circuit Court of Appeals for the
District of Columbia entered a ruling in 2001 that found in favor of the
defendants on an appeal they filed from a ruling by a trial court that
refused to dismiss four union cases. During 2001, an intermediate
California court of appeal affirmed the final judgment entered in favor of
the defendants in a union case, and the California Supreme Court has
accepted plaintiffs' appeal. Several cases pending in state courts also
have been dismissed.
CONTRIBUTION CLAIMS - In addition to the foregoing cases, approximately
ten cases are pending in which private companies seek recovery of funds
expended by them to individuals whose asbestos disease or illness was
alleged to have been caused in whole or in part by smoking-related
illnesses. Lorillard is named as a defendant in each action, although it
has not received service of process in one of the cases. The Company is
named as a defendant in two of the cases but has not received service of
process in one of them.
FILTER CASES - A number of cases have been filed against Lorillard seeking
damages for cancer and other health effects claimed to have resulted from
exposure to asbestos fibers which were incorporated, for a limited period
of time, ending more than 40 years ago, into the filter material used in
one of the brands of cigarettes manufactured by Lorillard. Approximately
50 filter cases are pending in federal and state courts against Lorillard.
The Company is a defendant in three of the pending filter cases. The
number of pending filter cases has approximately doubled during 2002.
Allegations of liability include negligence, strict liability, fraud,
misrepresentation and breach of warranty. Plaintiffs in most of these
cases seek unspecified amounts in compensatory and punitive damages.
Trials have been held in 15 such cases, including three since January 1,
2000. Juries have returned verdicts in favor of Lorillard in 11 of the 15
trials. Four verdicts have been returned in plaintiffs' favor. In a 1995
trial, a California jury awarded plaintiffs approximately $1.2 in actual
damages and approximately $0.7 in punitive damages. In a 1996 trial,
another California jury awarded plaintiff approximately $0.1 in actual
damages. In a 1999 trial, a Maryland jury awarded plaintiff approximately
$2.2 in actual damages. In a 2000 trial, a California jury awarded
plaintiffs $1.1 in actual damages and the case was settled prior to a
determination of punitive damages.
TOBACCO-RELATED ANTITRUST CASES - Wholesalers and Direct Purchaser Suits -
Lorillard and other domestic and international cigarette manufacturers and
their parent companies, including the Company, were named as defendants in
nine separate federal court actions brought by tobacco product wholesalers
for violations of U.S. antitrust laws and international law. The
complaints allege that defendants conspired to fix the price of cigarettes
to wholesalers since 1993 in violation of the Sherman Act. These actions
seek certification of a class including all domestic and international
58
wholesalers similarly affected by such alleged conduct, and damages,
injunctive relief and attorneys' fees. These actions were consolidated for
pre-trial purposes in the U.S. District Court for the Northern District of
Georgia. The Court has granted class certification for a four-year class
(beginning in 1996 and ending in 2000) of domestic direct purchasers. The
Company has been voluntarily dismissed without prejudice from all direct
purchaser cases. On July 11, 2002, the Court granted motions for summary
judgment filed by Lorillard and all other defendants dismissing the
actions in their entirety. Plaintiffs have filed a notice of appeal in the
U.S. Court of Appeals for the Eleventh Circuit.
Indirect Purchaser Suits - 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 all but one of these indirect purchaser
cases. One indirect purchaser suit, in New York, has been dismissed in its
entirety. The Arizona indirect purchaser suit was dismissed by the trial
court, but the dismissal was reversed on appeal in May 2002. While one
court has granted plaintiff's motion to certify a class of consumers, two
other courts have refused to do so, and other motions seeking class
certification have been deferred by other courts pending resolution of the
federal case discussed above. In Kansas, a Motion to Compel against
Lorillard (and one other defendant) seeking certain documents for which
Lorillard has claimed privilege is pending before the court. 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.
Tobacco Growers Suit - DeLoach v. Philip Morris Inc., et al. (U.S.
District Court, Middle District of North Carolina, filed February 16,
2000). Lorillard is named as a defendant in a lawsuit that, after several
amendments, alleges only antitrust violations. The other major domestic
tobacco companies are also presently named as defendants, and the
plaintiffs have now added the major leaf buyers as defendants. This case
was originally filed in U.S. District Court, District of Columbia, and
transferred to a North Carolina federal court upon motion by the
defendants. The plaintiffs' claims relate to the conduct of the companies
in the purchase of tobacco through the auction system under the federal
program. The suit seeks an unspecified amount of actual damages, trebled
under the antitrust laws, and injunctive relief. On April 3, 2002 the
court certified a class consisting of all persons holding a quota (the
licenses that a farmer must either own or rent to sell the crop) to grow,
and all domestic producers who sold, flue-cured or burley tobacco at
anytime from February 1996 to present. Defendants' petition to the United
States Court of Appeals for the Fourth Circuit seeking permission to
appeal the District Court's decision on class certification was denied on
June 12, 2002. Pre-trial discovery has commenced and is currently
scheduled to be completed on or before July 1, 2003. A trial date has not
yet been scheduled.
REPARATION CASES - During 2002, the Company has been named as a defendant
in three cases in which plaintiffs seek reparations for the alleged
financial benefits derived from the uncompensated use of slave labor. The
Company was named as a defendant in these matters as a result of conduct
purportedly engaged in by Lorillard and its predecessor corporations.
Plaintiffs in these suits seek various types of damages including
disgorgement of profits, restitution and punitive damages. Plaintiffs seek
class certification on behalf of the descendants of enslaved African
Americans. An attempt to serve the Company has been made in one of these
59
matters. During October of 2002, an order was entered by the Judicial
Panel on Multidistrict Litigation that transferred certain reparations
matters to the U.S. District Court for the Northern District of Illinois
for coordinated and consolidated pretrial proceedings. The Company is not
a party to these matters, although the Judicial Panel, in its October 2002
order, advised that the cases in which the Company has been named as a
defendant may be treated as potential tag-along actions in the
Multidistrict Litigation proceeding.
* * * *
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.
Contingencies
CNA has a commitment to purchase a $100.0 floating rate note issued by
the California Earthquake Authority in the event California earthquake-
related insurance losses exceed $4,900.0 prior to December 31, 2002.
As of September 30, 2002, the Company and its subsidiaries are obligated
to make future payments totaling $605.0 for non-cancelable operating
leases expiring from 2002 through 2014 primarily for office space and data
processing, office and transportation equipment. Estimated future minimum
payments under these contracts are as follows: $30.1 in 2002; $103.4 in
2003; $84.1 in 2004; $75.2 in 2005; and $312.2 in 2006 and beyond.
14. In the opinion of Management, the accompanying consolidated condensed
financial statements reflect all adjustments (consisting of only normal
recurring accruals) necessary to present fairly the financial position as
of September 30, 2002 and December 31, 2001 and the statements of
operations for the three and nine months and changes in cash flows for the
nine months ended September 30, 2002 and 2001.
Results of operations for the quarter and the first nine months of each
of the years is not necessarily indicative of results of operations for
that entire year.
60
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
---------------------------------------------------------------------
OVERVIEW
Three Months Ended September 30, 2002 compared with 2001
The Company reported consolidated net income (including both the Loews Group
and Carolina Group) for the 2002 third quarter of $240.4 million, compared to
$165.7 million in 2001.
Consolidated net operating income, which excludes net investment gains and
discontinued operations, for the quarter ended September 30, 2002 was $231.3
million, compared to $116.3 million in the third quarter of 2001.
Net operating income is calculated by deducting net investment gains or
losses, discontinued operations and the cumulative effect of a change in
accounting principle (after deduction of related income taxes and minority
interests), from net income (loss). Analysts following the Company's stock
have advised the Company that such information is meaningful in assisting them
in measuring the performance of its insurance subsidiaries. In addition, it is
used in management's discussion of the results of operations for the insurance
related segments due to the significance of the amount of net investment gains
or losses. Net operating income is also a common measure throughout the
insurance industry. Net realized investment gains are excluded from this
operating measure because investment gains or losses related to CNA's
available-for-sale investment portfolio are largely discretionary, are
generally driven by economic factors that are not necessarily consistent with
key drivers of underwriting performance, and are therefore not an indication
of trends in operations.
Net income attributable to Loews Common Stock for the third quarter of 2002
amounted to $196.0 million or $1.06 per share, compared to $165.7 million or
$0.85 per share in the comparable period of the prior year. Net income in the
third quarter of 2002 includes net investment gains attributable to Loews
Common Stock of $5.8 million or $0.03 per share, compared to $44.8 million or
$0.23 per share in the comparable period of the prior year.
Net operating income attributable to Loews Common Stock, which excludes net
investment gains and discontinued operations, for the quarter ended September
30, 2002, was $190.2 million or $1.03 per share, compared to $116.3 million or
$0.60 per share in the comparable period of the prior year. Net income
attributable to Carolina Group Stock for the 2002 third quarter amounted to
$44.4 million or $1.10 per Carolina Group share.
Net income and net income attributable to Loews Common Stock for the third
quarter of 2001 included losses at CNA of $264.6 million, after taxes and
minority interest, related to the September 11, 2001 World Trade Center
disaster and related events ("WTC event").
Nine Months Ended September 30, 2002 compared with 2001
For the nine months ended September 30, 2002 consolidated net income
(including both the Loews Group and Carolina Group) amounted to $655.6
million, compared to a net loss of $777.2 million in the comparable period of
the prior year.
61
The first nine months of 2002 included a loss for discontinued operations at
CNA of $31.0 million or $0.16 per share of Loews Common Stock, compared to
income from discontinued operations of $6.7 million or $0.03 per share of
Loews Common Stock in the comparable period of the prior year. The first nine
months of 2002 also included a charge for accounting changes of $39.6 million
or $0.21 per share of Loews Common Stock, related to accounting for goodwill
and other intangible assets, compared to a charge of $53.3 million or $0.27
per share of Loews Common Stock in the comparable period of the prior year,
related to accounting for derivative instruments at CNA.
Consolidated net operating income, which excludes net investment gains
(losses), discontinued operations and accounting changes, was $819.2 million
in the first nine months of 2002, compared to a loss of $1,285.0 million in
the comparable period of the prior year.
Net operating income attributable to Loews Common Stock, which excludes net
investment (losses) gains, discontinued operations and accounting changes, for
the first nine months of 2002, was $720.2 million or $3.82 per share, compared
to a loss of $1,285.0 million or $6.54 per share in the comparable period of
the prior year.
The net loss and net loss attributable to Loews Common Stock for the nine
months ended September 30, 2001 included a $1.8 billion charge at CNA, after
taxes and minority interest, related to a change in estimate of prior year net
loss and allocated loss adjustment expense reserves and retrospective premium
accruals, the WTC event charge of $264.6 million discussed above, and a $121.0
million after tax charge at Lorillard related to an agreement with the class
in the Engle case.
Net income attributable to Carolina Group Stock for the first nine months of
2002 amounted to $103.8 million or $2.58 per Carolina Group share.
At September 30, 2002, the book value per share of Loews Common Stock was
$61.09, compared to $50.39 at December 31, 2001. The increase in book value
per share of Loews Common Stock is primarily due to proceeds from the issuance
of the Carolina Group Stock in February 2002 and the Loews Group's net
economic interest in the notional intergroup debt receivable from the Carolina
Group.
Classes of Common Stock
The issuance of Carolina Group Stock has resulted in a two class common
stock structure for Loews Corporation. Carolina Group Stock, commonly called a
tracking stock, is intended to reflect the economic performance of a defined
group of assets and liabilities of the Company referred to as the Carolina
Group. The principal assets and liabilities attributed to the Carolina Group
are (a) the Company's 100% stock ownership interest in Lorillard, Inc.; (b)
$2.5 billion of notional, intergroup debt owed by the Carolina Group to the
Loews Group, bearing interest at the annual rate of 8.0% and, subject to
optional prepayment, due December 31, 2021; and (c) any and all liabilities,
costs and expenses arising out of or related to tobacco or tobacco-related
businesses.
As of September 30, 2002, the outstanding Carolina Group Stock represents a
23.01% economic interest in the economic performance of the Carolina Group.
The Loews Group, reflecting the earnings attributable to Loews Common Stock,
consists of all the Company's assets and liabilities other than the 23.01%
economic interest represented by the outstanding Carolina Group Stock, and
includes as an asset the notional, intergroup debt of the Carolina Group.
62
The existence of separate classes of common stock could give rise to
occasions where the interests of the holders of Loews Common Stock and
Carolina Group Stock diverge or conflict or appear to diverge or conflict.
Subject to its fiduciary duties, the Company's board of directors could, in
its sole discretion, from time to time, make determinations or implement
policies that affect disproportionately the groups or the different classes of
stock. For example, Loews's board of directors may decide to reallocate
assets, liabilities, revenue, expenses and cash flows between groups, without
the consent of shareholders. The board of directors would not be required to
select the option that would result in the highest value for holders of
Carolina Group Stock.
As a result of the flexibility provided to Loews's board of directors, it
might be difficult for investors to assess the future prospects of the
Carolina Group based on the Carolina Group's past performance.
The creation of the Carolina Group and the issuance of Carolina Group Stock
does not change the Company's ownership of Lorillard, Inc. or Lorillard,
Inc.'s status as a separate legal entity. The Carolina Group and the Loews
Group are notional groups that are intended to reflect the performance of the
defined sets of assets and liabilities of each such group as described above.
The Carolina Group and the Loews Group are not separate legal entities and the
attribution of assets and liabilities to the Loews Group or the Carolina Group
does not affect title to the assets or responsibility for the liabilities.
Holders of the Company's common stock and of Carolina Group stock are
shareholders of Loews Corporation and are subject to the risks related to an
equity investment in Loews Corporation.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
CNA Financial
- -------------
Insurance operations are conducted by subsidiaries of CNA Financial
Corporation ("CNA"). CNA is a 90% owned subsidiary of the Company.
CNA conducts its operations through five operating groups: Standard Lines,
Specialty Lines and CNA Re (these groups comprise the Company's Property-
Casualty segment); Group Operations and Life Operations. In addition to these
five operating segments, certain other activities are reported in the Other
Insurance segment. The Other Insurance segment consists of royalty and
administrative service activities related to the personal insurance business
that was sold to The Allstate Corporation in 1999, losses and expenses related
to centralized adjusting and settlement of asbestos, pollution and mass tort
claims, certain insurance operations that are operating in run-off and not
conducting new underwriting, interest expense on corporate debt, e-Business
initiatives, and intercompany eliminations. These segments reflect the way CNA
manages its operations and makes business decisions.
During the second quarter of 2002, Group Reinsurance, the business which
assumes reinsurance from unaffiliated entities on group life, accident and
health products as well as excess medical risk coverages for self-funded
employers, was transferred from Group Operations to the Other Insurance
segment to be included as part of run-off insurance operations. Also, CNA
Trust, a limited-operations bank specializing in 401(k) plan administration,
was transferred from Life Operations to Group Operations. Segment disclosures
63
of prior periods have been modified to conform with the current period
presentation.
The consolidated operations for the three and nine months ended September
30, 2001 were significantly impacted by the second quarter 2001 prior year
reserve strengthening, WTC event, corporate aggregate reinsurance treaties,
and restructuring and other related charges. A discussion of these items,
along with CNA's current terrorism exposure and description of reserves is
presented before the results of operations by business segment.
WTC Event
During the third quarter of 2001, CNA experienced a severe catastrophe loss
estimated at $468.0 million pretax, net of reinsurance, related to the WTC
event. The loss estimate is based on a total industry loss of $50.0 billion
and includes all lines of insurance. The estimate takes into account CNA's
substantial reinsurance agreements, including its catastrophe reinsurance
program and corporate reinsurance programs. CNA has closely monitored reported
losses as well as the collection of reinsurance on WTC event claims. Based on
experience to-date, CNA believes its recorded reserves are adequate.
During the first quarter of 2002, CNA Re revised its estimate of premiums
and losses related to the WTC event. In estimating CNA Re's WTC event losses,
CNA performed a treaty-by-treaty analysis of exposure. CNA's loss estimate was
based on a number of assumptions including the loss to the industry, the loss
to individual lines of business and the market share of CNA Re's cedants.
Information available in the first quarter of 2002 resulted in CNA Re
increasing its estimate of WTC event related premiums and losses on its
property facultative and property catastrophe business. The impact of
increasing the estimate of gross WTC event losses by $144.0 million was fully
offset on a net of reinsurance basis (before the impact of the CCC Cover) by
higher reinstatement premiums and a reduction of return premiums.
The WTC event and related items comprising the amounts noted above, for the
three and nine months ended September 30, 2001, are detailed by segment in the
following table.
Pretax
Corporate
Aggregate Total Total
Pretax Reinsurance Pretax After-tax
Gross Losses Net Impact* Benefit Impact Impact
- ------------------------------------------------------------------------------------------------
(In millions)
Standard Lines . . . . . . . $ 375.0 $ 185.0 $ 108.0 $ 77.0 $ 44.0
Specialty Lines . . . . . . 214.0 30.0 12.0 18.0 11.0
CNA Re . . . . . . . . . . . 662.0 410.0 139.0 271.0 153.0
- ------------------------------------------------------------------------------------------------
Total property and casualty 1,251.0 625.0 259.0 366.0 208.0
Group Operations . . . . . . 235.0 53.0 53.0 31.0
Life Operations . . . . . . 75.0 22.0 22.0 12.0
Corporate and Other . . . . 87.0 27.0 27.0 14.0
- -----------------------------------------------------------------------------------------------
Total . . . . . . . . . . . $ 1,648.0 $ 727.0 $ 259.0 $ 468.0 $265.0
================================================================================================
64
*Pretax impact of the WTC event before the corporate aggregate reinsurance
treaties. The pretax net impact includes $85.0 million of reinstatement and
additional premiums.
Second Quarter 2001 Prior Year Reserve Strengthening
During the second quarter of 2001, CNA noted the continued emergence of
adverse loss experience across several lines of business related to prior
years that are discussed in further detail below. CNA completed a number of
reserve studies during the second quarter of 2001 for many of its lines of
business, including those in which these adverse trends were noted.
With respect to environmental and mass tort reserves, commencing in 2000 and
continuing into the first and second quarters of 2001, CNA received a number
of new reported claims, some of which involved declaratory judgment actions
premised on court decisions purporting to expand insurance coverage for
pollution claims. In these decisions, several courts adopted rules of
insurance policy interpretation which established joint and several liability
for insurers consecutively on a risk during a period of alleged property
damage; and in other instances adopted interpretations of the "absolute
pollution exclusion," which weakened its effectiveness in most circumstances.
In addition to receiving new claims and declaratory judgment actions premised
upon these unfavorable legal precedents, these court decisions also impacted
CNA's pending pollution and mass tort claims and coverage litigation. During
the spring of 2001, CNA reviewed specific claims and litigation, as well as
general trends, and concluded reserve strengthening in this area was
warranted.
In the area of mass torts, several well-publicized verdicts arising out of
bodily injury cases related to allegedly toxic mold led to a significant
increase in mold-related claims in 2000 and the first half of 2001. CNA's
reserve increase in the second quarter of 2001 was caused in part by this
increased area of exposure.
With respect to other court cases and how they might affect CNA's reserves
and reasonable possible losses, the following should be noted. State and
federal courts issue numerous decisions each year, which potentially impact
losses and reserves in both a favorable and unfavorable manner. Examples of
favorable developments include decisions to allocate defense and indemnity
payments in a manner so as to limit carriers' obligations to damages taking
place during the effective dates of their policies; decisions holding that
injuries occurring after asbestos operations are completed are subject to the
completed operations aggregate limits of the policies; and decisions ruling
that carriers' loss control inspections of their insured's premises do not
give rise to a duty to warn third parties to the dangers of asbestos.
Examples of unfavorable developments include decisions limiting the
application of the "absolute pollution" exclusion; and decisions holding
carriers liable for defense and indemnity of asbestos and pollution claims and
on a joint and several basis.
Throughout 2000, and into 2001, CNA experienced significant increases in new
asbestos bodily injury claims. In light of this development, CNA formed the
view that payments for asbestos claims could be higher in future years than
previously estimated. Moreover, in late 2000 through mid-2001, industry
sources such as rating agencies and actuarial firms released analyses and
studies commenting on the increase in claim volumes and other asbestos
liability developments. For example, A.M. Best released a study in May 2001
increasing its ultimate asbestos reserve estimate 63.0% from $40.0 billion to
65
$65.0 billion, citing an unfunded insurance industry reserve shortfall of
$33.0 billion. In June 2001, Tillinghast raised its asbestos ultimate exposure
from $55.0 billion to $65.0 billion for the insurance industry and its
estimate of the ultimate asbestos liability for all industries was raised to
$200.0 billion.
Also in the 2000 to 2001 time period, a number of significant asbestos
defendants filed for bankruptcy, increasing the likelihood that excess layers
of insurance coverage could be called upon to indemnify policyholders and
creating the potential that novel legal doctrines could be employed which
could accelerate the time when such indemnification payments could be due.
These developments led CNA's claims management to the conclusion that its
asbestos reserves required strengthening.
The non-APMT adverse reserve development was the result of analyses of
several lines of business. This development related principally to commercial
insurance coverages including automobile liability and multiple-peril, as well
as assumed reinsurance and healthcare-related coverages. A brief summary of
these lines of business and the associated reserve development is discussed
below.
Approximately $600.0 million of the adverse loss development is a result of
several coverages provided to commercial entities. Reserve analyses performed
during 2001 showed unexpected increases in the size of claims for several
lines, including commercial automobile liability, general liability and the
liability portion of commercial multiple-peril coverages. In addition, the
number of commercial automobile liability claims was higher than expected and
several state-specific factors resulted in higher than anticipated losses,
including developments associated with commercial automobile liability
coverage in Ohio and general liability coverage provided to contractors in New
York.
The commercial automobile liability analysis indicated increased ultimate
loss and allocated loss adjustment expense across several accident years due
to higher paid and reported loss and allocated loss adjustment expense
resulting from several factors. These factors include uninsured/underinsured
motorists coverage in Ohio, a change in the rate at which the average claim
size is increasing and a lack of improvement in the ratio of the number of
claims per exposure unit, the frequency. First, Ohio courts have significantly
broadened the population covered through the uninsured/underinsured motorists'
coverage. The broadening of the population covered by this portion of the
policy, and the retrospective nature of this broadening of coverage, resulted
in additional claims for older years. Second, in recent years, the average
claim size has been increasing at less than a 2.0% annual rate. The most
recent available data indicates that the rate of increase is now closer to
8.0% with only a portion of this increase explainable by a change in mix of
business. Finally, the review completed during the second quarter of 2001
indicated that the frequency for the 2000 accident year was 6.0% higher than
1999. Expectations were that the 2000 frequency would show an improvement from
the 1999 level.
The analyses of general liability and the liability portion of commercial
multiple-peril coverages showed several factors affecting these lines.
Construction defect claims in California and a limited number of other states
have had a significant impact. It was expected that the number of claims being
reported and the average size of those claims would fall quickly due to the
decrease in business exposed to those losses. However, the number of claims
reported during the first six months of 2001 increased from the number of
66
claims reported during the last six months of 2000. In addition to the effects
of construction defect claims, the average claim associated with New York
labor law has risen to more than $125,000 from less than $100,000, which was
significantly greater than previously expected.
An analysis of assumed reinsurance business showed that the paid and
reported losses for recent accident years were higher than expectations, which
resulted in management recording net unfavorable development on prior year
loss reserves of approximately $560.0 million. Because of the long and
variable reporting pattern associated with assumed reinsurance as well as
uncertainty regarding possible changes in the reporting methods of the ceding
companies, the carried reserves for assumed reinsurance are based mainly on
the pricing assumptions until experience emerges to show that the pricing
assumptions are no longer valid. The reviews completed during the second
quarter of 2001, including analysis at the individual treaty level, showed
that the pricing assumptions were no longer appropriate. The classes of
business with the most significant changes include excess of loss liability,
professional liability and proportional and retrocessional property.
Approximately $320.0 million of adverse loss development was due to adverse
experience in all other lines, primarily in coverages provided to healthcare-
related entities. The level of paid and reported losses associated with
coverages provided to national long-term care facilities were higher than
expected. The long-term care facility business had traditionally been limited
to local facilities. In recent years, CNA began to provide coverage to large
chains of long-term care facilities. Original assumptions were that these
chains would exhibit loss ratios similar to the local facilities. The most
recent review of these large chains indicated an overall loss ratio in excess
of 500.0% versus approximately 100.0% for the remaining business. In addition,
the average size of claims resulting from coverages provided to physicians and
institutions providing healthcare related services increased more than
expected. The most recent review indicated that the average loss had increased
to over $330,000. Prior to this review, the expectation for the average loss
was approximately $250,000.
Concurrent with CNA's review of loss reserves, CNA completed comprehensive
studies of estimated premium receivable accruals on retrospectively rated
insurance policies and involuntary market facilities. These studies included
ground-up reviews of retrospective premium accruals utilizing a more
comprehensive database of retrospectively rated contracts. This review
included application of the policy retrospective rating parameters to the
revised estimate of ultimate loss ratio and consideration of actual interim
cash settlement. This study resulted in a change in the estimated
retrospective premiums receivable balances.
As a result of this review and changes in premiums associated with the
change in estimates for loss reserves, CNA recorded a pretax reduction in
premium accruals of $566.0 million. The effect on net earned premiums was
$616.0 million offset by a reduction of accrued commissions of $50.0 million.
The studies included the review of all such retrospectively rated insurance
policies and the estimate of ultimate losses.
Approximately $188.0 million of this amount resulted from a change in
estimate in premiums related to involuntary market facilities, which had an
offsetting impact on net losses and therefore had no impact on the net
operating results. Accruals for ceded premiums related to other reinsurance
treaties increased $83.0 million due to the reserve strengthening. The
remainder of the decrease in premium accruals relates to the change in
67
estimate of the amount of retrospective premium receivables as discussed
above.
Reinsurance
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.
Amounts recoverable from reinsurers are estimated in a manner consistent
with claim and claim adjustment expense reserves or future policy benefit
reserves and are reported as a reinsurance receivable in the Consolidated
Condensed Balance Sheets. CNA has a credit risk exposure with respect to these
receivables and has established an estimated allowance for doubtful accounts.
The allowance is recorded on the basis of periodic evaluations of balances due
from reinsurers, reinsurer solvency, management's experience and current
economic conditions.
In the event that a specific reinsurer is experiencing difficulties, CNA may
engage in commutation discussions. The outcome of such discussions may result
in a settlement that is less than the recoverable, net of the allowance for
doubtful accounts, and could have an adverse material impact on the Company's
results of operations and/or financial condition.
CNA's overall reinsurance program includes certain property and casualty
contracts, such as the corporate aggregate reinsurance treaties discussed in
more detail later in this section, that are entered into and accounted for on
a "funds withheld" basis. Under the funds withheld basis, CNA records the cash
remitted to the reinsurer for the reinsurer's margin, or cost of the
reinsurance contract, as ceded premiums. The remainder of the premiums ceded
under the reinsurance contract is recorded as a funds withheld liability. CNA
is required to increase the funds withheld balance at stated interest
crediting rates applied to the funds withheld balance or as otherwise
specified under the terms of the contract. The funds withheld liability is
reduced by any cumulative claim payments made by CNA in excess of CNA's
retention under the reinsurance contract. If the funds withheld liability is
exhausted, interest crediting will cease and additional claim payments are
recoverable from the reinsurer. The funds withheld liability is recorded in
reinsurance balances payable in the Consolidated Condensed Balance Sheets.
Interest cost on these contracts is credited during all periods in which a
funds withheld liability exists. Interest cost, which is included in other net
investment income, was $53.0 million and $84.0 million for the third quarter
of 2002 and 2001 and $168.0 million and $206.0 million for the nine months
ended September 30, 2002 and 2001. The amount subject to interest crediting
rates on such contracts was $2,904.0 million and $2,724.0 million at September
30, 2002 and December 31, 2001.
The amount subject to interest crediting on these funds withheld contracts
will vary over time based on a number of factors, including the timing of loss
payments and ultimate gross losses incurred. CNA expects that it will continue
to incur significant interest costs on these contracts for several years.
68
For 2002, CNA has entered into an aggregate reinsurance treaty covering
substantially all of CNA's property and casualty lines of business (the "2002
Cover"). The loss protection provided by the 2002 Cover is dependent on the
level of subject premium, but there is a maximum aggregate limit of $1,125.0
million of ceded losses. Maximum ceded premium under the contract is $683.0
million, and premiums, claims recoveries and interest charges other than the
reinsurer's margin and related fees are made on a funds withheld basis.
Interest is credited on funds withheld at 8.0% per annum, and all premiums are
deemed to have been paid as of January 1, 2002. Ceded premium related to the
reinsurer's margin in the amount of $2.5 million and $7.5 million was recorded
for the 2002 Cover for the three months and nine months ended September 30,
2002.
The aggregate reinsurance protection from the 2002 Cover attaches at a
defined accident year loss and allocated loss adjustment expense
(collectively, losses) ratio. Under the contract, CNA has the right to elect
to cede losses to the 2002 Cover when its recorded accident year losses exceed
the attachment point. This election period expires March 31, 2004. If no
losses are ceded by this date, the contract is considered to be commuted. If
CNA elects to cede any losses to the 2002 Cover, it must continue to cede all
losses subject to the terms of the contract. As of September 30, 2002 CNA has
not recorded any ceded losses related to this cover.
In 1999, CNA entered into an aggregate reinsurance treaty related to the
1999 through 2001 accident years covering substantially all of CNA's property
and casualty lines of business (the "Aggregate Cover"). CNA has two sections
of coverage under the terms of the Aggregate Cover. These coverages attach at
defined loss ratios for each accident year. Coverage under the first section
of the Aggregate Cover, which is available for all accident years covered by
the contract, has annual limits of $500.0 million of ceded losses with an
aggregate limit of $1.0 billion of ceded losses for the three year period. The
ceded premiums are a percentage of ceded losses and for each $500.0 million of
limit the ceded premium is $230.0 million. The second section of the Aggregate
Cover, which was only utilized for accident year 2001, provides additional
coverage of up to $510.0 million of ceded losses for a maximum ceded premium
of $310.0 million. Under the Aggregate Cover, interest charges on the funds
withheld accrue at 8.0% per annum. If the aggregate loss ratio for the three-
year period exceeds certain thresholds, additional premiums may be payable and
the rate at which interest charges are accrued would increase to 8.25% per
annum commencing in 2006.
The coverage under the second section of the Aggregate Cover was triggered
for the 2001 accident year. As a result of losses related to the WTC event,
the limit under this section was exhausted. Additionally, as a result of the
significant reserve additions recorded in the second quarter of 2001, the
$500.0 million limit on the 1999 accident year under the first section was
also fully utilized. No losses have been ceded to the remaining $500.0 million
of aggregate limit on accident years 2000 and 2001 under the first section.
69
The impact of the Aggregate Cover on pretax operating results was as
follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------------------------
2002 2001 2002 2001
------------------------------------------------
(In millions)
Ceded earned premiums . . . . . . . . . . . . $ (83.0) $ (543.0)
Ceded claim and claim adjustment expense . . 288.0 1,010.0
Interest charges (included in investment
income, net of expenses) . . . . . . . . . . $(13.0) (11.0) $(38.0) (70.0)
- ------------------------------------------------------------------------------------------------
Pretax impact on operating results . . . . . $(13.0) $ 194.0 $(38.0) $ 397.0
================================================================================================
In 2001, CNA entered into a one-year aggregate reinsurance treaty related to
the 2001 accident year covering substantially all property and casualty lines
of business in the Continental Casualty Company pool (the "CCC Cover"). The
loss protection provided by the CCC Cover has an aggregate limit of
approximately $760.0 million of ceded losses. The ceded premiums are a
percentage of ceded losses. The ceded premium related to the full utilization
of the $760.0 million of limit is $456.0 million. The CCC Cover provides
continuous coverage in excess of the second section of the Aggregate Cover
discussed above. Under the CCC Cover, interest charges on the funds withheld
generally accrue at 8.0% per annum. The interest rate increases to 10.0% per
annum if the aggregate loss ratio exceeds certain thresholds. Losses of $618.0
million have been ceded under the CCC Cover through September 30, 2002.
The impact of the CCC Cover on pretax operating results was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------------------------
2002 2001 2002 2001
------------------------------------------------
(In millions)
Ceded earned premiums . . . . . . . . . . . . $(39.0) $(232.0) $(100.0) $ (234.0)
Ceded claim and claim adjustment expense . . 55.0 427.0 148.0 427.0
Interest charges (included in investment
income, net of expenses) . . . . . . . . . . (11.0) (15.0) (27.0) (15.0)
- ------------------------------------------------------------------------------------------------
Pretax impact on operating results . . . . . $ 5.0 $180.0 $ 21.0 $ 178.0
================================================================================================
70
The impact by operating segment of the 2002 Cover, Aggregate Cover and the
CCC Cover on pretax operating results was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------------------------
2002 2001 2002 2001
------------------------------------------------
(In millions)
Standard Lines . . . . . . . . . . . . . . $(15.0) $ 201.0 $ (43.0) $383.0
Specialty Lines . . . . . . . . . . . . . 8.0 32.0 3.0 26.0
CNA Re . . . . . . . . . . . . . . . . . .
Corporate and Other . . . . . . . . . . . (3.0) 141.0 16.0 166.0
- ------------------------------------------------------------------------------------------------
Pretax impact on operating results . . . . $(10.0) $ 374.0 $ (24.0) $575.0
================================================================================================
2001 Restructuring
In 2001, CNA finalized and approved two separate restructuring plans. The
first plan related to the Company's Information Technology operations (the "IT
Plan"). The second plan related to restructuring the property and casualty
segments and Life Operations, discontinuation of the variable life and annuity
business and consolidation of real estate locations (the "2001 Plan").
IT Plan
The overall goal of the IT Plan was to improve technology for the
underwriting function and throughout CNA and to eliminate inefficiencies in
the deployment of IT resources. The changes facilitated a strong focus on
enterprise-wide system initiatives. The IT Plan had two main components, which
included the reorganization of IT resources into the Technology and Operations
Group with a structure based on centralized, functional roles and the
implementation of an integrated technology roadmap that included common
architecture and platform standards that directly support CNA's strategies.
For the nine months ended September 30, 2001 CNA incurred $62.0 million
pretax of restructuring and other related charges for the IT Plan primarily
related to employee severance charges and the write-off of impaired assets.
There were no charges recorded during the three months ended September 30,
2001.
The following table summarizes the pretax effect of these costs for the nine
months ended September 30, 2001 on CNA's operating segments.
(In millions)
Property and Casualty Operations . . . . . . . . . . . . . . . . . . . . . . $ 8.0
Life Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17.0
Other Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37.0
- ------------------------------------------------------------------------------------------------
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $62.0
================================================================================================
71
No restructuring and other related charges related to the IT Plan have been
incurred in 2002; however, payments were made during the nine months ended
September 30, 2002 related to amounts accrued as of December 31, 2001. The
following table summarizes the remaining IT Plan accrual at September 30, 2002
and the activity in that accrual since inception. Approximately $5.0 million
of the remaining accrual is expected to be paid during the remainder of 2002.
72
Employee
Termination Impaired
and Related Asset Other
Benefit Costs Charges Costs Total
- ------------------------------------------------------------------------------------------------
(In millions)
IT Plan initial accrual . . . . . . . . . . . . $ 29.0 $ 32.0 $1.0 $ 62.0
Costs that did not require cash in 2001 . . . . (32.0) (32.0)
Payments charged against liability in 2001 . . . (19.0) (19.0)
- ------------------------------------------------------------------------------------------------
Accrued costs at December 31, 2001 . . . . . . . 10.0 1.0 11.0
Payments charged against liability in 2002 . . . (1.0) (1.0)
- ------------------------------------------------------------------------------------------------
Accrued costs at September 30, 2002 . . . . . . $ 9.0 $1.0 $ 10.0
================================================================================================
The IT Plan is not expected to result in decreased operating expenses in the
foreseeable future because savings from the workforce reduction will be used
to fund new technology-related initiatives. Employee termination and related
benefit payments will continue through 2004 due to employment contract
obligations.
2001 Plan
The overall goal of the 2001 Plan was to create a simplified and leaner
organization for customers and business partners. The major components of the
plan included a reduction in the number of strategic business units ("SBU"s)
in the property and casualty operations, changes in the strategic focus of the
Life Operations and consolidation of real estate locations. The reduction in
the number of property and casualty SBUs resulted in consolidation of SBU
functions, including underwriting, claims, marketing and finance. The
strategic changes in Life Operations included a decision to discontinue
writing variable life and annuity business.
No restructuring and other related charges related to the 2001 Plan have
been incurred in 2002; however, payments were made during the nine months
ended September 30, 2002 related to amounts accrued as of December 31, 2001.
The following table summarizes the remaining 2001 Plan accrual as of September
30, 2002 and the activity in that accrual since inception. Approximately $29.0
million of the remaining accrual is expected to be paid during the remainder
of 2002.
2001 Plan Accrual
Employee
Termination Lease Impaired
and Related Termination Asset Other
Benefit Costs Costs Charges Costs Total
- ------------------------------------------------------------------------------------------------
(In millions)
2001 Plan initial accrual . . . . . $ 68.0 $ 56.0 $ 30.0 $ 35.0 $189.0
Costs that did not require cash
in 2001 . . . . . . . . . . . . . . (35.0) (35.0)
Payments charged against liability
in 2001 . . . . . . . . . . . . . . (2.0) (2.0)
- ------------------------------------------------------------------------------------------------
Accrued costs at December 31, 2001 . 66.0 56.0 30.0 152.0
Costs that did not require cash
in 2002 . . . . . . . . . . . . . . (25.0) (25.0)
Payments charged against liability
in 2002 . . . . . . . . . . . . . . (50.0) (11.0) (1.0) (62.0)
- ------------------------------------------------------------------------------------------------
Accrued costs at September 30, 2002 $ 16.0 $ 45.0 $ 4.0 $ 65.0
================================================================================================
Reserves - Estimates and Uncertainties
CNA maintains loss reserves ("reserves") to cover its estimated ultimate
unpaid liability for losses and loss adjustment expenses, including the
estimated cost of the claims adjudication process, for claims that have been
reported but not yet settled and claims that have been incurred but not
reported. Reserves are reflected as liabilities on the Consolidated Condensed
Balance Sheets under the heading "Insurance Reserves." Changes in estimates of
reserves are reflected in the Company's Consolidated Condensed Statements of
Operations, as incurred losses in the period in which the change arises.
The level of reserves maintained by CNA represents management's best
estimate, as of a particular point in time, of what the ultimate settlement
and administration of claims will cost based on its assessment of facts and
circumstances known at that time. Reserves are not an exact calculation of
liability but instead are estimates that are derived by CNA, generally
utilizing a variety of actuarial reserve estimation techniques, from numerous
assumptions and expectations about future events, both internal and external,
many of which are highly uncertain. Some of the many uncertain future events
about which CNA makes assumptions and estimates are claims severity, frequency
of claims, economic inflation, the impact of underwriting policy and claims
handling practices and the lag time between the occurrence of an insured event
and the time it is ultimately settled (referred to in the insurance industry
as the "tail").
CNA's experience has been that the inherent uncertainties of estimating
insurance reserves are generally greater for casualty coverages (particularly
long-tail casualty risks such as APMT losses) than for property coverages.
Estimates of the cost of future APMT claims are highly complex and include an
assessment of, among other things, whether certain costs are covered under the
policies and whether recovery limits apply, allocation of liability among
numerous parties, some of whom are in bankruptcy proceedings, inconsistent
court decisions and developing legal theories and tactics of plaintiffs'
lawyers. Reserves for property-related catastrophes, both natural disasters
and man-made catastrophes such as terrorist acts, are also difficult to
73
estimate. See the discussion of Environmental Pollution and Mass Tort and
Asbestos Reserves below, for further information on APMT.
In addition to the uncertainties inherent in estimating APMT and catastrophe
losses, CNA is subject to the uncertain effects of emerging or potential
claims and coverage issues, which arise as industry practices and legal,
judicial, social, and other environmental conditions change. These issues can
have a negative effect on CNA's business by either extending coverage beyond
the original underwriting intent or by increasing the number or size of
claims. Either development could require material increases in reserves.
Examples of emerging or potential claims and coverage issues include: (i)
increases in the number and size of water damage claims related to expenses
for testing and remediation of mold conditions; (ii) increases in the number
and size of claims relating to injuries from medical products, and exposure to
lead and radiation related to cellular phone usage; (iii) expected increases
in the number and size of claims relating to accounting and financial
reporting, including director and officer and errors and omissions insurance
claims, in an environment of major corporate bankruptcies; and (iv) a growing
trend of plaintiffs targeting insurers in class action litigation relating to
claims-handling and other practices. The future impact of these and other
unforeseen emerging or potential claims and coverage issues is extremely hard
to predict and could materially adversely affect the adequacy of CNA's
reserves and could lead to future reserve additions.
CNA's current reserve levels reflect management's best estimate of CNA's
ultimate claims and claim adjustment expenses at September 30, 2002, based
upon known facts and current law. However, in light of the many uncertainties
associated with making the estimates and assumptions necessary to establish
reserve levels, CNA reviews its reserve estimates on a regular and ongoing
basis and makes changes as experience develops. CNA may in the future
determine that its recorded reserves are not sufficient and may increase its
reserves by amounts that may be material, which could materially adversely
affect the Company's business and financial condition. Any such increase in
reserves would be recorded as a charge against CNA's earnings for the period
in which the change in estimate arises.
Terrorism Exposure
CNA and the insurance industry incurred substantial losses related to the WTC
event. For the most part, CNA believes the industry was able to absorb the loss
of capital from these losses, but the capacity to withstand the effect of any
additional terrorism events was significantly diminished. The public debate
following the WTC event centered on the role, if any, the U.S. federal
government should play in providing a "terrorism backstop" for the industry. On
October 17, 2002, a conference committee of the U.S. Congress produced a bill
reconciling two bills formerly passed by the U.S. Senate and House of
Representatives. The bill, entitled The Terrorism Risk Insurance Act (the
"Act"), establishes a program within the Department of the Treasury, under
which the federal government would share the risk of loss from future terrorist
attacks with the insurance industry. The Act terminates on December 31, 2005.
Each participating insurance company would pay a deductible before federal
assistance becomes available. This deductible is based on a percentage of
direct premiums for commercial insurance lines from the previous calendar year,
and rises from 7.0 percent during the first year to 10.0 percent in year two
and 15.0 percent in year three. For losses above a company's deductible, the
federal government will cover 90.0%, while companies contribute 10.0%. Losses
covered by the program will be capped at $100.0 billion; above this amount,
Congress is to determine the procedures for and the source of any payments.
Insurance companies providing commercial property and casualty
74
insurance are required to participate in the program. The Act does not cover
life or health insurance products. During the first two years of the program,
the bill has a mandatory offer requirement for terrorism coverage by insurers.
The Secretary of Treasury has discretion to extend this requirement to the
third year of the program.
The Act, if it becomes law, would provide the property and casualty industry
with a greater ability to withstand the effect of any terrorist event in the
next three years. In addition, the Act may help to encourage reinsurers to
offer terrorism coverage on a broader basis than they have been writing
following the WTC event.
To date, however, the U.S. Congress has not enacted the Act. Without any
federal backstop in place, CNA is exposed to potentially material losses
arising from a future terrorism event. Accordingly, the Company's results of
operations and equity could be materially adversely impacted by a future
terrorism event. CNA is attempting to mitigate this exposure through its
underwriting practices, policy terms and conditions, and the use of
reinsurance. CNA is generally prohibited from excluding terrorism exposure
from its primary workers compensation, individual life and group life and
health policies. CNA's current reinsurance arrangements either exclude
terrorism coverage or significantly limit the level of coverage.
Property and Casualty
- ---------------------
CNA conducts its property and casualty operations through the following
operating segments: Standard Lines, Specialty Lines and CNA Re. The discussion
of underwriting results and ratios reflect the underlying business results of
CNA's property and casualty insurance subsidiaries. Underwriting ratios are
industry measures of property and casualty underwriting results. The loss
ratio is the percentage of net incurred claim and claim adjustment expenses to
net earned premiums. The expense ratio is the percentage of underwriting and
acquisition expenses, including the amortization of deferred acquisition
costs, to net earned premiums. The dividend ratio is the ratio of dividends
incurred to net earned premiums.
75
The following table summarizes key components of the Property-Casualty
segment operating results for the three and nine months ended September 30,
2002 and 2001.
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions)
Net written premiums. . . . . . . . . . . . $1,828.0 $ 1,390.0 $5,406.0 $ 3,863.0
Net earned premiums . . . . . . . . . . . . 1,700.0 1,362.0 5,096.0 3,375.0
Underwriting loss . . . . . . . . . . . . . (133.0) (388.0) (358.0) (2,612.0)
Net investment income . . . . . . . . . . . 145.0 227.0 600.0 718.0
Net operating income (loss) . . . . . . . . 12.9 (76.6) 182.4 (1,051.6)
Ratios:
Loss and loss adjustment expense . . . . 75.5% 84.6% 74.6% 125.6%
Expense . . . . . . . . . . . . . . . . . 30.8 41.1 31.2 49.2
Dividend . . . . . . . . . . . . . . . . 1.5 2.8 1.2 2.6
- ------------------------------------------------------------------------------------------------
Combined . . . . . . . . . . . . . . . . 107.8% 128.5% 107.0% 177.4%
================================================================================================
2001 adjusted underwriting loss* . . . . . $ (39.0) $ (348.0)
================================================================================================
2001 adjusted ratios*
Loss and loss adjustment expense . . . . 63.3% 68.2%
Expense . . . . . . . . . . . . . . . . . 36.8 37.6
Dividend . . . . . . . . . . . . . . . . 2.5 2.0
- ------------------------------------------------------------------------------------------------
Combined . . . . . . . . . . . . . . . 102.6% 107.8%
================================================================================================
* The 2001 adjusted underwriting loss and adjusted ratios exclude the impact of the second
quarter 2001 reserve strengthening, the WTC event, net of the related corporate aggregate
reinsurance treaties and restructuring and other related charges.
Net operating results improved $89.5 million for the third quarter of 2002
as compared with the same period in 2001. The impact of the third quarter 2001
WTC event, net of the related corporate aggregate reinsurance treaties
benefit, was $207.2 million (after-tax and minority interest).
Excluding these 2001 significant items, net operating results decreased
$117.7 million for the third quarter of 2002 as compared with the same period
in 2001. This decrease was due primarily to a decline in net investment
income, including a $47.7 million decrease in limited partnership investment
income and decreased underwriting results.
The combined ratio increased 5.2 points for the third quarter of 2002 as
compared with the adjusted combined ratio for the same period in 2001, and
underwriting results decreased by $94.0 million as compared with the adjusted
underwriting results for the same period in 2001. This decline was due to an
increase in the loss ratio, partially offset by decreases in both the expense
and dividend ratio. The loss ratio increased 12.2 points due to unfavorable
net prior year loss reserve development in Specialty Lines, primarily for
medical professional business, and CNA Re, primarily for professional
liability and fiduciary liability business, and a decreased benefit from the
76
use of reinsurance, including the corporate aggregate reinsurance treaties,
partially offset by improved current accident year results primarily related
to rate increases and new business across property and casualty operations and
favorable net prior year loss reserve development in Standard Lines for
involuntary markets and new claims initiatives. The expense ratio decreased
6.0 points primarily as a result of reduced underwriting expenses resulting
from decreased head count as a result of the 2001 Plan and other expense
reduction initiatives and an increase in the net earned premium base. Also
contributing to the decrease in expense ratio was a shift in business mix
resulting in a lower commission rate in CNA Re. The dividend ratio decreased
1.0 points due primarily to favorable current accident year dividends and
lower adverse dividend reserve development recorded in 2002 in Standard Lines.
Net written premiums increased $438.0 million for the third quarter of 2002
as compared with the same period in 2001. Third quarter results for 2001
included reductions in net written premiums totaling $229.0 million related to
both the WTC event and the corporate aggregate reinsurance treaties from core
operations. Excluding these 2001 significant items, net written premiums
increased $209.0 million. This increase was due primarily to strong rate
increases across the property and casualty operations, lower ceded premiums in
Standard Lines, and clients increasing their premium writings above original
estimates in CNA Re. These increases were partially offset by the decision
made in the third quarter of 2001 to cease new and renewal business writings
in the CNA Re U.K. subsidiary, and increased ceded premiums related to the
additional cessions to the CCC Cover in CNA Re in 2002.
Net earned premiums increased $338.0 million for the third quarter of 2002
as compared with the same period in 2001. Third quarter results for 2001
included reductions in net earned premiums totaling $229.0 million related to
both the WTC event and the corporate aggregate reinsurance treaties from core
operations. Excluding these 2001 significant items, net earned premiums
increased $109.0 million due primarily to the increases in net written
premiums noted above.
Net operating results improved $1,234.0 million for the nine months ended
September 30, 2002 as compared with the same period in 2001. The impact of the
third quarter 2001 WTC event, net of the related corporate aggregate
reinsurance treaties benefit, was $207.2 million (after-tax and minority
interest). The impact of the third quarter 2001 reserve strengthening, net of
the related corporate aggregate reinsurance treaty benefit, was $1,114.9
million (after-tax and minority interest). In addition, net operating results
for the nine months ended September 30, 2001 included a $4.4 million loss for
restructuring and other related charges.
Excluding these 2001 significant items, net operating results decreased
$92.5 million for the nine months ended September 30, 2002 as compared with
the same period in 2001. This decrease was due primarily to a decline in net
investment income, including a $48.2 million decrease in limited partnership
investment income and decreased underwriting results.
The combined ratio decreased 0.8 points for the nine months ended September
30, 2002 as compared with the adjusted combined ratio for the same period in
2001, and underwriting results decreased by $10.0 million as compared with the
adjusted underwriting results for the same period in 2001. This change was due
to decreases in both the expense and dividend ratios, partially offset by an
increase in the loss ratio. The loss ratio increased 6.4 points due to
unfavorable prior year loss reserve development in Specialty Lines, primarily
for medical professional business, and CNA Re, primarily for professional
liability and fiduciary liability business, and a decreased benefit from the
77
use of reinsurance, partially offset by improved current accident year results
related to rate increases and new business across property and casualty
operations. The expense ratio decreased 6.4 points primarily as a result of
reduced underwriting expenses resulting from decreased head count as a result
of the 2001 Plan and other expense reduction initiatives. Also contributing to
the decrease in expense ratio was a shift in business mix resulting in a lower
commission rate in CNA Re. The dividend ratio decreased 0.8 points due
primarily to favorable current accident year dividends in Standard Lines.
Net written premiums increased $1,543.0 million for the nine months ended
September 30, 2002 as compared with the same period in 2001. The nine months
ended September 30, 2001 included reductions in net written premiums totaling
$965.0 million related to the corporate aggregate reinsurance treaties,
additional ceded premiums arising from the reserve strengthening and the WTC
event and a change in estimate for involuntary market premium accruals.
Excluding these 2001 significant items, net written premiums increased $578.0
million. This increase was due principally to strong rate increases across the
property and casualty operating units, a higher level of new business in
Standard Lines and Specialty Lines and clients increasing their premium
writings above original estimates in CNA Re. These increases were partially
offset by the decision made in the third quarter of 2001 to cease new and
renewal business writings in CNA Re U.K.
Net earned premiums increased $1,721.0 million for the nine months ended
September 30, 2002 as compared with the same period in 2001. The nine months
ended September 30, 2001 included reductions in net earned premiums totaling
$1,251.0 million related to the corporate aggregate reinsurance treaties,
additional ceded premiums and a change in estimate for retrospective premium
accruals arising from the reserve strengthening and WTC event and a change in
estimate for involuntary market premium accruals. Excluding these 2001
significant items, net earned premiums increased $470.0 million due primarily
to the increases in net written premiums noted above.
Group
- -----
During the second quarter of 2002, CNA announced the sale of the Claims
Administration Corporation and the transfer of the National Postal Mail
Handlers Union group benefits plan (the "Mail Handlers Plan") to First Health
Group Corporation, effective July 1, 2002. In the third quarter of 2002, CNA
recognized a $5.0 million pretax realized loss on the sale of Claims
Administration Corporation and $14.0 million pretax of non-recurring fee
income related to the transfer of the Mail Handlers Plan.
Net operating results improved $40.3 million for the third quarter of 2002
as compared with the same period in 2001. Included in the 2001 results was a
$30.5 million (after-tax and minority interest) loss related to the WTC event.
Excluding this 2001 significant item, net operating results improved $9.8
million due primarily to increased net investment income and the non-recurring
fee income related to the transfer of the Mail Handlers Plan. Net earned
premiums decreased $552.7 million for the third quarter of 2002 as compared
with the same period in 2001. This decline was due primarily to the transfer
of the Mail Handlers Plan.
Net operating income improved $44.3 million for the nine months ended
September 30, 2002 as compared with the same period in 2001. Included in the
2001 results was a $30.5 million loss related to the WTC event. Excluding this
2001 significant item, net operating results improved $13.8 million due
78
primarily to increased net investment income and the non-recurring fee income
related to the transfer of the Mail Handlers Plan.
Net earned premiums decreased $508.0 million for the nine months ended
September 30, 2002 as compared with the same period in 2001. This decline was
due primarily to the transfer of the Mail Handlers Plan partially offset by an
increase in premiums in the disability and long term care products within
Group Benefits.
Life
- ----
Net operating results improved $31.8 million for the third quarter of 2002
as compared with the same period in 2001. Included in the 2001 results was a
$12.2 million (after-tax and minority interest) loss related to the WTC event.
Excluding this 2001 significant item, net operating results improved $19.6
million due primarily to improved 2002 Individual Life mortality experience
and a decrease in reinsurance charges as compared with 2001, partially offset
by unfavorable Long Term Care morbidity in 2002.
Sales volume decreased $117.0 million for the third quarter of 2002 as
compared with the same period in 2001. This decrease was attributable
primarily to lower sales of synthetic guaranteed investment contracts and
structured settlement annuities, along with reduced sales in the variable
products business, which CNA decided to exit in the fourth quarter of 2001.
These decreases were partially offset by increased sales in the Long Term Care
business. Net earned premiums increased $2.0 million for the third quarter of
2002 as compared with the same period in 2001, attributable primarily to
growth in the Long Term Care business partially offset by sales declines in
structured settlements.
Net operating results improved $35.9 million for the nine months ended
September 30, 2002 as compared with the same period in 2001. Included in the
2001 results was a $12.2 million (after-tax and minority interest) loss
related to the WTC event and an $9.6 million loss related to restructuring and
other related charges. Excluding these 2001 significant items, net operating
results improved $14.1 million (after-tax and minority interest) due primarily
to higher net investment income and a decrease in reinsurance charges as
compared with 2001, partially offset by unfavorable Long Term Care morbidity
in 2002.
Sales volume decreased $695.0 million for the nine months ended September
30, 2002 as compared with the same period in 2001. This decrease was
attributable primarily to lower sales of synthetic guaranteed investment
contracts and structured settlement annuities, along with reduced sales in the
variable products business, which CNA decided to exit in the fourth quarter
2001. These decreases were partially offset by increased sales in the Long
Term Care business. Net earned premiums increased $34.0 million for the nine
months ended September 30, 2002 as compared with the same period in 2001
attributable primarily to growth in the Long Term Care business partially
offset by sales declines in structured settlements and the Retirement Services
business.
Other Insurance
- ---------------
Net operating results improved $12.6 million for the third quarter of 2002
as compared with the same period in 2001. Included in the 2001 results was a
$14.8 million (after-tax and minority interest) loss related to the WTC event
79
related to Group Reinsurance. Excluding the impact of the WTC event, net
operating results were comparable to the same period in the prior year.
Reduced expenses for e-Business initiatives and improved results for Group
Reinsurance were offset by lower net investment income, higher losses related
to CNA UniSource and severance and other costs related to changes in senior
management during the third quarter of 2002.
Operating revenues decreased $39.0 million for the third quarter of 2002 as
compared with the same period in 2001. This decrease was due primarily to
reduced revenues for CNA UniSource and reduced net investment income partially
offset by increased net earned premiums in Group Reinsurance.
Net operating results improved $787.3 million for the nine months ended
September 30, 2002 as compared with the same period in 2001. Included in the
2001 results were $695.2 million related to the second quarter 2001 reserve
strengthening, including $644.7 million for APMT, $14.8 million related to the
WTC event and $20.9 million of restructuring and other related charges.
Excluding these 2001 significant items, net operating results improved $56.4
million (after-tax and minority interest) for the nine months ended September
30, 2002 as compared with the same period in 2001. Reduced expenses for e-
Business initiatives and improved results for Group Reinsurance were offset by
lower net investment income, higher losses related to CNA UniSource and
severance and other costs related to changes in senior management during the
third quarter of 2002.
Operating revenues decreased $15.0 million for the nine months ended
September 30, 2002 as compared with the same period in 2001. This decrease was
due primarily to reduced revenues for CNA UniSource and reduced net investment
income partially offset by increased net earned premiums in Group Reinsurance.
In the second quarter of 2001, CNA planned the disposition of CNA UniSource,
a payroll processor and professional employer organization ("PEO"). After
exploring possible transactions to dispose of its PEO business, CNA UniSource
exited the PEO business as of March 31, 2002. As of that date, substantially
all existing PEO client contracts were terminated. After exploring possible
transactions to dispose of its payroll business, CNA UniSource has decided to
exit the payroll processing business as of December 31, 2002. All obligations
related to the PEO operation are being run-off in an orderly manner and the
associated costs are included in continuing operations. CNA anticipates
additional operating losses from the PEO run-off and payroll operations run-
off for the remainder of 2002 and into the first half of 2003.
Environmental Pollution and Mass Tort and Asbestos Reserves
CNA's property and casualty insurance subsidiaries have actual and potential
exposures related to environmental pollution and mass tort and asbestos
claims.
Environmental pollution cleanup is the subject of both federal and state
regulation. By some estimates, there are thousands of potential waste sites
subject to cleanup. 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. The Comprehensive Environmental Response Compensation and Liability
Act of 1980 ("Superfund") and comparable state statutes ("mini-Superfunds")
govern the cleanup and restoration of toxic waste sites and formalize the
concept of legal liability for cleanup and restoration by "Potentially
Responsible Parties" ("PRP"s). Superfund and the mini-Superfunds establish
mechanisms to pay for cleanup of waste sites if PRPs fail to do so, and to
80
assign liability to PRPs. The extent of liability to be allocated to a PRP is
dependent upon a variety of factors. Further, the number of waste sites
subject to cleanup is unknown. To date, approximately 1,500 cleanup sites have
been identified by the Environmental Protection Agency ("EPA") and included on
its National Priorities List ("NPL"). State authorities have designated many
cleanup sites as well.
Many policyholders have made claims against various CNA insurance
subsidiaries for defense costs and indemnification in connection with
environmental pollution matters. The vast majority of these claims relate to
accident years 1989 and prior, which coincides with CNA's adoption of the
Simplified Commercial General Liability coverage form, which includes what is
referred to in the industry as an "absolute pollution exclusion." CNA and the
insurance industry are disputing coverage for many such claims. Key coverage
issues include whether cleanup costs are considered damages under the
policies, trigger of coverage, allocation of liability among triggered
policies, applicability of pollution exclusions and owned property exclusions,
the potential for joint and several liability and the definition of an
occurrence. To date, courts have been inconsistent in their rulings on these
issues.
A number of proposals to reform Superfund have been made by various parties.
However, no reforms were enacted by Congress during 2001 or the first nine
months of 2002, and it is unclear what positions Congress or the
administration will take and what legislation, if any, will result in the
future. If there is legislation, and in some circumstances even if there is no
legislation, the federal role in environmental cleanup may be significantly
reduced in favor of state action. Substantial changes in the federal statute
or the activity of the EPA may cause states to reconsider their environmental
cleanup statutes and regulations. There can be no meaningful prediction of the
pattern of regulation that would result or the effect upon the Company's
results of operations and/or equity.
Due to the inherent uncertainties described above, including the
inconsistency of court decisions, the number of waste sites subject to
cleanup, and the standards for cleanup and liability, the ultimate liability
of CNA for environmental pollution claims may vary substantially from the
amount currently recorded.
As of September 30, 2002 and December 31, 2001, CNA carried approximately
$526.0 and $617.0 million of claim and claim adjustment expense reserves, net
of reinsurance recoverables, for reported and unreported environmental
pollution and mass tort claims. There was no environmental pollution and mass
tort net development for the three and nine months ended September 30, 2002
and the three months ended September 30, 2001. Unfavorable environmental
pollution and mass tort development for the nine months ended September 30,
2001 amounted to $453.0 million. CNA made environmental pollution-related
claim payments and other mass tort related claim payments, net of reinsurance
recoveries, of $91.0 and $153.0 million for the nine months ended September
30, 2002 and 2001.
CNA's property and casualty insurance subsidiaries also have exposure to
asbestos-related claims. Estimation of asbestos-related claim and claim
adjustment expense reserves involves many of the same limitations discussed
above for environmental pollution claims, such as inconsistency of court
decisions, specific policy provisions, allocation of liability among insurers
and insureds, and additional factors such as missing policies and proof of
coverage. Furthermore, estimation of asbestos-related claims is difficult due
to, among other reasons, the proliferation of bankruptcy proceedings and
81
attendant uncertainties, the targeting of a broader range of businesses and
entities as defendants, the uncertainty as to which other insureds may be
targeted in the future, and the uncertainties inherent in predicting the
number of future claims.
As of September 30, 2002 and December 31, 2001, CNA carried approximately
$1,216.0 million and $1,204.0 million of net claim and claim adjustment
expense reserves, net of reinsurance recoverables, for reported and unreported
asbestos-related claims. There was no asbestos net claim and claim adjustment
expense development for the three and nine months ended September 30, 2002 and
the three months ended September 30, 2001. Unfavorable asbestos net claim and
claim adjustment reserve development for the nine months ended September 30,
2001 amounted to $769.0 million. CNA had a net $12.0 million receipt of cash
related to asbestos in the first nine months of 2002 as reinsurance recoveries
collected exceeded claim payments. CNA made asbestos-related claim payments,
net of reinsurance recoveries, of $78.0 million for the nine months ended
September 30, 2001.
In the past several years, CNA has experienced significant increases in
claim counts for asbestos-related claims. The factors that led to these
increases included, among other things, intensive advertising campaigns by
lawyers for asbestos claimants, mass medical screening programs sponsored by
plaintiff lawyers, and the addition of new defendants such as the distributors
and installers of products containing asbestos. Currently, the majority of
asbestos bodily injury claims are filed by persons exhibiting few, if any,
disease symptoms. It is estimated that approximately 90.0% of the current non-
malignant asbestos claimants do not meet the American Medical Association's
definition of impairment. Some courts, including the federal district court
responsible for pre-trial proceedings in all federal asbestos bodily injury
actions, have ordered that so-called "unimpaired" claimants may not recover
unless at some point the claimant's condition worsens to the point of
impairment.
Since 1982, at least sixty-two companies that mined asbestos, or
manufactured or used asbestos-containing products, have filed for bankruptcy.
Of these sixty-two companies, twenty-six companies have filed bankruptcy since
January 1, 2000. This phenomenon has prompted plaintiff attorneys to file
claims against companies that had only peripheral involvement with asbestos.
Many of these defendants were users or distributors of asbestos-containing
products, or manufacturers of products in which asbestos was encapsulated.
These defendants include equipment manufacturers, brake, gasket, and sealant
manufacturers, and general construction contractors. According to a
comprehensive report on asbestos litigation recently released by the Rand
Corporation, over 6,000 companies have been named as defendants in asbestos
lawsuits, with 75 out of 83 different types of industries in the United States
impacted by asbestos litigation. The study found that a typical claimant names
70 to 80 defendants, up from an average of 20 in the early years of asbestos
litigation.
Some asbestos-related defendants have asserted that their claims for
insurance are not subject to aggregate limits on coverage. CNA has such claims
from a number of insureds. Some of these claims involve insureds facing
exhaustion of products liability aggregate limits in their policies, who have
asserted that their asbestos-related claims fall within so-called "non-
products" liability coverage contained within their policies rather than
products liability coverage, and that the claimed "non-products" coverage is
not subject to any aggregate limit. It is difficult to predict the ultimate
size of any of the claims for coverage not subject to aggregate limits or
predict to what extent, if any, the attempts to assert "non-products" claims
82
outside the products liability aggregate will succeed. CNA is currently
attempting to achieve settlements of several of these claims for coverage not
subject to aggregate limits. Nevertheless, there can be no assurance any of
these settlement efforts will be successful, or that any such claims can be
settled on terms acceptable to CNA. Adverse developments with respect to such
matters discussed in this paragraph could have a material adverse effect on
the Company's results of operations and/or equity.
Policyholders have also initiated litigation directly against CNA and other
insurers. CNA has been named in Adams v. Aetna, Inc., at. al. (Circuit Court
of Kanhwha County, West Virginia), a purported class action against CNA and
other insurers, alleging that the defendants violated West Virginia's Unfair
Trade Practices Act in handling and resolving asbestos claims against their
policyholders. In addition, lawsuits have been filed in Texas against CNA and
other insurers and non-insurer corporate defendants asserting liability for
failing to warn of the dangers of asbestos. (Boston v. Union Carbide Corp., et
al., (District Court of Nueces County, Texas)). It is difficult to predict the
outcome or financial exposure represented by this type of litigation in light
of the broad nature of the relief requested and the novel theories asserted.
Due to the uncertainties created by volatility in claim numbers and
settlement demands, the effect of bankruptcies, the extent to which non-
impaired claimants can be precluded from making claims and the efforts by
insureds to obtain coverage not subject to aggregate limits, the ultimate
liability of CNA for asbestos-related claims may vary substantially from the
amount currently recorded. Other variables that will influence CNA's ultimate
exposure to asbestos-related claims will be medical inflation trends, jury
attitudes, the strategies of plaintiff attorneys to broaden the scope of
defendants, the mix of asbestos-related diseases presented, CNA's abilities to
recover reinsurance, future court decisions and the possibility of legislative
reform. Adverse developments with respect to such matters discussed in this
paragraph could have a material adverse effect on CNA's results of operations
and/or equity.
CNA reviews each active asbestos account every six months to determine
whether changes in reserves may be warranted. CNA considers input from its
analyst professionals with direct responsibility for the claims, inside and
outside counsel with responsibility for representation of CNA, and its
actuarial staff. These professionals review, among many factors, the
policyholder's present and future exposures (including such factors as claims
volume, disease mix, trial conditions, settlement demands and defense costs);
the policies issued by CNA (including such factors as aggregate or per
occurrence limits, whether the policy is primary, umbrella or excess, and the
existence of policyholder retentions and/or deductibles); the existence of
other insurance; and reinsurance arrangements.
The results of operations and equity of CNA in future years may be adversely
affected by environmental pollution and mass tort and asbestos claim and claim
adjustment expenses. Management will continue to review and monitor these
liabilities and make further adjustments, including the potential for further
reserve strengthening, as warranted.
83
Lorillard
- ---------
Lorillard, Inc. and subsidiaries ("Lorillard"). Lorillard, Inc. is a wholly
owned subsidiary of the Company.
During the first quarter of 2002, Lorillard adopted Emerging Issues Task
Force ("EITF") No. 00-25 and No. 00-14 relating to the classification of
vendor consideration and certain sales incentives. As a result, promotional
expenses historically included in other operating expenses have been
reclassified primarily as reductions of revenues from manufactured products,
or to cost of manufactured products sold. Prior period amounts have been
reclassified for comparative purposes. Adoption of the EITF issues had no
impact on the results of operations and cash flows of Lorillard.
Revenues decreased by $100.6 and $27.1 million, or 9.3% and 0.9%, and net
income decreased by $22.9 million, or 10.0%, and increased by $103.2 million
or 21.8%, respectively, for the quarter and nine months ended September 30,
2002, as compared to the corresponding periods of the prior year.
Revenues and net income for the quarter decreased due to lower net sales and
lower investment income. Net sales decreased by $95.5 million for the quarter
ended September 30, 2002, as compared to 2001, due to lower unit sales volume
of approximately $160.9 million, or 15.2%, assuming prices were unchanged from
the prior year. The decline in unit sales volume was partially offset by
higher average unit prices which increased revenues by approximately $65.4
million, or 6.2%, including $24.9 million from an increase in federal excise
taxes effective January 1, 2002.
Net income for the nine months ended September 30, 2001, included a charge
of $121.0 million related to an agreement with the class in the Engle case.
Excluding this charge, net income decreased by $17.8 million, or 3.0%.
Revenues and net income for the nine month period decreased due to lower
investment income and lower unit sales, partially offset by increased unit
prices. Investment income declined by approximately $30.1 million due to lower
invested cash balances and reduced yields on investments. Net sales increased
by $8.2 million due to higher average unit prices which resulted in an
aggregate increase of approximately $177.7 million, or 6.0%, including $71.5
million from an increase in federal excise taxes effective January 1, 2002.
The increased unit prices were partially offset by a decline in unit sales
volume of approximately $169.5 million, or 5.7%.
During the quarter and nine months ended September 30, 2002, Lorillard
increased its net wholesale price of cigarettes by an average of $5.22 and
$6.88 per thousand cigarettes ($0.10 and $0.14 per pack of 20 cigarettes),
respectively, or 4.3% and 5.8%, before the impact of any promotional
activities. Federal excise taxes are included in the price of cigarettes and
on January 1, 2002, the federal excise tax on cigarettes increased by $2.50
per thousand cigarettes ($0.05 per pack of 20 cigarettes) to $19.50 per
thousand cigarettes. All of the states also levy excise taxes on cigarettes.
Various states and municipalities have proposed, and some have recently
passed, increases in their tobacco excise taxes. Such actions may adversely
affect Lorillard's volume, net sales and net income.
The increased unit prices reflect the increase in net wholesale prices,
partially offset by promotional expenses, mostly in the form of coupons and
other discounts provided to retailers and passed through to the consumer.
Increased promotional expenses for the nine months ended September 30, 2002,
84
as compared to the corresponding period of the prior year, partially offset
the higher average unit prices in 2002.
Lorillard's overall unit sales volume decreased 13.2% and 5.0% for the
quarter and nine months ended September 30, 2002, as compared to 2001.
Newport's unit sales volume decreased by 11.0% and 1.1% for the quarter and
nine months ended September 30, 2002. Continued decreases in unit volume for
Old Gold and Maverick in the discount segment were also contributing factors.
The unit volume decrease for the 2002 third quarter, as compared to the
corresponding period of the prior year, reflects increased wholesale purchases
in June 2002 in anticipation of an increase in State excise taxes.
Additionally, the 2002 third quarter as compared with the prior year quarter
was negatively impacted by increased wholesale shipments beginning in
September 2001 prior to the commencement of a federal excise tax increase in
January 2002.
In addition to the impact of variances in wholesale purchase patterns
quarter over quarter, the 2002 third quarter unit volume was adversely
impacted by the continued growth of deep discounted brands at the expense of
discount brands and premium priced brands; the generally weak economic
climate; lower promotional spending in the third quarter of 2002 as compared
to the prior year's quarter and ongoing limitations imposed by Philip Morris'
merchandising arrangements.
The decline in unit volume for the 2002 nine month period compared with the
2001 nine month period reflects increased unit volume in the 2001 period in
anticipation of the January 2002 increase in the federal excise tax and the
generally weak economic conditions, continued market share gains of deep
discount products at the expense of discount brands and premium brands and
ongoing limitations imposed by Philip Morris' merchandising arrangements.
Overall, industry unit sales volumes decreased by 2.6% for the nine months
ended September 30, 2002. Lorillard's share of wholesale cigarette shipments
was 9.33% for the nine months ended September 30, 2002, as compared to 9.57%
for 2001. Newport, a premium brand, accounted for approximately 88% of
Lorillard's unit sales for the nine months ended September 30, 2002, compared
to 85% for the year ended December 31, 2001. Newport's market share of the
premium segment was 11.2% for the nine months ended September 30, 2002,
compared to 10.9% for the year ended December 31, 2001. The premium brand
market share amounted to 73.1% of industry sales for the nine months ended
September 30, 2002, as compared to 74.2% in the corresponding period of the
prior year.
Lorillard recorded pretax charges of $255.2, $309.0, $842.9 and $890.3
million ($153.7, $188.2, $510.6 and $542.2 million after-taxes), for the
quarter and nine months ended September 30, 2002 and 2001, respectively, to
accrue its obligations under various settlement agreements. Lorillard's
portion of ongoing adjusted settlement payments and related legal fees are
based on its share of domestic cigarette shipments in the year preceding that
in which the payment is due. Accordingly, Lorillard records its portions of
ongoing settlement payments as part of cost of manufactured products sold as
the related sales occur. Funds required for these payment obligations have
been provided by Lorillard's operating activities.
The State Settlement Agreements impose a stream of future payment
obligations on Lorillard and the other major U.S. cigarette manufacturers and
place significant restrictions on their ability to market and sell cigarettes.
The Company believes that the implementation of the State Settlement
85
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 U.S. cigarette
sales in the premium and discount segments, Lorillard's share of the domestic
premium and discount segments, and the effect of any resulting cost advantage
of manufacturers not subject to all of the payments of the State Settlement
Agreements. See Note 13 of the Notes to Consolidated Condensed Financial
Statements in Part I.
Loews Hotels
- ------------
Loews Hotels Holding Corporation and subsidiaries ("Loews Hotels"). Loews
Hotels Holding Corporation is a wholly owned subsidiary of the Company.
Revenues decreased by $0.7 and $17.5 million, or 1.0% and 7.1%, and net
income decreased by $0.2 and $2.6 million, for the quarter and nine months
ended September 30, 2002, as compared to the corresponding periods of the
prior year.
Revenues decreased for the quarter ended September 30, 2002, as compared to
the corresponding period of the prior year, due primarily to lower other hotel
operating revenues and reduced investment income, partially offset by an
increase in revenue per available room. Revenue per available room increased
by $0.77, or 0.7%, to $110.63 due to higher occupancy rates, partially offset
by lower average room rates.
Revenue per available room is an industry measure of the combined effect of
occupancy rates and average room rates on room revenues. Other hotel operating
revenues include, among other items, guest charges for food and beverages,
telecommunication services, garage and parking fees.
Revenues decreased for the nine months ended September 30, 2002, as compared
to the corresponding period of the prior year, due primarily to lower other
hotel operating revenues, reduced investment income and a decline in revenue
per available room. Revenue per available room decreased by $8.19, or 6.4%, to
$119.08, primarily due to lower average room rates, partially offset by higher
occupancy rates.
Net income decreased for the quarter and nine month periods due to the lower
revenues, partially offset by improved results at the Loews Philadelphia
Hotel, lower interest expense, and for the quarter ended September 30, 2002,
improved results at the Universal Orlando properties.
Diamond Offshore
- ----------------
Diamond Offshore Drilling, Inc. and subsidiaries ("Diamond Offshore").
Diamond Offshore Drilling, Inc. is a 54% owned subsidiary of the Company.
Revenues decreased by $63.7 and $135.5 million, or 26.1% and 19.1%, and net
income decreased by $19.9 and $42.0 million, or 87.7% and 76.1%, for the
quarter and nine months ended September 30, 2002, respectively, as compared to
the corresponding periods of the prior year.
Revenues from high specification floaters and other semisubmersible rigs
decreased by $29.2 and $54.0 million, or 12.0% and 7.6%, for the quarter and
nine months ended September 30, 2002, as compared to the corresponding periods
of the prior year. The decrease reflects lower dayrates ($17.9 and $26.7
86
million) and lower utilization ($24.2 and $54.1 million) partially offset by
revenues generated by the Ocean Baroness which completed a conversion to a
high specification semisubmersible drilling unit ($12.9 and $26.8 million),
for the quarter and nine months ended September 30, 2002, as compared to the
corresponding periods of the prior year.
Revenues from jack-up rigs decreased by $29.6 and $64.2 million, or 12.1%
and 9.1%, due primarily to decreased dayrates ($17.0 and $41.1 million) and
lower utilization ($12.6 and $23.1 million) for the quarter and nine months
ended September 30, 2002.
Revenues from investment income for the quarter and nine months ended
September 30, 2002, decreased by $6.5 and $12.5 million, respectively, as
compared to the corresponding periods of the prior year, due primarily to
lower yields.
Net income decreased due primarily to the decreased revenues discussed
above, and for the nine months ended September 30, 2002, partially offset by
lower interest expenses related to a premium paid on early extinguishment of
debt in 2001.
Bulova
- ------
Bulova Corporation and subsidiaries ("Bulova"). Bulova Corporation is a 97%
owned subsidiary of the Company.
Revenues increased by $5.5 and $14.5 million, or 15.5% and 14.5%,
respectively, for the quarter and nine months ended September 30, 2002. Net
income increased $0.8 and $0.8 million or 53.3% and 14.0% for the quarter and
nine months ended September 30, 2002. Revenues and net income increased due
primarily to the addition of the Wittnauer watch brand, acquired in the third
quarter of 2001, increased sales of Harley Davidson licensed product
associated with the license agreement signed in May 2001, and increased clock
unit sales volume as compared to the corresponding periods of the prior year.
These increases were partially offset by unit volume decreases in the Bulova
brand as compared to 2001, and a pretax charge of $0.7 and $1.1 million for
the quarter and nine months ended September 30, 2002 related to an accrual for
environmental remediation costs.
Corporate
- ---------
Corporate operations consist primarily of investment income, including
investment gains (losses) from non-insurance subsidiaries, as well as equity
earnings from a shipping joint venture, corporate interest expenses and other
corporate administrative costs.
87
The components of investment gains (losses) included in Corporate operations
are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -------------------------
2002 2001 2002 2001
---------------------------------------------------
(In millions)
Revenues:
Derivative instruments . . . . . . . . $ (16.3) $ 0.3 $(19.5) $ 4.5
Fixed maturities . . . . . . . . . . . 28.0 12.4 35.2 24.3
Equity securities, including short
positions . . . . . . . . . . . . . . (52.0) 50.8 (90.3) 75.8
Short-term investments, primarily U.S.
government securities . . . . . . . . 42.9 8.4 67.0 21.1
- ------------------------------------------------------------------------------------------------
2.6 71.9 (7.6) 125.7
Income tax (expense) benefit . . . . . . (1.7) (25.2) 1.8 (44.0)
Minority interest . . . . . . . . . . . (6.6) (2.0) (10.3) (6.0)
- ------------------------------------------------------------------------------------------------
Net income (loss) . . . . . . . . . $ (5.7) $ 44.7 $ (16.1) $ 75.7
================================================================================================
Exclusive of investment gains (losses), revenues decreased $26.5 and $79.3
million and net loss increased $17.0 and $56.7 million for the quarter and
nine months ended September 30, 2002, compared to the corresponding periods of
the prior year, due primarily to lower revenues from a shipping joint venture
reflecting reduced demand and charter rates in the crude oil tanker markets,
and lower investment income.
Liquidity and Capital Resources:
- -------------------------------
CNA Financial
- -------------
The principal operating cash flow sources of CNA's property and 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.
For the nine months ended September 30, 2002 net cash provided by operating
activities was $807.0 million as compared with net cash used by operating
activities of $698.0 million for the same period in 2001. The improvement
related primarily to federal tax refunds received in 2002 as compared to taxes
paid in 2001, and decreased net payments for insurance claims in the first
nine months of 2002 as compared to 2001.
Cash flows from investing activities include purchases and sales of
financial instruments, as well as the purchase and sale of land, buildings,
equipment and other assets not generally held for resale.
For the nine months ended September 30, 2002, net cash used by investing
activities was $636.0 million as compared with net cash provided by investing
activities of $345.0 million for the same period in 2001. This decrease was
due primarily to purchases of fixed maturity securities and $264.0 million of
88
net proceeds related to the sale of 180 Maiden Lane, New York facility in
2001.
Cash flows from financing activities include proceeds from the issuance of
debt or equity securities, outflows for dividends or repayment of debt and
outlays to reacquire equity instruments.
For the nine months ended September 30, 2002, net cash used by financing
activities was $54.0 million as compared with net cash provided by financing
activities of $310.0 million for the same period in 2001. Cash provided by
financing activities in 2001 includes the completion of a common stock rights
offering by CNA on September 26, 2001, successfully raising $1.0 billion (40.3
million shares sold at $25.00 per share). The Company purchased 38.3 million
shares issued in connection with the rights offering for $957.0 million.
Additionally, CNA repaid debt of $646.0 million in 2001.
CNA is monitoring the cash flows related to claims and reinsurance
recoverables from the WTC event. It is anticipated that significant claim
payments will be made prior to receipt of the corresponding reinsurance
recoverables. CNA does not anticipate any liquidity problems resulting from
these payments. Approximately 37.0%, 36.0% and 22.0% of the reinsurance
recoverables on the estimated losses related to the WTC event are from
companies with S&P ratings of AAA, AA or A, respectively. As of November 1,
2002, CNA has paid $438.0 million in claims and recovered $229.0 million from
reinsurers.
CNA is currently evaluating various capital raising alternatives. Any
capital raised in the near-term would be used to refinance debt, which matures
in 2003, and to enhance the overall capital position of CNA's insurance
subsidiaries. The effects on net income of any near-term capital raising
activities on future operations is currently uncertain.
On September 30, 2002, CNA Surety Corporation ("CNA Surety"), a 64.0% owned
and consolidated subsidiary of CNA, entered into a $65.0 million credit
agreement with one bank, which consists of a $35.0 million 364-day revolving
credit facility and a $30.0 million term loan. As of September 30, 2002, the
facility was fully utilized. The credit agreement replaced a $130.0 million
revolving credit facility that terminated September 30, 2002. Under the new
agreement, CNA Surety pays a facility fee of 12.5 basis points, interest at
LIBOR plus 45.0 basis points, and for utilization greater than 50.0% of the
amount available to borrow an additional fee of 5.0 basis points. On the term
loan, CNA Surety pays interest at LIBOR plus 62.5 basis points.
Under the former agreement, CNA Surety paid interest on outstanding
borrowings based on, among other rates, LIBOR plus the applicable margin. The
applicable margin was determined by CNA Surety's leverage ratio (debt to total
capitalization). At the termination date of the facility, the applicable
margin was 30.0 basis points, including the 10.0 basis point facility fee.
The terms of the agreement require the assumption by a second bank of $15.0
million of the credit risk by November 30, 2002 or CNA Surety will be required
to repay $15.0 million to reduce the amount of the credit facility commitment
from $35.0 million to $20.0 million. CNA and CNA Surety have entered into an
agreement whereby CNA will lend CNA Surety the amount needed to repay its bank
loans, if necessary. CNA Surety is exploring other capital opportunities to
repay or refinance $15.0 million of loans, and currently believes that it is
reasonably possible that CNA may be required to perform on some portion of its
guaranty.
89
The terms of CNA's and CNA Surety's credit facilities require CNA and CNA
Surety to maintain certain financial ratios and combined property and casualty
company statutory surplus levels. At September 30, 2002 and December 31, 2001,
CNA and CNA Surety were in compliance with all restrictive debt covenants.
In the normal course of business, CNA has obtained letters of credit in
favor of various unaffiliated insurance companies, regulatory authorities and
other entities. At September 30, 2002 there were approximately $282.0 million
of outstanding letters of credit.
As of September 30, 2002, CNA had committed approximately $157.0 million for
future capital calls from various third-party limited partnership investments
in exchange for an ownership interest in the related partnerships.
CNA has a commitment to purchase a $100.0 million floating rate note issued
by the California Earthquake Authority in the event California earthquake-
related insurance losses exceed $4.9 billion prior to December 31, 2002.
As of September 30, 2002, CNA is obligated to make future payments totaling
$470.0 million for non-cancelable operating leases expiring from 2002 through
2014 primarily for office space and data processing, office and transportation
equipment. Estimated future minimum payments under these contracts are as
follows: $27.0 million in 2002; $94.0 million in 2003; $75.0 million in 2004;
$66.0 million in 2005; and $208.0 million in 2006 and beyond. Additionally,
CNA has entered into a limited number of guaranteed payment contracts,
primarily relating to telecommunication services, amounting to approximately
$25.0 million. Estimated future minimum purchases under these contracts are as
follows: $4.0 million in 2002; $11.0 million in 2003; $8.0 million in 2004;
and $2.0 million in 2005.
Ratings have become an increasingly important factor in establishing the
competitive position of insurance companies. CNA's insurance company
subsidiaries are rated by major rating agencies, and these ratings reflect the
rating agency's opinion of the insurance company's financial strength,
operating performance, strategic position and ability to meet its obligations
to policyholders. Agency ratings are not a recommendation to buy, sell or hold
any security, and may be revised or withdrawn at any time by the issuing
organization. Each agency's rating should be evaluated independently of any
other agency's rating. One or more of these agencies could take action in the
future to change the ratings of CNA's insurance subsidiaries. If those ratings
were downgraded as a result, the Company's results of operations and/or equity
could be materially adversely affected.
The table below reflects ratings issued by A.M. Best, S&P, Moody's and Fitch
as of November 13, 2002 for the CCC Pool, the Continental Insurance Company
("CIC") Pool, Continental Assurance Corporation ("CAC") Pool and CNA Group
Life Assurance Company ("CNAGLA"). Also rated were CNA's senior debt and The
Continental Corporation ("Continental") senior debt.
90
Insurance Financial Strength Ratings Debt Ratings
------------------------------------------ ---------------------------
Property & Casualty Life & Group CNA Continental
------------------- ------------------- --------- -----------
CCC CIC CAC Senior Senior
Pool Pool Pool CNAGLA Debt Debt
- ------------------------------------------------------------------------------------------------
A.M. Best A A A A BBB BBB-
Fitch A A AA- A+ BBB BBB
Moody's A3 A3 A2 NR Baa2 Baa3
(Negative)*
S&P A- A- A+ NR BBB- BBB-
- ------------------------------------------------------------------------------------------------
NR = Not Rated
* CAC and Valley Forge Life Insurance Company ("VFL") are rated separately by Moody's and both
have an A2 rating.
During the second quarter, the assignment of a new insurance financial
strength rating to CNAGLA was the only rating action. A.M. Best assigned an
"A" rating and Fitch assigned an "A+" rating with a stable outlook to CNAGLA.
Currently, group life and health policies are written in CCC, CAC, and VFL and
then assumed through reinsurance by CNAGLA. With the addition of these
separate entity specific ratings, CNAGLA has commenced direct writing group
insurance policies.
CNA's ability to pay dividends and other credit obligations is significantly
dependent on receipt of dividends from its subsidiaries. The payment of
dividends to CNA by its insurance subsidiaries without prior approval of the
insurance department of each subsidiary's domiciliary jurisdiction is limited
by formula. Dividends in excess of these amounts are subject to prior approval
of the respective state insurance departments.
Corporate bonds comprise a significant portion of CNA's investment
portfolio. CNA regularly reviews the market value of these securities, and
challenges whether an other than temporary decline in value has occurred for
securities that are trading below cost. In light of the current volatility in
the financial markets and the dramatic impact that several recent accounting
scandals have had on specific issuers, the Company may be subject to future
impairment losses that could materially adversely impact its results of
operations. Any future impairment losses would not have a material impact on
the Company's overall equity. See the discussion of CNA's impairment committee
in "Investments-Insurance" below.
CCC is the lead insurance company subsidiary within the CCC Pool and is the
main source of CNA dividends. All other insurance companies within the CCC
Pool are subsidiaries of CCC and are subject to the dividend rules of their
applicable state of domicile. Dividends from CCC are subject to the insurance
holding company laws of the State of Illinois, the domiciliary state of CCC.
Under these laws, ordinary dividends, or dividends that do not require prior
approval of the Illinois Department, may be paid only from earned surplus,
which is calculated by removing unrealized gains (under which statutory
accounting includes cumulative earnings of CCC's subsidiaries) from unassigned
surplus. As of September 30, 2002, CCC is in a negative earned surplus
position. In February 2002, the Illinois Department approved an extraordinary
dividend in the amount of $117.0 million to be used to fund CNA's 2002 debt
91
service requirements. Until CCC is in a positive earned surplus position, all
dividends require prior approval of the Illinois Department.
Prompted, in part, by the negative earned surplus position described above,
CNA has embarked on a capital realignment initiative within the CCC Pool,
which is excepted to restore CCC's earned surplus to a positive position. This
initiative involves the payment of dividends to CCC from the cumulative
undistributed earnings of its insurance subsidiaries during the fourth quarter
of 2002. This capital realignment initiative is pending regulatory approval
from the applicable domiciliary state insurance department of CCC's insurance
subsidiaries. As a result of this initiative, it is anticipated that CCC's
earned surplus will be restored to a positive level by December 31, 2002.
In addition, by agreement with the New Hampshire Insurance Department ("New
Hampshire Department"), as well as certain other state insurance departments,
dividend paying capacity for the subsidiary companies within the CIC Pool are
restricted to internal (intercompany) and external debt service requirements
through September 2003, up to a maximum of $85.0 million annually, without the
prior approval of the New Hampshire Department.
Lorillard
- ---------
Lorillard and other cigarette manufacturers continue to be confronted with
substantial litigation and regulatory issues. Approximately 4,575 product
liability cases are pending against cigarette manufacturers in the United
States. Of these, approximately 1,200 cases are pending in a West Virginia
court, and approximately 2,800 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.
On July 14, 2000, the jury in Engle v. R.J. Reynolds Tobacco Co., et al.
awarded a total of $145.0 billion in punitive damages against all defendants,
including $16.3 billion against Lorillard. The judgment also provides that the
jury's awards bear interest at the rate of 10% per year. Lorillard remains of
the view that the Engle case should not have been certified as a class action.
Lorillard believes that class certification in the Engle case is inconsistent
with the majority of federal and state court decisions which have held that
mass smoking and health claims are inappropriate for class treatment.
Lorillard has challenged the class certification, as well as numerous other
legal errors that it believes occurred during the trial. The Florida Third
District Court of Appeal heard argument in defendants' appeal on November 6,
2002. The Court of Appeal took the appeal under advisement. The Company and
Lorillard believe that an appeal of these issues on the merits should prevail.
The terms of the State Settlement Agreements require significant payments to
be made to the Settling States which began in 1998 and continue in perpetuity.
Lorillard expects its cash payment under the State Settlement Agreements in
2002 to be approximately $1.1 billion. See Note 13 of the Notes to
Consolidated Condensed Financial Statements in Part I of this Report for
additional information regarding this settlement and other litigation matters.
The principal source of liquidity for Lorillard's business and operating
needs is internally generated funds from its operations. Lorillard's cash
provided by operating activities amounted to $681.6 million for the nine
months ended September 30, 2002, compared to $1,015.9 million for the prior
year. Cash provided by operating activities declined primarily due to the
timing of estimated tax payments. Lorillard believes, based on current
92
conditions, that cash flows from operating activities will be sufficient to
enable it to meet its obligations under the State Settlement Agreements and to
fund its capital expenditures. Lorillard cannot predict the impact on its cash
flows of cash requirements related to future settlements or judgments,
including cash required to bond any appeals, if necessary, or the impact of
subsequent legislative actions, and thus can give no assurance that it will be
able to meet all of those requirements.
Loews Hotels
- ------------
In 2002, Loews Hotels, with its partners, opened a third hotel at Universal
Orlando in Florida. Capital expenditures in relation to this hotel project
were funded by a combination of equity from Loews Hotels and its partners, and
mortgages.
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.
Diamond Offshore
- ----------------
At September 30, 2002, cash and marketable securities totaled $946.9
million, down from $1.1 billion at December 31, 2001. Cash provided by
operating activities for the nine months ended September 30, 2002 decreased by
$17.6 million to $246.9 million, as compared to $264.5 million in 2001.
During 2002, Diamond Offshore purchased 1,716,700 shares of its common stock
at an aggregate cost of $43.4 million. Depending on market conditions Diamond
Offshore may, from time to time, purchase shares of its common stock in the
open market or otherwise.
During the first nine months of 2002, Diamond Offshore spent $150.8 million,
including capitalized interest expense, for rig upgrades, of which $81.3
million was for the conversion of the Ocean Rover and $31.5 million was for
the completion of the conversion of the Ocean Baroness. Diamond Offshore also
spent $33.9 million in the first nine months of 2002 to upgrade six jack-up
rigs. Diamond Offshore expects to spend approximately $242.0 million for rig
upgrade capital expenditures during 2002.
Diamond Offshore took delivery of the Ocean Baroness in January 2002 and
began operating offshore Malaysia in March 2002. The approximate cost of the
upgrade was $170.0 million. In January 2002, the Ocean Rover arrived at a
shipyard in Singapore for a major upgrade to water depths and specifications
similar to the enhanced Ocean Baroness. The estimated cost of this upgrade is
approximately $200.0 million with approximately $125.0 million to be spent in
2002. The upgrade is expected to take approximately 19 months to complete with
delivery estimated in the third quarter of 2003.
Diamond Offshore also plans to spend approximately $100.0 million over a two
year period to upgrade six of its jack-up rigs. Diamond Offshore expects to
finance these upgrades through the use of existing cash balances or internally
generated funds.
During the nine months ended September 30, 2002, Diamond Offshore expended
$55.3 million for its continuing rig enhancement program and to meet other
corporate capital expenditure requirements. Diamond Offshore expects to spend
93
$100.0 million for 2002 capital expenditures associated with these items
(other than rig upgrades) and other corporate requirements.
Diamond Offshore currently expects to finance these capital expenditures
through the use of existing cash balances or internally generated funds.
Cash required to meet Diamond Offshore's capital commitments is determined
by evaluating the need to upgrade rigs to meet specific customer requirements
and by evaluating Diamond Offshore's ongoing rig equipment replacement and
enhancement programs, including water depth and drilling capability upgrades.
It is management's opinion that operating cash flows and Diamond Offshore's
cash reserves will be sufficient to meet these capital commitments; however,
Diamond Offshore will continue to make periodic assessments based on industry
conditions. In addition, Diamond Offshore may, from time to time, issue debt
or equity securities, or a combination thereof, to finance capital
expenditures, the acquisition of assets and businesses, or for general
corporate purposes. Diamond Offshore's ability to effect any such issuance
will be dependent on its results of operations, its current financial and
market conditions, and other factors beyond its control.
On November 5, 2002, Diamond Offshore announced that it signed a memorandum
of agreement to purchase the semisubmersible drilling rig Omega for $65.0
million. The agreement is subject to certain conditions and the purchase is
expected to be completed in the first quarter of 2003.
Bulova
- ------
For the nine months ended September 30, 2002, net cash used from operating
activities was $7.1 million as compared with net cash provided of $12.2
million in the comparable period of 2001. The decrease in net cash flow is
primarily the result of an increase in the level of accounts receivable
related to higher net sales resulting primarily from the introduction of the
new Wittnauer brand product line and Harley Davidson licensed product, and an
increase in inventory purchases, partially offset by a change in the timing of
accounts payable and accrued expenses. Bulova's cash and cash equivalents, and
investments amounted to $11.4 million at September 30, 2002, compared to $18.9
million at December 31, 2001.
Bulova and the Company have a credit agreement which provides, under terms
and conditions set forth therein, for unsecured loans to Bulova by the Company
from time to time, in principal amounts aggregating up to $50.0 million.
Bulova has not utilized this credit agreement since 1995 and there are no
amounts outstanding thereunder. Bulova may require working capital advances
under this credit agreement to fund its capital expenditures and working
capital requirements associated with product line extensions and international
expansion efforts.
Majestic Shipping
- -----------------
Subsidiaries of Hellespont Shipping Corporation ("Hellespont"), a 49% owned
subsidiary of Majestic Shipping Corporation ("Majestic"), a wholly owned
subsidiary of the Company, entered into agreements with a Korean shipyard for
the new building of four 442,500 deadweight ton, ultra-large crude carrying
ships. These subsidiaries were purchased by Hellespont from Majestic at the
Company's carrying value, excluding pretax capitalized interest expense of
$3.1 million, in March 2002. In partial consideration for this purchase,
Hellespont issued to Majestic a promissory note in the principal amount of
94
$57.5 million, which remains outstanding. The total cost of the ships is
estimated to amount to approximately $360.0 million, to be financed in part by
up to an aggregate amount of $200.0 million of bank debt, guaranteed by
Hellespont as successor to Majestic. As of September 30, 2002, $100.0 million
principal amount of this debt was outstanding. The Company has agreed to
provide credit support for this bank debt by making available to the borrowers
an operating cash flow credit facility of up to an aggregate amount of $25.0
million, none of which is outstanding.
Parent Company
- --------------
On February 6, 2002, the Company sold 40,250,000 shares of a new class of
its common stock referred to as Carolina Group Stock for net proceeds of $1.1
billion. Proceeds from this sale have been allocated to the Loews Group and
will be used for general corporate purposes.
As of September 30, 2002, there were 185,441,200 shares of Loews Common
Stock outstanding. During the quarter and nine months ended September 30,
2002, the Company purchased 664,000 and 6,065,600 shares of Loews Common Stock
at an aggregate cost of $33.4 and $343.5 million, respectively. During the
quarter and nine months ended September 30, 2002, the Company purchased 53,500
and 2,717,876 shares of CNA common stock at an aggregate cost of $1.4 and
$73.1 million, respectively. The Company also purchased 340,000 shares of
Carolina Group Stock during the quarter ended September 30, 2002, for the
account of the Carolina Group, at an aggregate cost of $7.7 million. Depending
on market conditions, the Company from time to time may purchase shares of
its, and its subsidiaries', outstanding common stock in the open market or
otherwise.
The Company continues to pursue conservative financial strategies while
seeking opportunities for responsible growth. These include the expansion of
existing businesses, full or partial acquisitions and dispositions, and
opportunities for efficiencies and economies of scale.
The Company is a holding company and derives substantially all of its cash
flow from its subsidiaries, principally, Lorillard. The Company relies upon
its invested cash balances and distributions from its subsidiaries to generate
the funds necessary to meet its obligations and to declare and pay any
dividends to its stockholders. The ability of the Company's subsidiaries to
pay dividends is subject to, among other things, the availability of
sufficient funds in such subsidiaries, applicable state laws, including in the
case of the insurance subsidiaries of CNA, laws and rules governing the
payment of dividends by regulated insurance companies. Claims of creditors of
the Company's subsidiaries will generally have priority as to the assets of
such subsidiaries over the claims of the Company and its creditors and
stockholders.
Investments:
- -----------
Investment activities of non-insurance companies include investments in
fixed income securities, equity securities including short sales, derivative
instruments and short-term investments, and are carried at fair value. Equity
securities, which are considered part of the Company's trading portfolio,
short sales and derivative instruments are marked to market and reported as
investment gains or losses in the income statement.
95
The Company enters into short sales and invests in certain derivative
instruments 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.
Monitoring procedures include senior management review of daily detailed
reports of existing positions and valuation fluctuations to ensure that open
positions are consistent with the Company's portfolio strategy.
The credit exposure associated with these instruments is generally limited
to the positive market value of the instruments and will vary based on changes
in market prices. The Company enters into these transactions with large
financial institutions and considers the risk of nonperformance to be remote.
The Company does not believe that any of the derivative instruments utilized
by it are unusually complex, nor do these instruments contain imbedded
leverage features which would expose the Company to a higher degree of risk.
See "Results of Operations" and "Quantitative and Qualitative Disclosures
about Market Risk" for additional information with respect to derivative
instruments, including recognized gains and losses on these instruments. See
also Note 4 of the Notes to Consolidated Financial Statements in the 2001
Annual Report on Form 10-K.
Insurance
- ---------
The components of CNA's net investment income are presented in the following
table.
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity securities:
Bonds:
Taxable . . . . . . . . . . . . . . . . . $ 412.0 $ 438.0 $1,284.0 $1,247.0
Tax-exempt . . . . . . . . . . . . . . . 49.0 24.0 120.0 86.0
Limited Partnerships . . . . . . . . . . . . (72.0) 20.0 (28.0) 52.0
Short-term investments . . . . . . . . . . . 17.0 34.0 44.0 113.0
Other, including interest on funds withheld
and other deposits . . . . . . . . . . . . (21.0) (50.0) (81.0) (94.0)
- ------------------------------------------------------------------------------------------------
Gross investment income . . . . . . . . . . 385.0 466.0 1,339.0 1,404.0
Investment expense . . . . . . . . . . . . . (21.0) (18.0) (47.0) (47.0)
- ------------------------------------------------------------------------------------------------
Investment income, net of expense . . . . . $ 364.0 $ 448.0 $1,292.0 $1,357.0
================================================================================================
CNA experienced lower net investment income for the three and nine months
ended September 30, 2002 as compared with the same periods in 2001. The
decrease was due primarily to decreased limited partnership results and lower
investment yields, partially offset by reduced interest costs on funds
withheld reinsurance contracts. Other investment income includes interest
96
costs on funds withheld reinsurance contracts. (See "Results of Operations by
Business Segment - CNA Financial - Reinsurance," above for additional
information). The interest cost on these contracts increased significantly in
the second and third quarters of 2001 due to ceded losses resulting from the
second quarter 2001 reserve strengthening and the WTC event. The decline in
limited partnership income was primarily attributable to many of the same
factors that impacted the broader financial markets. Limited partnership
investment performance, particularly high yield bond and equity strategies,
was adversely affected by overall market volatility including concerns over
corporate accounting practices and credit deterioration. Based upon current
trends, CNA expects limited partnership losses in the fourth quarter of 2002
will likely be less than that reported in the third quarter of 2002. In future
quarters, CNA expects to reallocate a portion of its investment in limited
partnerships to other investments. The bond segment of the investment
portfolio yielded 6.0% in the first nine months of 2002 as compared with 6.4%
during the same period in 2001.
The components of CNA's net investment (losses) gains are presented in the
following table:
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------
(In millions)
Investment gains (losses):
Fixed maturity securities:
U.S. Government bonds . . . . . . . . . . $ 214.0 $ 49.0 $ 263.0 $ 156.0
Corporate and other taxable bonds . . . . (165.0) (73.0) (414.0) (80.0)
Tax-exempt bonds . . . . . . . . . . . . 41.0 7.0 57.0 45.0
Asset-backed bonds . . . . . . . . . . . 14.0 42.0 55.0
Redeemable Preferred Stock . . . . . . . (13.0) (28.0) (21.0)
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities . . . . . . 91.0 (17.0) (80.0) 155.0
Equity securities . . . . . . . . . . . . (17.0) 39.0 32.0 1,126.0
Derivative securities . . . . . . . . . . . (44.0) (29.0) (78.0) (26.0)
Other invested assets . . . . . . . . . . . (6.0) 8.0 (11.0) (316.0)
- ------------------------------------------------------------------------------------------------
Total realized investment (losses) gains . 24.0 1.0 (137.0) 939.0
Income tax benefit (expense) . . . . . . . (8.0) (1.0) 50.0 (390.0)
Minority interest . . . . . . . . . . . . . (1.0) 10.0 (71.0)
- ------------------------------------------------------------------------------------------------
Net investment (losses) gains . . . . . . . $ 15.0 $(77.0) $ 478.0
================================================================================================
Net realized investment gains increased $15.0 million for the three months
ended September 30, 2002 compared with the same period in 2001. This increase
was due primarily to gains on sales fixed maturity and equity securities,
partially offset by increased investment impairment losses.
Net realized investment gains decreased $555.0 million for the nine months
ended September 30, 2002 compared with the same period in 2001. This decline
was due primarily to a $237.5 million (after-tax and minority interest)
increase in impairment losses recorded in 2002 principally on corporate bonds,
97
contrasted with large gains realized in the second quarter of 2001 from
closing out the hedge agreements, entered into in early 2000, related to CNA's
investment in Global Crossing Ltd. common stock.
A primary objective in the management of the fixed maturity and equity
securities portfolios is to maximize total return relative to underlying
liabilities and respective liquidity needs. In achieving this goal, assets may
be sold to take advantage of market conditions or other investment
opportunities or credit and tax considerations. This activity will produce
realized gains and losses.
Substantially all of CNA's invested assets are marketable securities
classified as available-for-sale in the accompanying financial statements.
Accordingly, changes in fair value for these securities are reported in other
comprehensive income.
Invested assets are exposed to various risks, such as interest rate, market
and credit. Due to the level of risk associated with certain invested assets
and the level of uncertainty related to changes in the value if these assets,
it is possible that changes in risks in the near term may materially affect
the amounts reported in the Consolidated Condensed Balance Sheets and the
Consolidated Condensed Statements of Operations.
CNA's Impairment Committee (the "Committee") reviews the investment
portfolio no less frequently than quarterly for potentially troubled
securities. The Committee (comprised of representatives appointed by CNA's
Chief Financial Officer) determines which securities are impaired and the
extent of the impairment. Each quarter a screening list is prepared,
consisting of the securities which fall below certain thresholds. Each
security on the list is analyzed by the Committee in light of specific facts
and circumstances that may be unique to that security including, but not
limited to, the current market value relative to book value, the length of
time that the security's market value has been less than book value, the
current view of the security's market sector, its underlying circumstances and
near term prospects, and CNA's intended holding period. The Committee
evaluates available information and concludes if impairment losses are
warranted.
Realized investment losses for the three and nine months ended September 30,
2002, included $222.0 million and $533.0 million pretax of impairment losses
as compared with $41.0 million and $124.0 million of pretax impairment losses
for the same periods in 2001.
The impairments recorded in 2002 and 2001 were primarily the result of the
continued deterioration in the bond and equity markets and the effects on such
markets due to the overall slowing of the economy. These impairment losses
were related principally to corporate bonds in the taxable securities asset
class of fixed maturity securities and in equity securities.
For the three months ended September 30, 2002, the impairment losses related
primarily to corporate bonds in the communications sector of the market and
equities in the financial industry sector. On an aggregate basis, these
impairment losses were more than offset by the realized gains in the overall
investment portfolio.
For the three months ended September 30, 2001, the impairment losses related
to corporate bonds primarily in the internet communications sector of the
market.
98
For the nine months ended September 30, 2002, the impairment losses included
$129.0 million related to debt securities issued by WorldCom Inc., $74.0
million related to Adelphia Communications Corporation, and $57.0 million for
AT&T Canada, all of which recently filed for bankruptcy. The remainder of the
impairment losses were primarily in the communications sector. If the
deterioration in this and other industry sectors continues in future periods
and CNA continues to hold these securities, CNA is likely to have additional
impairment losses in the future.
For the nine months ended September 30, 2001 the impairment losses were
primarily in corporate bonds and included $61.0 million related to the
internet communications industry sector. The remainder of the impairment
losses were primarily in the equity class and medical services industry
sectors.
During the second quarter of 2001, CNA announced its intention to sell
certain businesses. The assets being held for disposition included the U.K.
subsidiaries of CNA Re ("CNA Re U.K.") and certain other businesses. Based
upon the impairment analyses performed at that time, CNA anticipated that it
would realize losses in connection with those planned sales. In determining
the anticipated loss from these sales, CNA estimated the net realizable value
of each business being held for sale. An estimated after-tax and minority
interest loss of $278.4 million was initially recorded in the second quarter
of 2001. This loss was reported in other realized investment losses.
CNA continues to monitor the impairment losses analyses recorded for these
businesses and perform updated impairment analyses. Based on these analyses
the impairment loss has been reduced by approximately $170.0 million,
primarily because the net assets of the businesses had been significantly
diminished by their operating losses, including adverse development recognized
by CNA Re U.K. in the fourth quarter of 2001.
In the fourth quarter of 2001, CNA sold certain businesses as planned. The
realized after-tax and minority interest loss applicable to these businesses
recognized in the second quarter of 2001 was $33.1 million. Revenues of these
businesses included in the three and nine months ended September 30, 2001
totaled approximately $6.0 and $28.0 million. These businesses contributed
approximately $2.6 million of net operating income and $12.2 million of losses
in the three and nine months ended September 30, 2001.
At September 30, 2002, CNA Re U.K. remained held for sale. On October 31,
2002, CNA completed the sale of CNA Re U.K. to Tawa U.K. Limited, a subsidiary
of Artemis Group, a diversified French-based holding company. The sale
includes business underwritten since inception by CNA Re U.K., except for
certain risks retained by CCC as discussed below. In October, the sale was
approved in the United Kingdom by the Financial Services Authority ("FSA") and
by the Illinois Insurance Department. This sale does not impact CNA Re's on-
going U.S.-based operations.
CNA Re U.K. was sold for one dollar, subject to adjustments that are
primarily driven by certain operating results and changes in interest rates
between January 1, 2002 and October 31, 2002, and realized foreign currency
losses recognized by CNA Re U.K. prior to December 31, 2002. CNA has also
committed to contribute up to $9.6 million to CNA Re U.K. over a four-year
period beginning in 2010 should the FSA deem CNA Re U.K. to be
undercapitalized. Due to the various components of the completion adjustments,
which are initially prepared by the buyer, the final settlement cannot yet be
determined. However, based upon information currently available to CNA,
management believes there will be a reduction in the previously recognized
99
impairment loss, which will be reflected as a realized gain when the
completion adjustments are finalized.
Concurrent with the sale, several reinsurance agreements under which CCC had
provided retrocessional protection to CNA Re U.K. will be terminated. As part
of the sale, CNA Re U.K.'s net exposure to all IGI Program liabilities will be
ceded to CCC. Further, CCC will provide a $100.0 million stop loss cover
attaching at carried reserves on CNA Re U.K.'s 2001 underwriting year
exposures for which CCC received premiums of $25.0 million.
The statutory surplus of CNA Re U.K., was below the required regulatory
minimum surplus level at December 31, 2001. CCC contributed $120.0 million of
capital on March 25, 2002 bringing the capital above the regulatory minimum.
CNA Re U.K. contributed revenues of approximately $14.0 and $57.0 million
for the three months ended September 30, 2002 and 2001, and $57.0 and $220.0
million for the nine months ended September 30, 2002 and 2001. CNA Re U.K.
contributed net operating income of $8.1 million and net operating losses of
$94.9 million for the three months ended September 30, 2002 and 2001 and net
operating income of $11.6 million and net operating losses of $153.2 million
for the nine months ended September 30, 2002 and 2001. The assets and
liabilities of CNA Re U.K., after including the effects of planned concurrent
transactions, were approximately $2.7 and $2.7 billion as of September 30,
2002 and $2.9 and $2.9 billion as of December 31, 2001.
The businesses sold in 2002, excluding CNA Vida, Claims Administration
Corporation and the Mail Handlers Plan, and those that continue to be held for
disposition as of September 30, 2002, excluding CNA Re U.K., contributed
revenues of approximately $6.0 and $28.0 million for the three months ended
September 30, 2002 and 2001, and $35.0 and $95.0 million for the nine months
ended September 30, 2002 and 2001. Additionally, these businesses contributed
net operating losses of $1.8 and $1.7 million for the three months ended
September 30, 2002 and 2001 and $12.5 and $10.4 million for the nine months
ended September 30, 2002 and 2001. The assets and liabilities of these
businesses were approximately $96.0 and $83.0 million as of September 30, 2002
and $126.0 and $109.0 million as of December 31, 2001. All anticipated
disposals are expected to be completed in 2002.
100
A summary of CNA's general account investments portfolios, at carrying
value, are as follows:
Change in
Unrealized
September 30, December 31, Gains
2002 2001 (Losses)
- ------------------------------------------------------------------------------
(In millions)
Fixed maturity securities:
U.S. Treasury securities and
obligations of government agencies . $ 3,697.0 $ 5,081.0 $ 250.0
Asset-backed securities . . . . . . . 7,643.0 7,723.0 199.0
Tax exempt securities . . . . . . . . 4,785.0 2,720.0 233.0
Corporate securities . . . . . . . . 8,389.0 9,587.0 (13.0)
Other debt securities . . . . . . . . 3,781.0 3,816.0 (213.0)
Redeemable preferred stock . . . . . 26.0 48.0 (1.0)
Options embedded inconvertible debt
securities . . . . . . . . . . . . . 122.0 189.0
- ------------------------------------------------------------------------------
Total fixed maturity securities . 28,443.0 29,164.0 455.0
Equity securities . . . . . . . . . . . 932.0 1,338.0 (155.0)
Short-term and other investments . . . 6,805.0 5,324.0 19.0
- ------------------------------------------------------------------------------
Total . . . . . . . . . . . . . . $36,180.0 $35,826.0 $ 319.0
==============================================================================
September 30, December 31,
2002 2001
- ------------------------------------------------------------------------------
(In millions)
Short-term and other investments:
Commercial paper . . . . . . . . . . . . . . . . $ 775.0 $ 1,194.0
Money market funds . . . . . . . . . . . . . . . 918.0 1,641.0
U.S. Treasury securities . . . . . . . . . . . . 2,254.0 175.0
Others . . . . . . . . . . . . . . . . . . . . . 1,238.0 730.0
Other investments . . . . . . . . . . . . . . . . . 1,620.0 1,584.0
- ------------------------------------------------------------------------------
Total short-term and other investments . . . . $ 6,805.0 $ 5,324.0
=============================================================================
CNA's general and separate account investment portfolio consists primarily
of publicly traded government bonds, asset-backed securities, mortgage-backed
securities, municipal bonds and corporate bonds.
Total net unrealized gain of the general account investments was $664.0
million at September 30, 2002 compared with $345.0 million at December 31,
2001. The unrealized position at September 30, 2002 was composed of a net
unrealized gain $650.0 million for fixed maturities and a net unrealized gain
of $14.0 million for equity securities. The unrealized position at December
101
31, 2001 was composed of a net unrealized gain of $194.0 million for fixed
maturities, a net unrealized gain of $170.0 million for equity securities and
a net unrealized loss of $19.0 million for short-term securities.
Unrealized Gains (Losses) Fixed Maturity and Equity Securities
September 30, 2002
- ------------------------------------------------------------------------------------------------
Cost or Gross Gross Net
Amortized Unrealized Unrealized Unrealized
Cost Gains Losses Gain (Loss)
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity securities:
U.S. Treasury securities and obligations
of government agencies . . . . . . . . . . . $ 3,369.0 $ 328.0 $ 328.0
Asset-backed securities . . . . . . . . . . . 7,323.0 345.0 $ 25.0 320.0
Tax-exempt securities . . . . . . . . . . . . 4,580.0 242.0 37.0 205.0
Corporate securities . . . . . . . . . . . . 8,384.0 496.0 491.0 5.0
Other debt securities . . . . . . . . . . . . 3,989.0 162.0 370.0 (208.0)
Redeemable preferred stock . . . . . . . . . 26.0
Options embedded in convertible debt
securities . . . . . . . . . . . . . . . . . 122.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities . . . . . . . 27,793.0 1,573.0 923.0 650.0
- ------------------------------------------------------------------------------------------------
Equity securities:
Common stock . . . . . . . . . . . . . . . . 580.0 188.0 135.0 53.0
Non-redeemable preferred stock . . . . . . . 338.0 4.0 43.0 (39.0)
- ------------------------------------------------------------------------------------------------
Total equity securities . . . . . . . . . . . 918.0 192.0 178.0 14.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity and equity securities . $ 28,711.0 $ 1,765.0 $1,101.0 $ 664.0
================================================================================================
102
Unrealized Gains (Losses) on Fixed Maturity and Equity Securities
December 31, 2001
- ------------------------------------------------------------------------------------------------
Cost or Gross Gross Net
Amortized Unrealized Unrealized Unrealized
Cost Gains Losses Gain (Loss)
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity securities:
U.S. Treasury securities and obligations
of government agencies . . . . . . . . . . . $ 5,002.0 $ 109.0 $ 30.0 $ 79.0
Asset-backed securities . . . . . . . . . . . 7,603.0 139.0 19.0 120.0
Tax-exempt securities . . . . . . . . . . . . 2,748.0 19.0 47.0 (28.0)
Corporate securities . . . . . . . . . . . . 9,569.0 247.0 229.0 18.0
Other debt securities . . . . . . . . . . . . 3,811.0 152.0 147.0 5.0
Redeemable preferred stock . . . . . . . . . 48.0 1.0 1.0
Options embedded in convertible debt
Securities . . . . . . . . . . . . . . . . . 189.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities . . . . . . . 28,970.0 667.0 473.0 194.0
- ------------------------------------------------------------------------------------------------
Equity Securities:
Common Stock . . . . . . . . . . . . . . . . 820.0 326.0 150.0 176.0
Non-redeemable preferred stock . . . . . . . 348.0 17.0 23.0 (6.0)
- ------------------------------------------------------------------------------------------------
Total equity securities . . . . . . . . . . . 1,168.0 343.0 173.0 170.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity and equity securities . $ 30,138.0 $ 1,010.0 $ 646.0 $ 364.0
================================================================================================
At September 30, 2002 CNA held fixed maturity and equity securities with a
net unrealized gain of $664.0 million. Included in this amount were gross
unrealized losses of $1,101.0 million which were more than offset by gross
unrealized gains of $1,765.0 million. As previously described, CNA's
Impairment Committee continually reviews the makeup of securities in an
unrealized position for potential impairments. At September 30, 2002 the
average market value of the securities in an unrealized loss position was
82.0% of cost or amortized cost as applicable.
At December 31, 2001 CNA held fixed maturity and equity securities with an
aggregate net unrealized gain of $364.0 million. Included in this amount were
gross unrealized losses of $646.0 million, which were more than offset by
gross unrealized gains of $1,010.0 million. At December 31, 2001 the average
market value of the securities in an unrealized loss position was 94.0% of
cost or amortized cost as applicable.
CNA's investment policies for both the general and separate accounts
emphasize high credit quality and diversification by industry, issuer and
issue. Assets supporting interest rate sensitive liabilities are segmented
within the general account to facilitate asset/liability duration management.
The general account portfolio consists primarily of high quality (rated BBB
or higher) bonds, 92.0% of which were rated as investment grade at both
September 30, 2002 and December 31, 2001.
At both September 30, 2002 and December 31, 2001, approximately 97.0% of the
general account portfolio were U.S. Government agencies or were rated by
Standard & Poor's ("S&P") or Moody's Investors Service ("Moody's"). The
103
remaining bonds were rated by other rating agencies, outside brokers or CNA
management.
Below investment grade bonds are high yield securities rated below BBB by
rating agencies, as well as 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 for the underlying insurance
products.
Included in CNA's general account fixed maturity securities at September 30,
2002 are $7,643.0 million of asset-backed securities, at fair value,
consisting of approximately 73.0% in collateralized mortgage obligations
("CMOs"), 13.0% in corporate asset-backed obligations 9.0% in U.S. Government
agency issued pass-through certificates, and 5.0% in corporate mortgage-backed
pass-through certificates. The majority of CMOs held are actively traded in
liquid markets and are priced by broker-dealers.
Other invested assets include investments in limited partnerships and
certain derivative securities. CNA's limited partnership investments are
recorded at fair value and typically reflect a reporting lag of up to three
months. Fair value of CNA's limited partnership investments represents CNA's
equity in the partnership's net assets as determined by the general partner.
The carrying value of CNA's limited partnership investments was $1,334.0 and
$1,307.0 million as of September 30, 2002 and December 31, 2001.
Limited partnerships are a relatively small portion of CNA's overall
investment portfolio. The majority of the limited partnerships invest in a
substantial number of securities that are readily marketable. CNA is a passive
investor in such partnerships and does not have influence over the
partnerships' management, who are committed to operate them according to
established guidelines and strategies. These strategies may include the use of
leverage and hedging techniques that potentially introduce more volatility and
risk to the partnerships.
CNA invests in certain derivative financial instruments primarily to reduce
its exposure to market risk (principally interest rate, equity price and
foreign currency risk). CNA considers the derivatives in its general account
to be held for purposes other than trading. Derivative securities are recorded
at fair value at the reporting date.
Most derivatives in separate accounts are held for trading purposes. CNA
uses these derivatives to mitigate market risk by purchasing S&P 500 index
futures in a notional amount equal to the contract liability relating to Life
Operations' Index 500 guaranteed investment contract product.
Accounting Standards
- --------------------
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations." SFAS No. 143 applies to the accounting and reporting obligations
associated with the retirement of tangible long-lived assets and the
associated asset retirement costs. This Statement applies to legal obligations
associated with the retirement of long-lived assets that result from the
acquisition, construction, development and/or the normal operation of a long-
lived asset, except for certain obligations of lessees. Adoption of this
Statement is required for fiscal years beginning after June 15, 2002. Adoption
104
of these provisions will not have a material impact on the equity or results
of operations of the Company.
In June of 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 addresses financial
accounting and reporting for costs associated with exit or disposal activities
and supercedes EITF No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)". CNA adopted the provisions of SFAS No.
146 for all disposal activities initiated after June 30, 2002. The adoption of
SFAS No. 146 did not have a significant impact on the results of operations or
equity of the Company.
Forward-Looking Statements
- --------------------------
Certain statements made or incorporated by reference by the Company in this
Report are "forward-looking" statements within the meaning of the federal
securities laws. Forward-looking statements include, without limitation, any
statement that may project, indicate or imply future results, events,
performance or achievements, and may contain the words "expect", "intend",
"plan", "anticipate", "estimate", "believe", "will be", "will continue", "will
likely result", and similar expressions. Statements in this report that
contain forward-looking statements include, but are not limited to, statements
regarding CNA's insurance business relating to asbestos, pollution and mass
tort claims, expected cost savings and other results from restructuring
activities; statements regarding insurance reserves and statements regarding
planned disposition of certain businesses; statements regarding litigation and
developments affecting Lorillard's tobacco business including, among other
things statements regarding claims, litigation and settlement, and statements
regarding regulation of the industry; statements regarding Diamond Offshore's
business including, without limitation, statements with respect to
expenditures for rig conversion and upgrade, oil and gas price levels,
exploration and production activity, and statements concerning actual or
potential damage, periods of inactivity and recovery and remediation efforts
with respect to the Ocean Baroness.
Such statements inherently are subject to a variety of risks and
uncertainties that could cause actual results to differ materially from those
anticipated or projected. Such risks and uncertainties include, among others,
the impact of competitive products, policies and pricing; product and policy
availability and demand and market responses, including the effect of the
absence of applicable terrorism legislation on coverages; development of
claims and the effect on loss reserves; exposure to liabilities due to claims
made by insured and others relating to asbestos remediation and health-based
asbestos impairments, and exposure to liabilities for environmental pollution
and mass tort claims; the sufficiency of CNA's loss reserves and the
possibility of future increases in reserves; the performance of reinsurance
companies under reinsurance contracts; the effects of corporate bankruptcies
and/or accounting restatements (such as Enron and WorldCom) on the financial
markets, and the resulting decline in value of securities held by the Company
which may result in additional charges for impairment; the effects of
corporate bankruptcies and/or accounting restatements on the markets for
directors and officers and errors and omissions coverages; limitations upon
CNA's ability to receive dividends from its insurance subsidiaries imposed by
state regulatory agencies; regulatory limitations and restrictions upon CNA
and its insurance subsidiaries generally; judicial decisions and rulings; the
possibility of downgrades in CNA's ratings by ratings agencies and changes in
rating agency policies and practices, and the results of financing efforts.
105
The tobacco industry continues to be subject to health concerns relating to
the use of tobacco products and exposure to environmental tobacco smoke,
legislation, including actual and potential excise tax increases, increasing
marketing and regulatory restrictions, governmental regulation, privately
imposed smoking restrictions, litigation, including risks associated with
adverse jury and judicial determinations, courts reaching conclusions at
variance with the general understandings of applicable law, bonding
requirements and the absence of adequate appellate remedies to get timely
relief from any of the foregoing, and the effects of price increases related
to concluded tobacco litigation settlements and excise tax increases on
consumption rates.
In addition to the factors noted above, all aspects of the operations of the
Company and its subsidiaries are affected by the impact of 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 domestic and foreign political, social and economic conditions, the
economic effects of the September 11, 2001 terrorist attacks, the impact of
judicial rulings and jury verdicts, regulatory initiatives and compliance with
governmental regulations and various other matters, many of which are beyond
the control of the Company and its subsidiaries.
Developments in any of these areas, which are more fully described elsewhere
in this Report could cause the Company's results to differ materially from
results that have been or may be anticipated or projected by or on behalf of
the Company and its subsidiaries. These forward-looking statements speak only
as of the date of this Report. The Company expressly disclaims any obligation
or undertaking to release publicly any updates or revisions to any forward-
looking statement contained herein to reflect any change in the Company's
expectations with regard thereto or any change in events, conditions or
circumstances on which any statement is based.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
-----------------------------------------------------------
The Company is a large diversified financial services company. As such, it
and its subsidiaries have significant amounts of financial instruments that
involve market risk. The Company's measure of market risk exposure represents
an estimate of the change in fair value of its financial instruments. Changes
in the trading portfolio would be recognized as investment gains (losses) in
the Consolidated Condensed Statements of Income. Market risk exposure is
presented for each class of financial instrument held by the Company at
September 30, 2002 and December 31, 2001, assuming immediate adverse market
movements of the magnitude described below. The Company believes that the
various rates of adverse market movements represent a measure of exposure to
loss under hypothetically assumed adverse conditions. The estimated market
risk exposure represents the hypothetical loss to future earnings and does not
represent the maximum possible loss nor any expected actual loss, even under
adverse conditions, because actual adverse fluctuations would likely differ.
In addition, since the Company's investment portfolio is subject to change
based on its portfolio management strategy as well as in response to changes
in the market, these estimates are not necessarily indicative of the actual
results which may occur.
Exposure to market risk is managed and monitored by senior management.
Senior management approves the overall investment strategy employed by the
Company and has responsibility to ensure that the investment positions are
consistent with that strategy and the level of risk acceptable to it. The
106
Company may manage risk by buying or selling instruments or entering into
offsetting positions.
Equity Price Risk - The Company has exposure to equity price risk as a
result of its investment in equity securities and equity derivatives. Equity
price risk results from changes in the level or volatility of equity prices
which affect the value of equity securities or instruments that derive their
value from such securities or indexes. Equity price risk was measured assuming
an instantaneous 25% change in the underlying reference price or index from
its level at September 30, 2002 and December 31, 2001, with all other
variables held constant.
Interest Rate Risk - The Company has exposure to interest rate risk, arising
from changes in the level or volatility of interest rates. The Company
attempts to mitigate its exposure to interest rate risk by utilizing
instruments such as interest rate swaps, interest rate caps, commitments to
purchase securities, options, futures and forwards. The Company monitors its
sensitivity to interest rate risk by evaluating the change in the value of its
financial assets and liabilities due to fluctuations in interest rates. The
evaluation is performed by applying an instantaneous change in interest rates
of varying magnitudes on a static balance sheet to determine the effect such a
change in rates would have on the recorded market value of the Company's
investments and the resulting effect on shareholders' equity. The analysis
presents the sensitivity of the market value of the Company's financial
instruments to selected changes in market rates and prices which the Company
believes are reasonably possible over a one-year period.
The sensitivity analysis estimates the change in the market value of the
Company's interest sensitive assets and liabilities that were held on
September 30, 2002 and December 31, 2001 due to instantaneous parallel shifts
in the yield curve of 100 basis points, with all other variables held
constant.
The interest rates on certain types of assets and liabilities may fluctuate
in advance of changes in market interest rates, while interest rates on other
types may lag behind changes in market rates. Accordingly the analysis may not
be indicative of, is not intended to provide, and does not provide a precise
forecast of the effect of changes of market interest rates on the Company's
earnings or shareholders' equity. Further, the computations do not contemplate
any actions the Company could undertake in response to changes in interest
rates.
The Company's long-term debt as of September 30, 2002 and December 31, 2001
is denominated in U.S. Dollars. The Company's debt has been primarily issued
at fixed rates, and as such, interest expense would not be impacted by
interest rate shifts. The impact of a 100 basis point increase in interest
rates on fixed rate debt would result in a decrease in market value of $380.8
and $395.0 million at September 30, 2002 and December 31, 2001, respectively.
A 100 basis point decrease would result in an increase in market value of
$448.7 and $464.6 million at September 30, 2002 and December 31, 2001,
respectively.
Foreign Exchange Rate Risk - Foreign exchange rate risk arises from the
possibility that changes in foreign currency exchange rates will impact the
value of financial instruments. The Company has foreign exchange rate exposure
when it buys or sells foreign currencies or financial instruments denominated
in a foreign currency. This exposure is mitigated by the Company's
asset/liability matching strategy and through the use of futures for those
instruments which are not matched. The Company's foreign transactions are
107
primarily denominated in Canadian Dollars, British Pounds, and the European
Monetary Unit. The sensitivity analysis also assumes an instantaneous 20%
change in the foreign currency exchange rates versus the U.S. Dollar from
their levels at September 30, 2002 and December 31, 2001, with all other
variables held constant.
Commodity Price Risk - The Company has exposure to commodity price risk as a
result of its investments in gold options. Commodity price risk results from
changes in the level or volatility of commodity prices that impact instruments
which derive their value from such commodities. Commodity price risk was
measured assuming an instantaneous change of 20% from their levels at
September 30, 2002 and December 31, 2001.
The following tables present the Company's market risk by category (equity
markets, interest rates, foreign currency exchange rates and commodity prices)
on the basis of those entered into for trading purposes and other than trading
purposes.
Trading portfolio:
Category of risk exposure: Fair Value Asset (Liability) Market Risk
- ------------------------------------------------------------------------------------------------
September 30, December 31, September 30, December 31,
2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------
(Amounts in millions)
Equity markets (1):
Equity securities . . . . . . . . . . . . $ 434.1 $ 290.1 $(109.0) $(73.0)
Options - purchased . . . . . . . . . . . 27.0 17.5 1.0 6.0
- written . . . . . . . . . . . (26.4) (7.8) 6.0 (3.0)
Index futures - long (1.0) (2.0)
Short sales . . . . . . . . . . . . . . . (171.0) (193.4) 43.0 48.0
Separate Accounts - Equity securities (a) 9.4 11.7 (2.0)
- Other invested assets 317.5 342.1 (6.0) (6.0)
Interest rate (2):
Fixed maturities . . . . . . . . . . . . 285.5 677.8 (14.0) (27.0)
Short sales on government securities . . (501.8) (43.0)
Options on government securities - short (2.5) (2.0)
Euro futures - long . . . . . . . . . . . 19.0
- short . . . . . . . . . . (43.0)
Separate Accounts:
Fixed maturities . . . . . . . . . . . 172.3 308.4 4.0 (5.0)
Short-term investments . . . . . . . . 108.8
Commodities:
Gold (3):
Options - purchased . . . . . . . . . . 1.2 2.6 (1.0) (3.0)
- written . . . . . . . . . . . (1.3) (0.4) 1.0
- ------------------------------------------------------------------------------------------------
Note: The calculation of estimated market risk exposure is based on assumed adverse changes
in the underlying reference price or index of (1) a decrease in equity prices of 25%,
(2) a decrease in interest rates of 100 basis points at September 30, 2002 and an
increase in interest rates of 100 basis points at December 31, 2001 and (3) an increase
in gold prices of 20%. Adverse changes on options which differ from those presented above
would not necessarily result in a proportionate change to the estimated market risk
exposure.
(a) In addition, the Separate Accounts carry positions in equity index futures. A decrease
in equity prices of 25% would result in market risk amounting to $(132.0) and $(217.0)
at September 30, 2002 and December 31, 2001, respectively. This market risk would be
offset by decreases in liabilities to customers under variable insurance contracts.
108
Other than trading portfolio:
Category of risk exposure: Fair Value Asset (Liability) Market Risk
- ------------------------------------------------------------------------------------------------
September 30, December 31, September 30, December 31,
2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------
(Amounts in millions)
Equity markets (1):
Equity securities:
General accounts (a) . . . . . . . . . $ 932.3 $ 1,338.4 $ (230.0) $ (322.0)
Separate accounts . . . . . . . . . . 105.8 148.6 (26.0) (37.0)
Other invested assets . . . . . . . . . 1,430.7 1,306.9 (161.0) (134.0)
Separate accounts - Other invested assets 384.3 533.0 (96.0) (133.0)
Interest rate (2):
Fixed maturities (a) (b) . . . . . . . . 28,807.5 30,513.2 (1,763.0) (1,533.0)
Short-term investments (a) . . . . . . . 10,509.3 6,734.8 (8.0) (1.0)
Other derivative securities . . . . . . 5.3 16.3 46.0 (19.0)
Separate accounts (a):
Fixed maturities . . . . . . . . . . 1,947.3 2,038.8 (105.0) (120.0)
Short-term investments . . . . . . . . 104.0 98.0
Long-term debt . . . . . . . . . . . . . (5,756.2) (5,399.0)
- ------------------------------------------------------------------------------------------------
Note: The calculation of estimated market risk exposure is based on assumed adverse changes in
the underlying reference price or index of (1) a decrease in equity prices of 25% and (2)
an increase in interest rates of 100 basis points.
(a) Certain securities are denominated in foreign currencies. An assumed 20% decline in the
underlying exchange rates would result in an aggregate foreign currency exchange rate
risk of $(288.0), and $(114.0) at September 30, 2002 and December 31, 2001, respectively.
(b) Certain fixed maturities positions include options embedded in convertible debt
securities. A decrease in underlying equity prices of 25% would result in market risk
amounting to $(18.0) and $(50.0) at September 30, 2002 and December 31, 2001,
respectively.
Item 4. Controls and Procedures
The Company maintains a system of disclosure controls and procedures which
are designed to ensure that information required to be disclosed by the
Company in reports that it files or submits under the federal securities laws,
including this report, is recorded, processed, summarized and reported on a
timely basis. These disclosure controls and procedures include controls and
procedures designed to ensure that information required to be disclosed under
the federal securities laws is accumulated and communicated to the Company's
management on a timely basis to allow decisions regarding required disclosure.
The Company's principal executive officer and principal financial officer
have conducted an evaluation of the Company's disclosure controls and
procedures as of a date within 90 days prior to the date of this report. Based
on this evaluation, the Company's principal executive officer and principal
financial officer have each concluded that the Company's disclosure controls
and procedures are adequate for their intended purpose.
There were no significant changes in the Company's internal controls or in
other factors that could significantly affect these controls subsequent to the
date of their evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
109
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
-----------------
1. CNA is involved in various lawsuits including environmental pollution
claims. Information involving such lawsuits is incorporated by reference to
Note 9 of the Notes to Consolidated Condensed Financial Statements in Part I.
2. As noted in Item 3 Legal Proceedings of the Company's Report on Form 10-K
for the year ended December 31, 2001, Lorillard is defendant in various
lawsuits seeking damages for cancer and health effects claimed to have
resulted from the use of cigarettes or from exposure to tobacco smoke.
Information involving such lawsuits is incorporated by reference to such Item
3 Legal Proceedings. The Company is a defendant in some of these cases.
Material developments in relation to the foregoing are described below and
incorporated by reference to Note 13 of the Notes to Consolidated Condensed
Financial Statements in Part I.
CLASS ACTIONS -
In the case of Anderson v. The American Tobacco Company, Inc., et al. (U.S.
District Court, Middle District, Tennessee, filed May 23, 1997), the case has
been transferred from the District Court for the Eastern District of Tennessee
to the Middle District. Plaintiffs have amended their complaint and now assert
reimbursement claims on behalf of Tennessee taxpayers and no longer assert
claims on behalf of Tennessee smokers. In their amended complaint, plaintiffs
withdrew their claims against the Company.
In the case of Badillo v. American Tobacco Company, et al. (U.S. District
Court, Nevada, filed October 8, 1997), the court has dismissed the case.
In the case of Blankenship v. American Tobacco Company, et al. (Circuit
Court, County, West Virginia, filed January 31, 1997), the plaintiffs have
noticed an appeal to the Supreme Court of Appeals of West Virginia from the
judgment entered in favor of the defendants following a 2001 trial.
In the case of Christensen v. Philip Morris Companies, Inc., et al. (U.S.
District Court, Nevada, filed April 3, 1998), the court has dismissed the
case.
In the case of Cole v. The Tobacco Institute, et al. (U.S. District Court,
Eastern District, Texas, Texarkana Division, filed May 5, 1997), plaintiffs
did not file a petition for writ of certiorari with the U.S. Supreme Court and
no further appellate options are available to the plaintiffs.
In the case of Connor v. The American Tobacco Company, et al. (Second
Judicial District Court, Bernalillo County, New Mexico, filed October 10,
1996), the court has entered the parties' stipulation of dismissal with
prejudice, concluding the case.
In the case of Creekmore v. Brown & Williamson Tobacco Corporation, et al.
(Superior Court, Buncombe County, North Carolina, filed July 31, 1998), the
court has entered an order granting plaintiffs' motion to voluntarily dismiss
the case pursuant to a tolling agreement. The dismissal order tolls the
individual claims of the purported class representatives for one year.
In the case of Daniels v. Philip Morris Companies, Inc., et al. (Superior
Court, San Diego County, California, filed April 2, 1998), this matter is
110
discussed under "Legal Proceedings and Contingent Liability - Non-Insurance,
Tobacco Related - Class Actions."
In the case of Decie v. The American Tobacco Company, et al. (U.S. District
Court, Eastern District, New York, filed April 21, 2000), plaintiffs have
voluntarily dismissed the case.
In the case of Ebert v. Philip Morris Incorporated, et al. (U.S. District
Court, Eastern District, New York, filed August 9, 2000), the plaintiffs have
voluntarily dismissed the suit. The Company was named as a defendant in this
matter. None of the defendants ever received service of process.
In the case of Engle v. R.J. Reynolds Tobacco Company, et al. (Circuit
Court, Dade County, Florida, filed May 5, 1994), this matter is discussed
under "Legal Proceedings and Contingent Liability - Non-Insurance, Tobacco
Related - Class Actions."
In the case of In re Simon II (U.S. District Court, Eastern District, New
York, filed - 2000), this matter is discussed under "Legal Proceedings and
Contingent Liability - Non-Insurance, Tobacco Related - Significant Recent
Developments - Class Action Cases."
In the case of Johnson v. Newport Lorillard, et al. (U.S. District Court,
Southern District, New York, filed October 31, 2001), the court has entered an
order dismissing the case.
In the case of Norton v. RJR Nabisco Holdings Corporation, et al. (Superior
Court, Madison County, Indiana, filed May 3, 1996), the court has granted
plaintiffs' motion to voluntarily dismiss the case. The Company was a
defendant in the case.
In the case of Scott v. The American Tobacco Company, et al. (District
Court, Orleans Parish, Louisiana, filed May 24, 1996), this matter is
discussed under "Legal Proceedings and Contingent Liabilities - Non-Insurance,
Tobacco Related - Significant Recent Developments - Class Action Cases."
In the case of Simon v. Philip Morris Incorporated, et al. (U.S. District
Court, Eastern District, New York, filed April 9, 1999), the court has entered
the parties' stipulation of dismissal of the matter.
In the case of Trivisonno v. Philip Morris, Incorporated, et al. (U.S.
District Court, Northern District, Ohio, filed on or about January 14, 2002),
the court entered an order during July of 2002 that granted defendants' motion
to dismiss the case and entered final judgment in favor of the defendants.
In the case of Vandermeulen v. Philip Morris Companies, Inc., et al.
(Circuit Court, Wayne County, Michigan, filed September 18, 2000), the court
entered the parties' stipulation of dismissal.
The following additional Class Action Cases have been filed:
The case of Birchall v. Philip Morris Incorporated, et al. (U.S. District
Court, Nevada, filed July 10, 2002).
The case of Goldfarb v. Philip Morris Incorporated, et al. (U.S. District
Court, Nevada, filed July 25, 2002).
The case of Ellington v. Philip Morris Incorporated, et al. (U.S. District
Court, Nevada, filed July 31, 2002).
111
The case of Vandina v. Philip Morris Incorporated, et al. (U.S. District
Court, Nevada, filed July 31, 2002).
The case of Vavrek v. Philip Morris Incorporated, et al. (U.S. District
Court, Nevada, filed July 31, 2002).
The case of Martinez v. Philip Morris Incorporated, et al. (U.S. District
Court, Nevada, filed September 4, 2002).
The case of Ginsburg v. Philip Morris Incorporated, et al. (U.S. District
Court, Nevada, filed September 6, 2002).
The case of Hamil v. Philip Morris Incorporated, et al (U.S. District Court,
Nevada, filed September 6, 2002).
The case of Ramsden v. Philip Morris Incorporated, et al. (U.S. District
Court, Nevada, filed September 6, 2002).
The case of Deller v. Philip Morris Incorporated, et al. (U.S. District
Court, Nevada, filed September 9, 2002).
The case of Hudson v. Philip Morris Incorporated, et al. (U.S. District
Court, Nevada, filed September 9, 2002).
REIMBURSEMENT CASES -
U.S. Local Governmental Reimbursement Cases -
In the case of County of Wayne v. Philip Morris Incorporated, et al. (U.S.
District Court, Eastern District, Michigan, filed December 6, 1999), the court
has entered the parties' stipulation of dismissal with prejudice.
Reimbursement Cases Filed in U.S. Courts by Foreign Governments -
In the case of Republic of Venezuela v. Philip Morris Companies, et al.
(Circuit Court, Dade County, Florida, filed January 27, 1999), the Florida
Third District Court of Appeal has affirmed the final judgment entered in
favor of the defendants by the trial court. Plaintiff has filed a notice to
invoke the discretionary jurisdiction of the Florida Supreme Court. As of
November 6, 2002, the court had not issued a ruling on plaintiff's petition.
The Company is a defendant in the case but never received service of process.
In the case of State of Rio de Janeiro of the Federative Republic of Brazil
v. Philip Morris Companies, et al. (District Court, Angelina County, Texas,
filed July 12, 1999), the court granted all motions filed separately by each
defendant that contested the court's jurisdiction over the defendants under
the claims asserted by the plaintiff. The Company was a defendant in this
matter. As of November 6, 2002, the deadline for the plaintiff to seek any
relief from the rulings that dismissed the case had not expired.
Private Citizens' Reimbursement Cases -
In the case of Anderson v. The American Tobacco Company, Inc., et al. (U.S.
District Court, Middle District, Tennessee, filed as a smoking and health
class action on May 23, 1997; amended complaint filed in order to pursue
claims on behalf of Tennessee tax payers filed July 26, 2002), plaintiffs
amended their complaint and now assert reimbursement claims on behalf of
Tennessee tax payers and no longer assert claims on behalf of Tennessee
112
smokers. In their amended complaint, plaintiffs withdrew their claims against
the Company.
In the case of Mason v. The American Tobacco Company, et al. (filed in U.S.
District Court, Northern District, Texas; transferred to U.S. District Court,
Eastern District, New York, filed December 23, 1997), the court entered an
order during July of 2002 that denied plaintiffs' motion for class
certification and granted defendants' motion to dismiss the complaint.
Plaintiffs have noticed an appeal to the U.S. Court of Appeals for the Second
Circuit.
In the case of Temple v. The State of Tennessee, et al. (U.S. District
Court, Middle District, Tennessee, filed as individual smoking and health case
on February 7, 2000; amended complaint filed in order to expand plaintiffs'
claims, September 11, 2000), plaintiffs have amended their complaint and have
withdrawn their claims against the Company.
Reimbursement Case Filed by American Indian Tribes -
In the case of The Alabama Coushatta Tribe of Texas v. American Tobacco
Company, et al. (U.S. District Court, Eastern District, Texas, filed August
30, 2000), the U.S. Court of Appeals for the Fifth Circuit entered an order
during 2002 that affirmed the final judgment entered in defendants' favor by
the trial court during 2001. The Court of Appeals subsequently denied
plaintiff's petition for rehearing.
Reimbursement Cases Filed by Hospital District -
The following additional Hospital District Reimbursement Case has been filed:
Jefferson County [Alabama] v. Philip Morris, Inc., et al. (Circuit Court,
Jefferson County, Alabama, filed October 10, 2002).
Reimbursement Cases Filed by Private Companies -
In the case of Group Health Plan, Inc., et al. v. Philip Morris
Incorporated, et al. (U.S. District Court, Minnesota, filed March 11, 1998),
plaintiffs have noticed an appeal to the U.S. Court of Appeal for the Eighth
Circuit from the trial court's order that granted defendants' motion for
summary judgment.
The following additional Private Company Reimbursement Case has been filed:
Clalit Health Services v. Philip Morris Inc., et al. (District Court,
Jerusalem, Israel, motion to issue summons to Loews and Lorillard granted
during 2002). The Company is a purported defendant in this action. The Company
and Lorillard have filed motions to set aside the court's order that permitted
attempted service of the summonses directed to them.
Reimbursement Cases Filed by Labor Unions -
In the case of Bergeron, et al. v. Philip Morris Incorporated, et al. (U.S.
District Court, Eastern District, New York, filed September 29, 1999), the
court has entered the parties' stipulation of dismissal with prejudice. The
Company was a defendant in the case. Plaintiffs were the trustees of the
Massachusetts State Carpenters Health Benefits Fund.
113
In the case of Central Laborers Welfare Fund, et al. v. Philip Morris, Inc.,
et al. (Circuit Court, Madison County, Illinois, filed on June 9, 1997),
plaintiffs voluntarily dismissed the case during April of 2002.
In the case of Holland, et al., Trustees of United Mine Workers v. Philip
Morris Incorporated, et al. (U.S. District Court, District of Columbia, filed
July 9, 1998), an order dismissing the case has been entered.
In the case of National Asbestos Workers, et al. v. Philip Morris
Incorporated, et al. (U.S. District Court, Eastern District, New York, filed
February 27, 1998), plaintiffs have voluntarily dismissed the case. The
Company was a defendant in the case.
In the case of S.E.I.U. v. Philip Morris, Inc., et al. (U.S. District Court,
District of Columbia, filed June 22, 1998), an order dismissing the case has
been entered.
In the case of Service Employees International Union Health & Welfare Fund,
et al. v. Philip Morris, Inc., et al. (U.S. District Court, District of
Columbia, filed March 19, 1998), an order dismissing the case has been
entered.
In the case of Sheet Metal Workers Trust Fund, et al. v. Philip Morris,
Inc., et al. (U.S. District Court, District of Columbia, filed August 31,
1999), an order dismissing the case has been entered.
CONTRIBUTION CASES -
In the case of Gasket Holdings, Inc., et al. v. RJR Nabisco, Inc., et al.
(Chancery Court, Claiborne County, Mississippi, filed April 18, 2001),
plaintiffs have voluntarily dismissed the case without prejudice.
In the case of Keene Creditors Trust v. Brown & Williamson Tobacco
Corporation, et al. (Supreme Court, New York County, New York, filed December
19, 1997), plaintiff has voluntarily dismissed the case. The Company was a
defendant in this matter.
In the case of Raymark Industries v. R.J. Reynolds Tobacco Company, et al.
(Circuit Court, Duval County, Florida, filed September 15, 1997), plaintiff
has voluntarily dismissed the case. The Company was a defendant in the case
but never received service of process.
In the case of Raymark Industries v. R.J. Reynolds Tobacco Co., et al.
(Circuit Court, Duval County, Florida, filed December 31, 1997), plaintiff has
voluntarily dismissed the case.
In the case of Raymark Industries v. The American Tobacco Company, et al.
(U.S. District Court, Eastern District, New York, filed January 30, 1998), the
court has entered the parties' stipulation of dismissal with prejudice.
TOBACCO-RELATED ANTITRUST CASES -
Wholesalers And Direct Purchaser Suits -
In the case of Holiday Markets, Inc., et al. v. Philip Morris Companies,
Inc., et al (U.S. District Court, Northern District, Georgia, filed March 17,
2000), and eight other separate cases that were brought in federal courts by
tobacco product wholesalers against cigarette manufacturers alleging
violations of antitrust laws, and consolidated together for pre-trial purposes
114
in the U.S. District Court for the Northern District of Georgia, the court
granted defendants motion for summary judgment and dismissed the cases in
their entirety.
Indirect Purchaser Suits -
In the case of Shafer v. Philip Morris Companies, Inc. et al. (District
Court, South Central Judicial District, Morton County, North Dakota, filed
April 18, 2000), the court denied defendants' motion to dismiss.
In the case of Del Serrone v. Philip Morris Companies, Inc. et al, (Circuit
Court, Wayne County, Michigan, filed February 8, 2000) the court denied
plaintiff's motion for class certification.
In the case of Gray v. Philip Morris Companies, Inc., et al. (Superior
Court, Pima County, Arizona, filed February 11, 2000), the court dismissed the
case in its entirety as to all defendants. On appeal, the appellate court
reversed the dismissal and reinstated the case.
Reparation cases:
The following Reparation Cases have been filed:
Bankhead v. Lloyd's of London, et al. (U.S. District Court, Southern District,
New York, filed September 3, 2002). The Company has not received service of
process of this matter.
Hurdle v. Fleetboston Financial Corporation, et al. (U.S. District Court,
Northern District, California, filed September 10, 2002). The Company has not
received service of process of this matter.
Johnson v. AETNA Life Insurance Company, et al. (U.S. District Court, Eastern
District, Louisiana, filed September 3, 2002). The Company is a named
defendant in this matter.
Item 5. Other Information
-----------------
On October 31, 2002 CNA consummated the sale of its wholly owned United
Kingdom subsidiaries of CNA Re ("CNA Re U.K.") to Tawa U.K. Limited, a
subsidiary of Artemis Group, a French conglomerate, pursuant to the share
purchase agreement dated July 15, 2002. The Company has prepared pro forma
financial statements in accordance with Item 2 of Form 8-K, which are included
as exhibits to this Report.
115
Item 6. Exhibits and Reports on Form 8-K.
--------------------------------
(a) Exhibits--
Description of Exhibit Number
---------------------- ------
Share Purchase Agreement dated as of October 31, 2002 by and
between CNA and Tawa U.K. Limited . . . . . . . . . . . . . . . . . 2.1
Pro Forma Financial Statements and Footnotes . . . . . . . . . . 99.1
Pro Forma Consolidated Condensed Balance Sheet at
September 30, 2002 (Unaudited)
Pro Forma Consolidated Condensed Statements of Operations
for the Year Ended December 31, 2001 (Unaudited)
Pro Forma Consolidated Condensed Statements of Operations
for the Nine Months Ended September 30, 2002 (Unaudited)
(b) Current reports on Form 8-K -- On August 13, 2002, Registrant filed a
report on Form 8-K regarding statements under oath of the Principal Executive
Officer and Principal Financial Officer in connection with the Company's
quarterly report on Form 10-Q for the quarter ended June 30, 2002.
116
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
LOEWS CORPORATION
-------------------------
(Registrant)
Dated: November 13, 2002 By /s/ Peter W. Keegan
-------------------------
PETER W. KEEGAN
Senior Vice President and
Chief Financial Officer
(Duly authorized officer
and principal financial
officer)
117
CERTIFICATIONS
I, James S. Tisch, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Loews Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Dated: November 13, 2002 By /s/ James S. Tisch
-------------------------
JAMES S. TISCH
President and
Chief Executive Officer
118
CERTIFICATIONS
I, Peter W. Keegan, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Loews Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) Designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Dated: November 13, 2002 By /s/ Peter W. Keegan
-------------------------
PETER W. KEEGAN
Senior Vice President and
Chief Financial Officer
119
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