==============================================================================
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, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
-------- --------
Commission file number 1-6541
LOEWS CORPORATION
(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
(Address of principal executive offices) (Zip code)
(212) 521-2000
(Registrant's telephone number, including area code)
NOT APPLICABLE
(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
------ ------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
------ ------
Class Outstanding at November 7, 2003
- ------------------------------ -------------------------------
Common stock, $1.00 par value 185,447,050 shares
Carolina Group stock, $0.01 par value 39,910,000 shares
==============================================================================
1
INDEX
Page
Part I. Financial Information No.
-----
Item 1. Financial Statements
Consolidated Condensed Balance Sheets
September 30, 2003 and December 31, 2002 3
Consolidated Condensed Statements of Operations
Three and Nine months ended September 30, 2003 and 2002 4
Consolidated Condensed Statements of Cash Flows
Nine months ended September 30, 2003 and 2002 6
Notes to Consolidated Condensed Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 71
Item 3. Quantitative and Qualitative Disclosures about Market Risk 145
Item 4. Disclosure Controls and Procedures 149
Part II. Other Information
Item 1. Legal Proceedings 149
Item 6. Exhibits and Reports on Form 8-K 155
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED BALANCE SHEETS
- ------------------------------------------------------------------------------------------------
(In millions)
September 30, December 31,
2003 2002
- ------------------------------------------------------------------------------------------------
Assets
Investments:
Fixed maturities, amortized cost of $27,545.0 and $26,688.8 $28,859.2 $27,433.7
Equity securities, cost of $655.1 and $1,002.8 897.0 1,120.5
Other investments 1,653.3 1,420.8
Short-term investments 11,307.4 10,161.7
- ------------------------------------------------------------------------------------------------
Total investments 42,716.9 40,136.7
Cash 233.4 185.4
Receivables-net 19,892.0 16,601.0
Property, plant and equipment-net 3,862.3 3,138.2
Deferred income taxes 425.6 627.2
Goodwill 442.9 177.8
Other assets 4,025.9 3,999.2
Deferred acquisition costs of insurance subsidiaries 2,662.0 2,551.4
Separate account business 3,532.6 3,102.7
- ------------------------------------------------------------------------------------------------
Total assets $77,793.6 $70,519.6
================================================================================================
Liabilities and Shareholders' Equity:
Insurance reserves:
Claim and claim adjustment expense $32,264.3 $27,369.9
Future policy benefits 7,949.2 7,408.9
Unearned premiums 5,237.2 4,820.0
Policyholders' funds 603.1 580.1
- ------------------------------------------------------------------------------------------------
Total insurance reserves 46,053.8 40,178.9
Payable for securities purchased 1,434.1 799.1
Securities sold under agreements to repurchase 880.6 552.4
Long-term debt, less unamortized discount 6,075.2 5,651.9
Reinsurance balances payable 3,285.9 2,763.3
Other liabilities 4,337.9 4,340.8
Separate account business 3,532.6 3,102.7
- ------------------------------------------------------------------------------------------------
Total liabilities 65,600.1 57,389.1
Minority interest 1,710.2 1,895.3
Shareholders' equity 10,483.3 11,235.2
- ------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $77,793.6 $70,519.6
================================================================================================
See accompanying Notes to Consolidated Condensed Financial Statements.
3
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
- ------------------------------------------------------------------------------------------------
(In millions)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2003 2002 2003 2002
---------------------------------------------------
(Restated) (Restated)
Revenues:
Insurance premiums $ 2,125.2 $ 2,261.4 $ 6,701.0 $ 7,922.9
Investment income, net of expense 373.4 396.8 1,275.2 1,399.7
Investment gains (losses) 179.5 26.5 503.2 (145.0)
Manufactured products (including excise
taxes of $173.1, $161.5, $493.4 and $518.0) 880.1 1,004.4 2,578.4 3,077.2
Other 381.8 382.2 1,067.5 1,241.6
- -----------------------------------------------------------------------------------------------
Total 3,940.0 4,071.3 12,125.3 13,496.4
- -----------------------------------------------------------------------------------------------
Expenses:
Insurance claims and policyholders'
benefits 4,032.2 1,850.1 7,968.9 6,542.4
Amortization of deferred acquisition
costs 494.5 447.7 1,433.7 1,349.2
Cost of manufactured products sold 532.7 553.2 1,489.6 1,761.4
Other operating expenses 1,350.3 731.1 2,968.4 2,384.1
Interest 80.9 77.1 230.3 231.8
- -----------------------------------------------------------------------------------------------
Total 6,490.6 3,659.2 14,090.9 12,268.9
- -----------------------------------------------------------------------------------------------
(2,550.6) 412.1 (1,965.6) 1,227.5
- -----------------------------------------------------------------------------------------------
Income tax (benefit) expense (916.4) 156.5 (735.3) 449.2
Minority interest (195.5) 16.9 (196.8) 59.2
- -----------------------------------------------------------------------------------------------
Total (1,111.9) 173.4 (932.1) 508.4
- -----------------------------------------------------------------------------------------------
(Loss) income from continuing operations (1,438.7) 238.7 (1,033.5) 719.1
Discontinued operations-net 55.8 0.4 55.4 (28.8)
Cumulative effect of change in
accounting principle-net (39.6)
- -----------------------------------------------------------------------------------------------
Net (loss) income $(1,382.9) $ 239.1 $ (978.1) $ 650.7
===============================================================================================
Net (loss) income attributable to:
Loews common stock:
(Loss) income from continuing operations $(1,465.5) $ 194.3 $(1,113.9) $ 615.3
Discontinued operations-net 55.8 0.4 55.4 (28.8)
Cumulative effect of change in
accounting principle-net (39.6)
- -----------------------------------------------------------------------------------------------
Loews common stock (1,409.7) 194.7 (1,058.5) 546.9
Carolina Group stock 26.8 44.4 80.4 103.8
- ----------------------------------------------------------------------------------------------
Total $(1,382.9) $ 239.1 $ (978.1) $ 650.7
==============================================================================================
4
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS (Continued)
- ------------------------------------------------------------------------------------------------
(In millions, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -------------------------
2003 2002 2003 2002
---------------------------------------------------
(Restated) (Restated)
(Loss) income per share of Loews common stock:
(Loss) income from continuing operations $ (7.90) $ 1.05 $ (6.01) $ 3.26
Discontinued operations-net 0.30 0.30 (0.15)
Cumulative effect of change in
accounting principle-net (0.21)
- ------------------------------------------------------------------------------------------------
Net (loss) income $ (7.60) $ 1.05 $ (5.71) $ 2.90
================================================================================================
Net income per share of Carolina Group stock $ 0.67 $ 1.10 $ 2.01 $ 2.58
================================================================================================
Weighted average number of shares
outstanding:
Loews common stock 185.45 185.71 185.45 188.31
Carolina Group stock 39.91 40.19 39.91 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,
-------------------------
2003 2002
-------------------------
Restated
Operating Activities:
Net income $ (978.1) $ 650.7
Adjustments to reconcile net (loss) income to net cash (used)
provided by operating activities-net (87.5) 316.8
(Gain) loss on disposal of discontinued operations (56.7) 32.8
Cumulative effect of change in accounting principle-net 39.6
Changes in assets and liabilities-net:
Reinsurance receivable (2,421.4) 167.3
Other receivables (35.7) 520.5
Federal income taxes (619.9) 845.7
Prepaid reinsurance premiums (42.7) (196.1)
Deferred acquisition costs (127.5) (129.7)
Insurance reserves and claims 5,880.4 (664.3)
Reinsurance balances payable 522.6 309.0
Other liabilities 4.6 56.4
Trading securities 132.2 (529.1)
Other-net 135.6 (20.3)
- -----------------------------------------------------------------------------------------------
2,305.9 1,399.3
- ------------------------------------------------------------------------------------------------
Investing Activities:
Purchases of fixed maturities (56,469.5) (61.756.9)
Proceeds from sales of fixed maturities 45,635.2 59,354.8
Proceeds from maturities of fixed maturities 10,336.3 4,520.8
Securities sold under agreements to repurchase 328.2 (390.7)
Purchases of equity securities (342.0) (746.1)
Proceeds from sales of equity securities 430.9 816.4
Change in short-term investments (1,166.9) (3,102.3)
Purchases of property, plant and equipment (370.3) (325.8)
Proceeds from sales of property, plant and equipment 106.0 102.2
Change in other investments 79.7 (234.3)
Purchase of Texas Gas Transmission, LLC (803.3)
- ------------------------------------------------------------------------------------------------
(2,235.7) (1,761.9)
- ------------------------------------------------------------------------------------------------
Financing Activities:
Dividends paid to Loews shareholders $ (137.5) $ (120.8)
Dividends paid to minority interests (22.6) (30.1)
Issuance of Loews common stock 0.2 0.5
Issuance of Carolina Group stock 1,069.6
Purchases of Loews treasury shares (351.2)
Purchases of treasury shares by subsidiaries (30.6)
Principal payments on long-term debt (547.3) (85.4)
Issuance of long-term debt 706.4 65.0
Receipts credited to policyholders 0.7 0.4
Withdrawals of policyholders account balances (19.4) (36.4)
Other (2.7) 9.1
- ------------------------------------------------------------------------------------------------
(22.2) 490.1
- ------------------------------------------------------------------------------------------------
Net change in cash 48.0 127.5
Cash, beginning of period 185.4 181.3
- ------------------------------------------------------------------------------------------------
Cash, end of period $ 233.4 $ 308.8
================================================================================================
See accompanying Notes to Consolidated Condensed Financial Statements.
6
Loews Corporation and Subsidiaries
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------
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); the operation of an interstate natural gas transmission pipeline
system (Texas Gas Transmission, LLC ("Texas Gas"), a wholly owned subsidiary);
and the distribution and sale of watches and clocks (Bulova Corporation
("Bulova"), a 97% owned subsidiary).
In May of 2003, a subsidiary of the Company acquired 100% of the capital
stock of Texas Gas Transmission Corporation (now known as Texas Gas
Transmission, LLC) from The Williams Companies, Inc. The transaction value was
approximately $1.05 billion. See Note 9 for additional discussion of the Texas
Gas acquisition.
Unless the context otherwise requires, the terms "Company" and "Registrant"
as used herein mean Loews Corporation excluding its subsidiaries.
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, 2003 and December 31, 2002 and the results of operations for the
three and nine months ended September 30, 2003 and 2002 and changes in cash
flows for the nine months ended September 30, 2003 and 2002.
Results of operations for the third quarter and the first nine months of
each of the years reported herein is not necessarily indicative of results of
operations for that entire year.
Reference is made to the Notes to Consolidated Financial Statements in the
2002 Annual Report to Shareholders on Form 10-K which should be read in
conjunction with these consolidated condensed financial statements.
Certain amounts applicable to prior periods have been reclassified to
conform to the classifications followed in 2003.
Restatement for CNA's Life Settlement Contract Accounting - As a result of a
routine review of CNA's periodic filings by the Division of Corporation
Finance of the Securities and Exchange Commission, the Company has restated
its results of operations prior to September 30, 2002. The restated financial
statements for the periods ended September 30, 2002 reflect an adjustment to
the Company's historical accounting for CNA's investment in life settlement
contracts and the related revenue recognition. The impact of this adjustment
on operating results was insignificant.
Accounting Changes - Effective January 1, 2002, in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other
Intangible Assets," the Company recorded a $39.6 million goodwill impairment
charge as a cumulative effect of a change in accounting principle, adjusted to
reflect purchase accounting adjustments, net of income taxes and minority
7
interest of $5.8 and $6.4 million, respectively, primarily related to CNA's
Specialty Lines and Life Operations.
In June of 2001, the Financial Accounting Standards Board ("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 in
January 2003 has not had a material impact on the Company's results of
operations or equity.
In January of 2003, the FASB issued Interpretation No. ("FIN") 46,
"Consolidation of Variable Interest Entities, an Interpretation of ARB No.
51." This Interpretation clarifies the application of ARB No. 51,
"Consolidated Financial Statements," to certain entities in which equity
investors do not have the characteristics of a controlling financial interest.
Prior to the issuance of this Interpretation, ARB No. 51 defined a controlling
financial interest as ownership of a majority voting interest. FIN 46 requires
an entity to consolidate a variable interest entity even though the entity
does not, either directly or indirectly, own more than 50% of the outstanding
voting shares. FIN 46 defines a variable interest entity as having one or both
of the following characteristics (1) the equity investment at risk is not
sufficient to permit the entity to finance its activities without additional
subordinated financial support from other parties or (2) the equity investors
lack one or more of the following (a) the direct or indirect ability to make
decisions about the entity's activities through voting rights or similar
rights, (b) the obligation to absorb the expected losses of the entity, if
they occur, which makes it possible for the entity to finance its activities
and (c) the right to receive the expected residual returns of the entity, if
they occur, which is the compensation for the risk of absorbing the expected
losses. FIN 46 applies immediately to variable interest entities created after
January 31, 2003, and for variable interest entities created before February
1, 2003, no later than the first interim or annual period ending after
December 15, 2003. The Company is currently evaluating the impact FIN 46 may
have on its consolidated financial statements.
On April 30, 2003 the FASB issued SFAS No. 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. SFAS No. 149 is effective for contracts entered into or modified
after June 30, 2003 and for hedging relationships designated after June 30,
2003. The adoption of SFAS No. 149 did not have a significant impact on the
results of operations or equity of the Company.
On May 15, 2003, the FASB issued SFAS No. 150, "Accounting for Certain
Financial Instruments with characteristics of both Liabilities and Equity."
SFAS No. 150 establishes standards for classifying and measuring as
liabilities certain financial instruments that embody obligations of the
issuer and have characteristics of both liabilities and equity. SFAS No. 150
modifies the accounting and financial statement disclosures of three types of
financial instruments that, under previous guidance, issuers could account for
as equity. The Company did not have any financial instruments outstanding to
which the provisions of SFAS No. 150 apply, therefore the adoption of SFAS No.
150 did not have a material impact on the equity or results of operations of
the Company.
8
In July of 2003, the Accounting Standards Executive Committee ("AcSEC") of
the American Institute of Certified Public Accountants ("AICPA") issued
Statement of Position ("SOP") 03-01, "Accounting and Reporting by Insurance
Enterprises for Certain Nontraditional Long-Duration Contracts and for
Separate Accounts". SOP 03-01 provides guidance on accounting and reporting by
insurance enterprises for certain nontraditional long-duration contracts and
for separate accounts. SOP 03-01 is effective for financial statements for
fiscal years beginning after December 15, 2003. SOP 03-01 may not be applied
retroactively to prior years' financial statements, and initial application
should be as of the beginning of an entity's fiscal year. The Company will
adopt SOP 03-01 as of January 1, 2004. The Company is in the process of
evaluating the effect of SOP 03-01.
Stock option plans - The Company has elected to follow Accounting Principles
Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees" and
related interpretations in accounting for its employee stock options and
awards. Under APB No. 25, no compensation expense is recognized when the
exercise prices of options equals the fair value (market price) of the
underlying stock on the date of grant.
SFAS No. 123, "Accounting for Stock-Based Compensation," requires the
Company to disclose pro forma information regarding option grants made to its
employees. SFAS No. 123 specifies certain valuation techniques that produce
estimated compensation charges for purposes of valuing stock option grants.
These amounts have not been included in the Company's Consolidated Condensed
Statements of Income, in accordance with APB No. 25. Several of the Company's
subsidiaries also maintain their own stock option plans. The pro forma effect
of applying SFAS No. 123 includes the Company's share of expense related to
its subsidiaries' plans as well. The Company's pro forma net (loss) income and
the related basic and diluted income per share of Loews common stock and
Carolina Group stock would have been as follows:
9
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -------------------------
2003 2002 2003 2002
---------------------------------------------------
(In millions, except per share data)
Net (loss) income:
Loews common stock:
Net (loss) income as reported $(1,409.7) $ 194.7 $(1,058.5) $ 546.9
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method, net (1.3) (1.1) (3.9) (3.0)
- -----------------------------------------------------------------------------------------------
Pro forma net (loss) income $(1,411.0) $ 193.6 $(1,062.4) $ 543.9
================================================================================================
Carolina Group stock:
Net income as reported $ 26.8 $ 44.4 $ 80.4 $ 103.8
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method, net (0.1)
- ------------------------------------------------------------------------------------------------
Pro forma net income $ 26.8 $ 44.4 $ 80.3 $ 103.8
================================================================================================
Net (loss) income per share:
Loews common stock:
As reported $ (7.60) $ 1.05 $ (5.71) $ 2.90
Pro forma (7.61) 1.04 (5.73) 2.89
Carolina Group stock:
As reported 0.67 1.10 2.01 2.58
Pro forma 0.67 1.10 2.01 2.58
================================================================================================
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, 2003 and 2002, comprehensive (loss) income totaled
$(1,703.2), $476.8, $(614.6) and $856.8 million, respectively. Comprehensive
income includes net income, unrealized appreciation (depreciation) of
investments and foreign currency translation gains or losses.
10
2. Investments
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -------------------------
2003 2002 2003 2002
---------------------------------------------------
(In millions)
Investment income consisted of:
Fixed maturity securities $ 419.0 $ 469.9 $ 1,274.5 $ 1,437.0
Short-term investments 20.3 34.7 74.8 92.5
Limited partnerships 61.1 (72.8) 158.8 (28.3)
Equity securities 5.3 12.0 17.3 28.9
Interest expense on funds withheld and
other deposits (147.6) (53.4) (287.8) (167.9)
Other 28.5 38.0 94.0 99.5
- ------------------------------------------------------------------------------------------------
Total investment income 386.6 428.4 1,331.6 1,461.7
Investment expenses (13.2) (31.6) (56.4) (62.0)
- ------------------------------------------------------------------------------------------------
Investment income, net of expense $ 373.4 $ 396.8 $ 1,275.2 $ 1,399.7
================================================================================================
Investment gains (losses) are as follows:
Trading securities:
Derivative instruments $ 27.7 $ (16.3) $ 10.1 $ (19.5)
Equity securities, including short
positions 22.2 (49.8) 30.8 (87.1)
- ------------------------------------------------------------------------------------------------
49.9 (66.1) 40.9 (106.6)
Other than trading:
Fixed maturities 10.4 118.4 370.4 (45.0)
Equity securities 30.5 (16.6) 88.6 32.3
Short?term investments (1.7) 43.7 1.9 77.4
Other, including guaranteed separate
account business 90.4 (52.9) 1.4 (103.1)
- ------------------------------------------------------------------------------------------------
Investment gains (losses) 179.5 26.5 503.2 (145.0)
Income tax (expense) benefit (64.4) (9.2) (174.4) 52.7
Minority interest (8.6) (8.2) (28.2) (0.7)
- ------------------------------------------------------------------------------------------------
Investment gains (losses)-net $ 106.5 $ 9.1 $ 300.6 $ (93.0)
================================================================================================
Realized investment losses included $9.0, $129.6, $176.4 and $309.0 million
(after tax and minority interest) of other than temporary impairment losses
for the three and nine months ended September 30, 2003 and 2002. The
impairment losses were recorded primarily in the forestry sector for the three
months ended September 30, 2003 and impairment losses were recorded primarily
in the communications sector for the same period in 2002. Impairment losses
were recorded across several sectors, including the airline, health care and
energy industries, for the nine months ended September 30, 2003 and impairment
losses were recorded primarily in the communications sector for the same
period in 2002.
3. Earnings Per Share
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 (loss) income attributable to each class of common
11
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, 2003 and 2002, (loss) income per common share
assuming dilution is the same as basic (loss) income per share because the
impact of securities that could potentially dilute basic (loss) income per
common share is insignificant or antidilutive for the periods presented.
Options to purchase 0.88, 0.31, 0.86 and 0.28 million shares of Loews common
stock were outstanding for the three and nine months ended September 30, 2003
and 2002, respectively, but were not included in the computation of diluted
earnings per share because the options' exercise prices were greater than the
average market price of the common shares and, therefore, the effect would be
antidilutive. Options to purchase 0.18, 0.20, 0.37 and 0.20 million shares of
Carolina Group stock were outstanding for the three and nine months ended
September 30, 2003 and 2002, but were not included in the computation of
diluted earnings per share because the options' exercise prices were greater
than the average market price of the common shares and, therefore, the effect
would be antidilutive.
The attribution of (loss) income to each class of common stock was as
follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2003 2002 2003 2002
----------------------------------------------------
(In millions)
Loews common stock:
Consolidated net (loss) income $(1,382.9) $ 239.1 $ (978.1) $ 650.7
Less income attributable to
Carolina Group stock 26.8 44.4 80.4 103.8
- ------------------------------------------------------------------------------------------------
(Loss) income attributable to Loews
common stock $(1,409.7) $ 194.7 $(1,058.5) $ 546.9
================================================================================================
Carolina Group stock:
Carolina Group net income $ 116.4 $ 191.7 $ 349.2 $ 521.2
Less net income for January 2002 73.1
- ------------------------------------------------------------------------------------------------
Income available to Carolina Group stock 116.4 191.7 349.2 448.1
Weighted average economic interest of the
Carolina Group stock 23.01% 23.14% 23.01% 23.16%
- ------------------------------------------------------------------------------------------------
Income attributable to
Carolina Group stock $ 26.8 $ 44.4 $ 80.4 $ 103.8
================================================================================================
12
4. Loews and Carolina Group Consolidating Condensed Financial Information
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. This stock is designed to track the performance of the Carolina
Group, which consists of the Company's ownership interest in Lorillard;
notional, intergroup debt owed by the Carolina Group to the Loews Group ($2.2
billion outstanding at September 30, 2003), 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.
The issuance of Carolina Group stock has resulted in a two class common
stock structure for the Company. During the year ended December 31, 2002, the
Company purchased, for the account of the Carolina Group, 340,000 shares of
Carolina Group stock. As of September 30, 2003, 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 23.01% economic interest represented by the
outstanding Carolina Group stock, and includes as an asset the notional,
intergroup debt of the Carolina Group. 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.
The Company has separated, for financial reporting purposes, the Carolina
Group and Loews Group. The following schedules present the consolidating
condensed financial information for these individual groups. Neither group is
a separate company or legal entity. Rather, each group is intended to reflect
a defined set of assets and liabilities.
13
Loews and Carolina Group
Consolidating Condensed Balance Sheet Information
Carolina Group Adjustments
------------------------------------ Loews and
September 30, 2003 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Assets:
Investments $1,978.4 $ 100.0 $ 2,078.4 $ 40,638.5 $42,716.9
Cash 1.7 0.5 2.2 231.2 233.4
Receivables-net 31.1 31.1 19,890.8 $ (29.9) (a) 19,892.0
Property, plant and
equipment-net 206.8 206.8 3,655.5 3,862.3
Deferred income taxes 457.0 457.0 (31.4) (c) 425.6
Goodwill 442.9 442.9
Other assets 415.9 415.9 3,610.0 4,025.9
Investment in combined
attributed net assets
of the Carolina Group 1,570.6 (2,163.2) (a)
592.6 (b)
Deferred acquisition
costs of insurance
subsidiaries 2,662.0 2,662.0
Separate account business 3,532.6 3,532.6
- ------------------------------------------------------------------------------------------------
Total assets $3,090.9 $ 100.5 $ 3,191.4 $ 76,234.1 $(1,631.9) $77,793.6
================================================================================================
Liabilities and Shareholders' Equity:
Insurance reserves $ 46,053.8 $46,053.8
Payable for securities
purchased $ 249.4 $ 249.4 1,184.7 1,434.1
Securities sold under
agreements to repurchase 880.6 880.6
Long-term debt, less
unamortized discount $ 2,163.2 2,163.2 6,075.2 $(2,163.2) (a) 6,075.2
Deferred income taxes 31.4 (31.4) (c)
Reinsurance balances
payable 3,285.9 3,285.9
Other liabilities 1,529.9 18.6 1,548.5 2,819.3 (29.9) (a) 4,337.9
Separate account business 3,532.6 3,532.6
- ------------------------------------------------------------------------------------------------
Total liabilities 1,779.3 2,181.8 3,961.1 63,863.5 (2,224.5) 65,600.1
Minority interest 1,710.2 1,710.2
Shareholders' equity 1,311.6 (2,081.3) (769.7) 10,660.4 592.6 (b) 10,483.3
- ------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $3,090.9 $ 100.5 $ 3,191.4 $ 76,234.1 $(1,631.9) $77,793.6
================================================================================================
(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 reclass debit and credit balances to the amounts in consolidation.
14
Loews and Carolina Group
Consolidating Condensed Balance Sheet Information
Carolina Group Adjustments
------------------------------------ Loews and
December 31, 2002 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Assets:
Investments $ 1,640.7 $ 150.3 $1,791.0 $38,345.7 $40,136.7
Cash 2.0 0.2 2.2 183.2 185.4
Receivables-net 30.2 30.2 16,603.9 $ (33.1) (a) 16,601.0
Property, plant and
equipment-net 197.8 197.8 2,940.4 3,138.2
Deferred income taxes 437.0 437.0 190.2 627.2
Goodwill 177.8 177.8
Other assets 469.2 469.2 3,530.0 3,999.2
Investment in combined
attributed net assets
of the Carolina Group 1,757.9 (2,438.1) (a)
680.2 (b)
Deferred acquisition
costs of insurance
subsidiaries 2,551.4 2,551.4
Separate account business 3,102.7 3,102.7
- ------------------------------------------------------------------------------------------------
Total assets $ 2,776.9 $ 150.5 $2,927.4 $69,383.2 $(1,791.0) $70,519.6
================================================================================================
Liabilities and Shareholders' Equity:
Insurance reserves $40,178.9 $40,178.9
Payable for securities
purchased 799.1 799.1
Securities sold under
agreements to repurchase 552.4 552.4
Long-term debt, less
unamortized discount $ 2,438.1 $ 2,438.1 5,651.9 $(2,438.1) (a) 5,651.9
Reinsurance balances
payable 2,763.3 2,763.3
Other liabilities $ 1,352.1 20.7 1,372.8 3,001.1 (33.1) (a) 4,340.8
Separate account business 3,102.7 3,102.7
- ------------------------------------------------------------------------------------------------
Total liabilities 1,352.1 2,458.8 3,810.9 56,049.4 (2,471.2) 57,389.1
Minority interest 1,895.3 1,895.3
Shareholders' equity 1,424.8 (2,308.3) (883.5) 11,438.5 680.2 (b) 11,235.2
- ------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $ 2,776.9 $ 150.5 $ 2,927.4 $69,383.2 $(1,791.0) $70,519.6
================================================================================================
(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.
15
Loews and Carolina Group
Consolidating Condensed Statement of Operations Information
Carolina Group Adjustments
Three Months Ended ------------------------------------ Loews and
September 30, 2003 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $2,125.2 $ 2,125.2
Investment income, net $ 11.2 $ 0.5 $ 11.7 406.9 $(45.2)(a) 373.4
Investment (losses) gains (8.8) (8.8) 188.3 179.5
Manufactured products 842.8 842.8 37.3 880.1
Other 381.8 381.8
- ------------------------------------------------------------------------------------------------
Total 845.2 0.5 845.7 3,139.5 (45.2) 3,940.0
- ------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' Benefits 4,032.2 4,032.2
Amortization of deferred
acquisition costs 494.5 494.5
Cost of manufactured
products sold 514.0 514.0 18.7 532.7
Other operating expenses (b) 97.7 0.3 98.0 1,252.3 1,350.3
Interest 45.2 45.2 80.9 (45.2)(a) 80.9
- ------------------------------------------------------------------------------------------------
Total 611.7 45.5 657.2 5,878.6 (45.2) 6,490.6
- ------------------------------------------------------------------------------------------------
233.5 (45.0) 188.5 (2,739.1) (2,550.6)
- -----------------------------------------------------------------------------------------------
Income tax expense (benefit) 89.3 (17.2) 72.1 (988.5) (916.4)
Minority interest (195.5) (195.5)
- ------------------------------------------------------------------------------------------------
Total 89.3 (17.2) 72.1 (1,184.0) (1,111.9)
- ------------------------------------------------------------------------------------------------
(Loss) income from operations 144.2 (27.8) 116.4 (1,555.1) (1,438.7)
Equity in earnings of the
Carolina Group 89.6 (89.6)(c)
- ------------------------------------------------------------------------------------------------
Income from continuing
operations 144.2 (27.8) 116.4 (1,465.5) (89.6) (1,438.7)
Discontinued operations-net 55.8 55.8
- ------------------------------------------------------------------------------------------------
Net (loss) income $ 144.2 $(27.8) $ 116.4 $(1,409.7) $(89.6) $(1,382.9)
================================================================================================
(a) To eliminate interest on the intergroup notional debt.
(b) Includes $0.1 of expenses allocated by the 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.
16
Loews and Carolina Group
Consolidating Condensed Statement of Operations Information
Carolina Group Adjustments
Three Months Ended --------------------------------- Loews and
September 30, 2002 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions) (Restated) (Restated)
Revenues:
Insurance premiums $2,261.4 $2,261.4
Investment income, net $ 13.3 $ 0.5 $ 13.8 433.0 $ (50.0)(a) 396.8
Investment gains 22.1 22.1 4.4 26.5
Manufactured products 963.4 963.4 41.0 1,004.4
Other 1.2 1.2 381.0 382.2
- ------------------------------------------------------------------------------------------------
Total 1,000.0 0.5 1,000.5 3,120.8 (50.0) 4,071.3
- ------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 1,850.1 1,850.1
Amortization of deferred
acquisition costs 447.7 447.7
Cost of manufactured
products sold 534.1 534.1 19.1 553.2
Other operating expenses 98.2 0.1 98.3 632.8 731.1
Interest 50.0 50.0 77.1 (50.0)(a) 77.1
- -----------------------------------------------------------------------------------------------
Total 632.3 50.1 682.4 3,026.8 (50.0) 3,659.2
- -----------------------------------------------------------------------------------------------
367.7 (49.6) 318.1 94.0 412.1
- -----------------------------------------------------------------------------------------------
Income tax expense (benefit) 146.2 (19.8) 126.4 30.1 156.5
Minority interest 16.9 16.9
- -----------------------------------------------------------------------------------------------
Total 146.2 (19.8) 126.4 47.0 173.4
- -----------------------------------------------------------------------------------------------
Income from operations 221.5 (29.8) 191.7 47.0 238.7
Equity in earnings of the
Carolina Group 147.3 (147.3)(b)
- -----------------------------------------------------------------------------------------------
Income from continuing
operations 221.5 (29.8) 191.7 194.3 (147.3) 238.7
Discontinued Operations-net 0.4 0.4
- ------------------------------------------------------------------------------------------------
Net income $ 221.5 $(29.8) $ 191.7 $ 194.7 $(147.3) $ 239.1
================================================================================================
(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.
17
Loews and Carolina Group
Consolidating Condensed Statement of Operations Information
Carolina Group Adjustments
Nine Months Ended ------------------------------------ Loews and
September 30, 2003 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $6,701.0 $6,701.0
Investment income, net $ 29.7 $ 1.7 $ 31.4 1,384.5 $(140.7)(a) 1,275.2
Investment (losses) gains (10.6) (10.6) 513.8 503.2
Manufactured products 2,467.9 2,467.9 110.5 2,578.4
Other (0.2) (0.2) 1,067.7 1,067.5
- ------------------------------------------------------------------------------------------------
Total 2,486.8 1.7 2,488.5 9,777.5 (140.7) 12,125.3
- ------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 7,968.9 7,968.9
Amortization of deferred
acquisition costs 1,433.7 1,433.7
Cost of manufactured
products sold 1,435.4 1,435.4 54.2 1,489.6
Other operating expenses (b) 352.3 0.5 352.8 2,615.6 2,968.4
Interest 140.7 140.7 230.3 (140.7)(a) 230.3
- ------------------------------------------------------------------------------------------------
Total 1,787.7 141.2 1,928.9 12,302.7 (140.7) 14,090.9
- ------------------------------------------------------------------------------------------------
699.1 (139.5) 559.6 (2,525.2) (1,965.6)
- ------------------------------------------------------------------------------------------------
Income tax expense (benefit) 262.8 (52.4) 210.4 (945.7) (735.3)
Minority interest (196.8) (196.8)
- ------------------------------------------------------------------------------------------------
Total 262.8 (52.4) 210.4 (1,142.5) (932.1)
- ------------------------------------------------------------------------------------------------
(Loss) income from operations 436.3 (87.1) 349.2 (1,382.7) (1,033.5)
Equity in earnings of the
Carolina Group 268.8 (268.8)(c)
- ------------------------------------------------------------------------------------------------
(Loss) income from continuing
operations 436.3 (87.1) 349.2 (1,113.9) (268.8) (1,033.5)
Discontinued operations-net 55.4 55.4
Cumulative effect of
changes in accounting
principles-net
- ------------------------------------------------------------------------------------------------
Net (loss) income $ 436.3 $ (87.1) $ 349.2 $(1,058.5) $(268.8) $ (978.1)
================================================================================================
(a) To eliminate interest on the intergroup notional debt.
(b) Includes $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.
(c) To eliminate the Loews Group's intergroup interest in the earnings of the Carolina Group.
18
Loews and Carolina Group
Consolidating Condensed Statement of Operations Information
Carolina Group Adjustments
Nine Months Ended --------------------------------- Loews and
September 30, 2002 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions) (Restated) (Restated)
Revenues:
Insurance premiums $7,922.9 $7,922.9
Investment income, net $ 34.8 $ 0.8 $ 35.6 1,493.1 $(129.0)(a) 1,399.7
Investment gains (losses) 32.7 32.7 (177.7) (145.0)
Manufactured products 2,963.4 2,963.4 113.8 3,077.2
Other 1.9 1.9 1,239.7 1,241.6
- ------------------------------------------------------------------------------------------------
Total 3,032.8 0.8 3,033.6 10,591.8 (129.0) 13,496.4
- ------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 6,542.4 6,542.4
Amortization of deferred
acquisition costs 1,349.2 1,349.2
Cost of manufactured
products sold 1,707.0 1,707.0 54.4 1,761.4
Other operating expenses (b) 337.1 0.2 337.3 2,046.8 2,384.1
Interest 129.0 129.0 231.8 (129.0)(a) 231.8
- -----------------------------------------------------------------------------------------------
Total 2,044.1 129.2 2,173.3 10,224.6 (129.0) 12,268.9
- -----------------------------------------------------------------------------------------------
988.7 (128.4) 860.3 367.2 1,227.5
- -----------------------------------------------------------------------------------------------
Income tax expense (benefit) 389.7 (50.6) 339.1 110.1 449.2
Minority interest 59.2 59.2
- -----------------------------------------------------------------------------------------------
Total 389.7 (50.6) 339.1 169.3 508.4
- -----------------------------------------------------------------------------------------------
Income from operations 599.0 (77.8) 521.2 197.9 719.1
Equity in earnings of the
Carolina Group 417.4 (417.4)(c)
- -----------------------------------------------------------------------------------------------
Income from continuing
operations 599.0 (77.8) 521.2 615.3 (417.4) 719.1
Discontinued operations- net (28.8) (28.8)
Cumulative effect of
change in accounting
principle-net (39.6) (39.6)
- ------------------------------------------------------------------------------------------------
Net income $ 599.0 $ (77.8)$ 521.2 $ 546.9 $(417.4) $ 650.7
================================================================================================
(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.
19
Loews and Carolina Group
Consolidating Condensed Statement of Cash Flows Information
Carolina Group Adjustments
Nine Months Ended ---------------------------------- Loews and
September 30, 2003 Lorillard Other Consolidated Group Eliminations Total
- -----------------------------------------------------------------------------------------------
(In millions)
Net cash provided (used)
in operating activities $ 869.7 $ (89.1) $ 780.6 $ 1,706.3 $(181.0) $ 2,305.9
- ------------------------------------------------------------------------------------------------
Investing activities:
Purchases of property and
equipment (38.4) (38.4) (331.9) (370.3)
Proceeds from sales of
property and equipment 1.0 1.0 105.0 106.0
Change in short-term
investments (283.6) 50.3 (233.3) (933.6) (1,166.9)
Other investing activities (529.6) (274.9) (804.5)
- ------------------------------------------------------------------------------------------------
(321.0) 50.3 (270.7) (1,690.1) (274.9) (2,235.7)
- ------------------------------------------------------------------------------------------------
Financing activities:
Dividends paid to
shareholders (549.0) 314.0 (235.0) (83.5) 181.0 (137.5)
Reduction of intergroup
notional debt (274.9) (274.9) 274.9
Other financing activities 115.3 115.3
- ------------------------------------------------------------------------------------------------
(549.0) 39.1 (509.9) 31.8 455.9 (22.2)
- ------------------------------------------------------------------------------------------------
Net change in cash (0.3) 0.3 48.0 48.0
Cash, beginning of period 2.0 0.2 2.2 183.2 185.4
- ------------------------------------------------------------------------------------------------
Cash, end of period $ 1.7 $ 0.5 $ 2.2 $ 231.2 $ 233.4
================================================================================================
20
Loews and Carolina Group
Consolidating Condensed Statement of Cash Flows Information
Carolina Group Adjustments
Nine Months Ended ----------------------------------- Loews and
September 30, 2002 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions) (Restated) (Restated)
Net cash provided (used)
by operating activities $ 681.6 $ (57.5) $ 624.1 $ 994.0 $ (218.8) $ 1,399.3
- ------------------------------------------------------------------------------------------------
Investing activities:
Purchases of property and
equipment (40.3) (40.3) (285.5) (325.8)
Proceeds from sales of
property and equipment 6.0 6.0 96.2 102.2
Change in short-term
investments (207.1) (120.8) (327.9) (2,774.4) (3,102.3)
Other investing activities 1,564.0 1,564.0
- ------------------------------------------------------------------------------------------------
(241.4) (120.8) (362.2) (1,399.7) (1,761.9)
- ------------------------------------------------------------------------------------------------
Financing activities:
Dividends paid to
shareholders (440.0) 185.4 (254.6) (85.0) 218.8 (120.8)
Other financing activities (7.7) (7.7) 618.6 610.9
- ------------------------------------------------------------------------------------------------
(440.0) 177.7 (262.3) 533.6 218.8 490.1
- ------------------------------------------------------------------------------------------------
Net change in cash 0.2 (0.6) (0.4) 127.9 127.5
Cash, beginning of period 1.0 0.7 1.7 179.6 181.3
- ------------------------------------------------------------------------------------------------
Cash, end of period $ 1.2 $ 0.1 $ 1.3 $ 307.5 $ 308.8
================================================================================================
5. Reinsurance
CNA assumes and cedes reinsurance with other insurers, reinsurers and
members of various reinsurance pools and associations. See Note 9 for
discussion of CNA's sale of the renewal rights for most of the treaty business
of CNA Re. 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.
Interest cost on reinsurance contracts accounted for on a funds withheld
basis is incurred during all periods in which a funds withheld liability
exists. Interest cost, which is included in net investment income, was $148.0
and $53.0 million for the three months ended September 30, 2003 and 2002 and
$288.0 and $168.0 million for the nine months ended September 30, 2003 and
2002. The amount subject to interest crediting rates on such contracts was
$2,892.0 and $2,766.0 million at September 30, 2003 and December 31, 2002.
Certain funds withheld reinsurance contracts, including the corporate
aggregate reinsurance treaties, require interest on additional premiums
arising from ceded losses as if those premiums were payable at the inception
of the contract. The amount of retroactive interest for the three months ended
21
September 30, 2003 was $103.0 million as compared with $5.0 million in the
same period of 2002. The amount of retroactive interest, included in the
totals above, for the nine months ended September 30, 2003 was $147.0 million
as compared with $10.0 million in the same period of 2002.
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.
As previously reported in the Company's Annual Report on Form 10-K for the
year ended December 31, 2002, CNA has reinsurance receivables from several
reinsurers who have recently experienced multiple downgrades of their
financial strength ratings, have announced that they will no longer accept new
business and are placing their books of business into run-off. One of CNA's
principal credit exposures from these recent events arose from reinsurance
receivables from Gerling Global Group of companies ("Gerling").
In the second quarter of 2003, CNA commuted three CNA HealthPro treaties
with Gerling which resulted in a $37.0 million pretax loss. In the third
quarter of 2003, CNA commuted all remaining ceded and assumed reinsurance
contracts with four Gerling entities. The commutations resulted in a pretax
loss of $72.0 million which is net of a previously established allowance for
doubtful accounts of $47.0 million. CNA has no further exposure to these four
Gerling companies that are in run-off.
CNA has established an allowance for doubtful accounts to provide for
estimated uncollectible reinsurance receivables. The reinsurance receivable
balances were $15,116.7 and $12,695.3 million at September 30, 2003 and
December 31, 2002. The increase in reinsurance receivables was primarily due
to ceded claim and allocated claim adjustment expenses related to asbestos,
environmental pollution and mass tort ("APMT") reserves and corporate
aggregate reinsurance treaties. The allowance for doubtful accounts was $547.6
and $195.7 million at September 30, 2003 and December 31, 2002. CNA increased
the allowance $308.0 million for the three months ended September 30, 2003 and
$348.0 million for the nine months ended September 30, 2003 in recognition of
deterioration of the financial strength ratings of several reinsurers. While
CNA believes the allowance for doubtful accounts is adequate based on existing
collateral and information currently available, failure of reinsurers to meet
their obligations could have a material adverse impact on the Company's
results of operations or equity.
22
The effects of reinsurance on earned premiums are shown in the following
table.
Direct Assumed Ceded Net
-------------------------------------------
Nine Months Ended September 30, 2003
-------------------------------------------
Property and casualty . . . . . . . . . . . . $7,977.0 $ 460.0 $3,459.0 $ 4,978.0
Accident and health . . . . . . . . . . . . . 1,193.0 78.0 42.0 1,229.0
Life . . . . . . . . . . . . . . . . . . . . 801.0 4.0 311.0 494.0
-------------------------------------------
Total earned premiums . . . . . . . . . . . . $9,971.0 $ 542.0 $3,812.0 $ 6,701.0
===========================================
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 earned premiums . . . . . . . . . . . . $10,272.0 $1,028.0 $3,377.0 $ 7,923.0
===========================================
Life premiums are primarily from long duration contracts; property and
casualty premiums and accident and health premiums are primarily from short
duration contracts.
CNA has an aggregate reinsurance treaty related to the 1999 through 2001
accident years that covers substantially all of CNA's property and casualty
lines of business (the "Aggregate Cover"). The Aggregate Cover provides for
two sections of coverage. 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 treaty, has a $500.0
million limit per accident year of ceded losses and an aggregate limit of $1.0
billion of ceded losses for the three accident years. The ceded premiums
associated with the first section 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 only relates to 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 liability accrue at 8.0% per annum. The
aggregate loss ratio for the three-year period has exceeded certain thresholds
which requires additional premiums to be paid and an increase in the rate at
which interest charges are accrued. This rate will increase to 8.25% per annum
commencing in 2006.
During the second and third quarters of 2003, as a result of the unfavorable
development recorded related to accident years 2000 and 2001, the $500.0
million limit related to the 2000 and 2001 accident years under the first
section was fully utilized and losses of $500.0 million were ceded under the
first section of the Aggregate Cover. In 2001, as a result of reserve
additions including those related to accident year 1999, the $500.0 million
limit related to the 1999 accident year under the first section was fully
utilized and losses of $510.0 million were ceded under the second section as a
result of losses related to the World Trade Center Disaster and related events
("WTC event").
23
The pretax impact of the Aggregate Cover was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions)
Ceded earned premiums $(223.0) $(251.0)
Ceded claim and claim adjustment expense 422.0 500.0
Interest charges (88.0) $(13.0) (123.0) $ (38.0)
- ------------------------------------------------------------------------------------------------
Pretax benefit (expense) $ 111.0 $(13.0) $ 126.0 $ (38.0)
================================================================================================
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 $761.0 million of ceded losses. The ceded premiums are a
percentage of ceded losses. The ceded premium related to full utilization of
the $761.0 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. As of September
30, 2003, the CCC Cover has been fully utilized.
The pretax impact of the CCC Cover was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions)
Ceded earned premiums $ (10.0) $(39.0) $(100.0) $(100.0)
Ceded claim and claim adjustment expense 17.0 55.0 143.0 148.0
Interest charges (13.0) (11.0) (48.0) (27.0)
- ------------------------------------------------------------------------------------------------
Pretax (expense) benefit $ (6.0) $ 5.0 $ (5.0) $ 21.0
================================================================================================
24
The pretax impact by operating segment of the Aggregate Cover and the CCC
Cover was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions)
Property and casualty $ 105.0 $ (8.0) $ 122.0 $ (17.0)
Other Insurance (1.0)
- ------------------------------------------------------------------------------------------------
Pretax benefit (expense) $ 105.0 $ (8.0) $ 121.0 $ (17.0)
================================================================================================
6. Receivables
September 30, December 31,
2003 2002
- ------------------------------------------------------------------------------------------------
(In millions)
Reinsurance $15,116.7 $12,695.3
Other insurance 3,166.2 3,163.2
Security sales 1,283.2 493.3
Accrued investment income 372.5 316.8
Other 910.0 294.8
- -----------------------------------------------------------------------------------------------
Total 20,848.6 16,963.4
Less: Allowance for doubtful accounts on reinsurance receivables 547.6 195.7
Allowance for doubtful accounts and cash discounts 409.0 166.7
- -----------------------------------------------------------------------------------------------
Receivables-net $19,892.0 $16,601.0
===============================================================================================
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 ("IBNR") 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.
Establishing claim and claim adjustment expense reserves, including claim
and claim adjustment expense 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
25
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 workers compensation, general liability and
professional liability claims. Adjustments to prior year reserve estimates, if
necessary, are reflected in the results of operations in the period that the
need for such adjustments is determined.
Catastrophes are an inherent risk of the property and casualty insurance
business and have contributed to material fluctuations in CNA'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 or
equity of CNA.
APMT Reserves
CNA's property and casualty insurance subsidiaries have actual and potential
exposures related to APMT claims.
Establishing reserves for APMT claim and claim adjustment expenses is
subject to uncertainties that are greater than those presented by other
claims. Traditional actuarial methods and techniques employed to estimate the
ultimate cost of claims for more traditional property and casualty exposures
are less precise in estimating claim and claim adjustment expense reserves for
APMT, particularly in an environment of emerging or potential claims and
coverage issues that arise from industry practices and legal, judicial, and
social conditions. Therefore, these traditional actuarial methods and
techniques are necessarily supplemented with additional estimating techniques
and methodologies, many of which involve significant judgments that are
required of management. Accordingly, a high degree of uncertainty remains for
CNA's ultimate liability for APMT claim and claim adjustment expenses.
In addition to the difficulties described above, estimating the ultimate
cost of both reported and unreported APMT claims is subject to a higher degree
of variability due to a number of additional factors, including among others:
the number and outcome of direct actions against CNA; coverage issues,
including whether certain costs are covered under the policies and whether
policy limits apply; allocation of liability among numerous parties, some of
whom may be in bankruptcy proceedings, and in particular the application of
"joint and several" liability to specific insurers on a risk; inconsistent
court decisions and developing legal theories; increasingly aggressive tactics
of plaintiffs' lawyers; the risks and lack of predictability inherent in major
litigation; increased filings of claims in certain states to avoid the
application of tort reform statute effective dates; a further increase in
asbestos and environmental claims which cannot now be anticipated; continued
increase in mass tort claims relating to silica and silica-containing
products, and the outcome of ongoing disputes as to coverage in relation to
these claims; a further increase of claims and claims payment that may exhaust
underlying umbrella and excess coverage at accelerated rates; and future
developments pertaining to CNA's ability to recover reinsurance for asbestos
and environmental claims.
Since 1999, CNA has performed semi-annual ground up reviews of all open APMT
claims to evaluate the adequacy of CNA's APMT reserves. The completion of a
comprehensive ground up analysis of its APMT exposures that was previously
scheduled for the second quarter was completed in the third quarter of 2003.
During the second quarter of 2003, significant resources were dedicated to the
proposed national asbestos reform litigation and to support regulatory
reviews. CNA completed its formal and comprehensive analysis of all open APMT
26
claims in the third quarter of 2003. In performing its comprehensive ground up
analysis, CNA considers input from its 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, 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.
Due to the inherent uncertainties in estimating reserves for APMT claim and
claim adjustment expenses and due to the significant uncertainties previously
described related to APMT claims, the ultimate liability for these cases, both
individually and in aggregate, may exceed the recorded reserves. Any such
potential additional liability, or any range of potential additional amounts,
cannot be reasonably estimated currently, but could be material to CNA's
business, results of operations, equity, insurer financial strength and debt
ratings. Due to, among other things, the factors described above, it may be
necessary for CNA to record material changes in its APMT claim and claim
adjustment expense reserves in the future, should new information become
available or other developments emerge.
The following table provides data related to CNA's APMT claim and claim
adjustment expense reserves.
September 30, 2003 December 31, 2002
- ------------------------------------------------------------------------------------------------
Environmental Environmental
Pollution and Pollution and
Mass Tort Asbestos Mass Tort Asbestos
- ------------------------------------------------------------------------------------------------
(In millions)
Gross reserves $ 872.0 $ 3,434.0 $ 830.0 $1,758.0
Ceded reserves (270.0) (1,647.0) (313.0) (512.0)
- ------------------------------------------------------------------------------------------------
Net reserves $ 602.0 $ 1,787.0 $ 517.0 $1,246.0
================================================================================================
Environmental Pollution and Mass Tort
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
27
subject to cleanup is unknown. To date, approximately 1,244 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 2002 or during the first
nine months of 2003, 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 possible effect upon CNA's
results of operations or equity.
As of September 30, 2003 and December 31, 2002, CNA carried approximately
$602.0 and $517.0 million of claim and claim adjustment expense reserves, net
of reinsurance recoverables, for reported and unreported environmental
pollution and mass tort claims. There was $153.0 million of environmental
pollution and mass tort net prior year unfavorable claim and claim adjustment
expense reserve development for the three and nine months ended September 30,
2003 and no environmental pollution and mass tort net claim and claim
adjustment expense reserve development for the three and nine months ended
September 30, 2002. CNA paid environmental pollution-related claims and mass
tort-related claims, net of reinsurance recoveries, of $68.0 and $91.0 million
for the nine months ended September 30, 2003 and 2002.
CNA has increased its net environmental pollution reserves to $405.0 million
reflecting $72.0 million in unfavorable net prior year environmental pollution
reserve development in the third quarter of 2003. This increase was in part
due to the emergence of certain negative legal developments, including several
court decisions which have reduced the effectiveness of the absolute pollution
exclusion by limiting its application to traditional industrial pollution, and
which have increased the scope of damages compensable under policies of
insurance. In addition, management has noted the potential emergence of
Natural Resource Damage claims under the Comprehensive Environmental Response
Compensation and Liability Act of 1980 and other federal statutes.
CNA has made settlement of large environmental pollution exposures a
management priority. CNA has resolved a number of its large environmental
accounts by negotiating favorable settlement agreements. In its settlements,
CNA sought to resolve those exposures and obtain the broadest release language
to avoid future claims from the same policyholders seeking coverage for sites
28
or claims that had not emerged at the time CNA settled with its policyholder.
While the terms of each settlement agreement vary, CNA sought to obtain broad
environmental releases that include known and unknown sites, claims and
policies. The broad release provisions contained in those settlement
agreements should, in many cases, prevent future exposure from settled
policyholders. It remains uncertain, however, whether a court interpreting the
language of the settlement agreements will uphold the broad language of the
agreements.
In the third quarter of 2003, CNA began to classify its environmental
pollution accounts into several categories, which include structured
settlements, coverage in place agreements and active accounts. CNA has a
structured settlement agreement with one of its policyholders for which it has
future payment obligations. Structured settlement agreements provide for
payments over multiple years as set forth in each individual agreement. As to
the one structured settlement agreement existing at September 30, 2003, CNA
has a reserve of $12.0 million, net of reinsurance.
CNA has also used coverage in place agreements to resolve large pollution
exposures. Coverage in place agreements are typically agreements between CNA
and its policyholders identifying the policies and the terms for payment of
pollution related liabilities. Claims payments are contingent on presentation
of adequate documentation of damages during the policy periods and other
documentation supporting the demand for claims payment. Coverage in place
agreements may have annual payment caps. At September 30, 2003, CNA had
negotiated five such agreements in which CNA committed coverage for payment of
claims and claim related adjustment expenses subject to documentation
requirements as set forth in the terms of each specific agreement. CNA has
evaluated these commitments and has a $12.0 million reserve, net of
reinsurance, as of September 30, 2003 related to coverage in place agreements.
CNA categorizes active accounts as large or small accounts in the pollution
area. CNA defines a large account as an active account with more than $100,000
cumulative paid losses. CNA has 148 large accounts with a collective reserve
of $101.0 million, net of reinsurance, at September 30, 2003. CNA has made
closing large accounts a significant management priority. Small accounts are
defined as active accounts with $100,000 or less cumulative paid losses. CNA
has 427 small accounts with a collective reserve of $60.0 million, net of
reinsurance, at September 30, 2003.
CNA also evaluates its environmental pollution exposures arising from its
assumed reinsurance and its participation in various pools, including Excess &
Casualty Reinsurance Association ("ECRA"). At September 30, 2003, CNA has a
reserve of $38.0 million related to these liabilities.
At September 30, 2003, CNA's unassigned IBNR reserve for environmental
pollution was $182.0 million, net of reinsurance. This IBNR reserve relates to
potential development on accounts that have not settled and potential future
claims from unidentified policyholders.
CNA has also increased its net mass tort reserves to $197.0 million
reflecting $81.0 million in net mass tort prior year reserve development, due
in part to the elevated volume of silica claims. In 2003, CNA observed a
marked increase in silica claims frequency in Mississippi, where plaintiff
attorneys appear to have filed claims to avoid the effect of a tort reform.
The most significant silica exposures identified to date include a relatively
small number of accounts with significant numbers of new claims and
substantial insurance limits issued by CNA. Establishing claim and claim
adjustment expense reserves for silica claims is subject to uncertainties
29
because of disputes concerning medical causation with respect to certain
diseases, including lung cancer, geographical concentration of the lawsuits
asserting the claims, and the large rise in the total number of claims without
underlying epidemiological developments suggesting an increase in disease
rates or plaintiffs.
CNA's ultimate liability for its environmental pollution and mass tort
claims is impacted by several factors including ongoing disputes with
policyholders over scope and meaning of coverage terms and, in the area of
environmental pollution, court decisions that continue to restrict the scope
and applicability of the absolute pollution exclusion contained in policies
issued by CNA after 1989. Due to the inherent uncertainties described above,
including the inconsistency of court decisions, the number of waste sites
subject to cleanup, and in the area of environmental pollution, the standards
for cleanup and liability, the ultimate liability of CNA for environmental
pollution and mass tort claims may vary substantially from the amount
currently recorded.
Asbestos
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.
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.
Several factors are, in management's view, negatively impacting asbestos
claim trends. Plaintiff attorneys who previously sued entities who are now
bankrupt are seeking other viable targets. As a result, companies with few or
no previous asbestos claims are becoming targets in asbestos litigation and,
although they may have little or no liability, nevertheless must be defended
by their insurers. Additionally, plaintiff attorneys and trustees for future
claimants are demanding that policy limits be paid lump-sum into the
bankruptcy asbestos trusts prior to presentation of valid claims and medical
proof of these claims. The ultimate impact or success of this tactic remains
uncertain. Plaintiff attorneys and trustees for future claimants are also
attempting to devise claims payment procedures for bankruptcy trusts that
30
would allow asbestos claims to be paid under lax standards. This also presents
the potential for exhausting policy limits in an accelerated fashion.
In addition, management has observed an increase in the total number of
policyholders with current asbestos claims as additional defendants are added
to existing lawsuits and are named in new asbestos bodily injury lawsuits. New
asbestos bodily injury claims have also increased substantially in 2003.
Following the third quarter of 2003 ground up review, CNA has increased its
gross asbestos reserves to $3,434.0 million and its net asbestos reserves to
$1,787.0 million at September 30, 2003 reflecting $1,808.0 million and $642.0
million in unfavorable gross and net asbestos prior year reserve development
principally due to potential losses from policies issued by CNA with high
attachment points, which previous exposure analysis indicated would not be
reached. As part of its semi-annual review, CNA examined the claims filing
trends and the projected erosion rates of underlying primary and lower excess
insurance on open asbestos accounts to determine timeframes within which high
excess policies issued by CNA could be reached. Elevated claims volumes,
together with certain adverse court decisions affecting rapidity by which
asbestos claims are paid supported the conclusion that excess policies with
high attachment points previously thought not to be exposed may now
potentially be exposed.
CNA has resolved a number of its large asbestos accounts by negotiating
favorable settlement agreements. CNA has structured settlement agreements with
seven of its policyholders for which it has future payment obligations.
Structured settlement agreements provide for payments over multiple years as
set forth in each individual agreement. At December 31, 2002, CNA had four
structured settlement agreements reserved at $118.0 million, net of
reinsurance. Since year end 2002, CNA has resolved three additional asbestos
accounts through structured settlement agreements As to the seven structured
settlement agreements existing at September 30, 2003, payment obligations
under those settlement agreements are projected to terminate in 2016. CNA has
evaluated its exposure and the expected reinsurance recoveries under these
agreements and has a reserve of $160.0 million, net of reinsurance at
September 30, 2003, related to remaining payment obligations under these
agreements.
CNA, through its acquisition of CIC in 1995, assumed obligations under the
Wellington Agreement. In 1985, 47 asbestos producers and their insurers,
including CIC, executed the Wellington Agreement. The agreement intended to
resolve all issues and litigation related to coverage for asbestos exposures.
Under this agreement, signatory insurers committed scheduled policy limits and
made the limits available to pay asbestos claims based upon coverage blocks
designated by the policyholders in 1985, subject to extension by
policyholders. CIC was a signatory insurer to the Wellington Agreement. At
December 31, 2002, CNA had fulfilled its Wellington Agreement obligations as
to all but five accounts and has a reserve of $28.0 million, net of
reinsurance, related to its remaining Wellington obligations. At September 30,
2003, with respect to these five remaining unpaid Wellington obligations, CNA
has evaluated its exposure and the expected reinsurance recoveries under these
agreements and has a $23.0 million reserve, net of reinsurance.
CNA has also used coverage in place agreements to resolve large asbestos
exposures. Coverage in place agreements are typically agreements between CNA
and its policyholders identifying the policies and the terms for payment of
asbestos related liabilities. Claims payments are contingent on presentation
of adequate documentation showing exposure during the policy periods and other
documentation supporting the demand for claims payment. Coverage in place
31
agreements may have annual payment caps. At September 30, 2003, CNA had
negotiated 27 such agreements in which CNA committed coverage for payment of
claims and claim related adjustment expenses subject to documentation
requirements as set forth in the terms of each specific agreement. Coverage in
place agreements are evaluated based on claims filings trends and severities.
Due to adverse claims trends described in this section, management has
increased its estimate of exposure under current coverage in place agreements.
At December 31, 2002, CNA had estimated its exposure for its twenty-three
coverage in place agreements at $66.0 million, net of reinsurance. Since year
end 2002, CNA resolved four additional asbestos exposures through coverage in
place agreements and has also evaluated the possibility that high excess
coverages it issued could become impaired under these agreements. CNA has
evaluated these commitments and the expected reinsurance recoveries under
these agreements and has a $106.0 million reserve, net of reinsurance, related
to coverage in place agreements.
CNA categorizes active asbestos accounts as large or small accounts. CNA
defines a large account as an active account with more than $100,000
cumulative paid losses. CNA made closing large accounts a significant
management priority. At December 31, 2002, CNA had 150 large accounts and has
a reserve of $220.0 million, net of reinsurance. At September 30, 2003, CNA
has 156 large accounts with a collective reserve of $388.0 million, net of
reinsurance. Large accounts are typically accounts that have been long
identified as significant asbestos exposures. In its most recent ground up
reserve study, CNA observed that underlying layers of primary, umbrella and
lower layer excess policies were exhausting at accelerated rates due to
increased claims volumes, claims severities and increased defense expense
incurred in litigating claims for certain policyholders. Those accounts where
CNA had issued high excess policies were evaluated in the study to determine
potential impairment of the high excess layers of coverage. Management
concluded that high excess coverage previously thought not to be exposed could
potentially be exposed should current adverse claim trends continue.
Small accounts are defined as active accounts with $100,000 or less
cumulative paid losses. At December 31, 2002, CNA had 939 small accounts with
a reserve of $90.0 million, net of reinsurance. At September 30, 2003, CNA has
1,028 small accounts, approximately 84.0% of its total active asbestos
accounts. Small accounts are typically representative of policyholders with
limited connection to asbestos. As entities who were historic targets in
asbestos litigation continue to file for bankruptcy protection, plaintiffs'
attorneys are seeking other viable targets. As a result, companies with few or
no previous asbestos claims are becoming targets in asbestos litigation and,
although they may have little or no liability, nevertheless must be defended
by their insurers. As claims filings continue to increase, costs incurred in
defending small accounts are expected to increase. CNA has evaluated small
accounts and has increased its collective reserve to $155.0 million, net of
reinsurance, as of September 30, 2003.
CNA also evaluates its asbestos liabilities arising from its assumed
reinsurance business and its participation in various pools. At December 31,
2002, CNA had a $91.0 million reserve related to these asbestos liabilities
arising from CNA's assumed reinsurance obligations and CNA's participation in
pools, including ECRA. At September 30, 2003, CNA has a $158.0 million net
reserve related to these liabilities.
At September 30, 2003, CNA's unassigned IBNR reserve for asbestos was $742.0
million, net of reinsurance. This IBNR reserve relates to potential
development on accounts that have not settled and potential future claims from
32
unidentified policyholders. At December 31, 2002, the unassigned IBNR reserve
was $584.0 million, net of reinsurance.
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
has attempted to manage its asbestos exposure by aggressively seeking to
settle claims on acceptable terms. There can be no assurance that any of these
settlement efforts will be successful, or that any such claims can be settled
on terms acceptable to CNA. Where CNA cannot settle a claim on acceptable
terms, CNA aggressively litigates the claim. Adverse developments with respect
to such matters could have a material adverse effect on the Company's results
of operations or equity.
Certain asbestos litigation in which CNA is currently engaged are described
below:
On February 13, 2003, CNA announced it had resolved asbestos related
coverage litigation and claims involving A.P. Green Industries, A.P. Green
Services and Bigelow - Liptak Corporation. Under the agreement, CNA will be
required to pay $74.0 million, net of reinsurance recoveries, over a ten year
period. The settlement resolves CNA's liabilities for all pending and future
asbestos claims involving A.P. Green Industries, Bigelow - Liptak Corporation
and related subsidiaries, including alleged "non-products" exposures. The
settlement has received initial bankruptcy court approval and CNA expects to
procure confirmation of a bankruptcy plan containing a channeling injunction
to protect CNA from any future claims.
CNA is engaged in insurance coverage litigation with underlying plaintiffs
who have asbestos bodily injury claims against the former Robert A. Keasbey
Company ("Keasbey") in New York State court (Continental Casualty Co. v.
Nationwide Indemnity Co. et al., No. 601037/03 (N.Y. County)). Keasbey, a
currently dissolved corporation, was a seller and installer of asbestos-
containing insulation products in New York and New Jersey. Thousands of
plaintiffs have filed bodily injury claims against Keasbey; however, Keasbey's
involvement at a number of work sites is a highly contested issue. Therefore,
the defense disputes the percentage of valid claims against Keasbey. CNA
issued Keasbey primary policies for 1970-1987 and excess policies for 1972-
1978. CNA has paid an amount substantially equal to the policies' aggregate
limits for products and completed operations claims. Claimants against Keasbey
allege, among other things, that CNA owes coverage under sections of the
policies not subject to the aggregate limits, an allegation CNA vigorously
contests in the lawsuit.
CNA has insurance coverage disputes related to asbestos bodily injury claims
against Burns & Roe Enterprises, Inc. ("Burns & Roe"). Originally raised in
litigation, now stayed, these disputes are currently part of In re: Burns &
Roe Enterprises, Inc., pending in the U.S. Bankruptcy Court for the District
of New Jersey, No. 00-41610. Burns & Roe provided engineering and related
services in connection with construction projects. At the time of its
bankruptcy filing, Burns & Roe faced approximately 11,000 claims alleging
33
bodily injury resulting from exposure to asbestos as a result of construction
projects in which Burns & Roe was involved. CNA allegedly provided primary
liability coverage to Burns & Roe from 1956-1969 and 1971-1974, along with
certain project-specific policies from 1964-1970.
CIC issued certain primary and excess policies to Bendix Corporation
("Bendix"), now part of Honeywell International Inc. ("Honeywell"). Honeywell
faces approximately 71,000 pending asbestos bodily injury claims resulting
from alleged exposure to Bendix friction products. CIC's primary policies
allegedly covered the period from at least 1939 (when Bendix began to use
asbestos in its friction products) to 1983, although the parties disagree
about whether CIC's policies provided product liability coverage before 1940
and from 1945 to 1956. CIC asserts that it owes no further material
obligations to Bendix under any primary policy. Honeywell alleges that two
primary policies issued by CIC covering 1969-1975 contain occurrence limits
but not product liability aggregate limits for asbestos bodily injury claims.
CIC has asserted, among other things, which even if Honeywell's allegation is
correct, which CNA denies, its liability is limited to a single occurrence
limit per policy or per year, and in the alternative, a proper allocation of
losses would substantially limit its exposure under the 1969-1975 policies to
asbestos claims. These and other issues are being litigated in Continental
Insurance Co., et al. v. Honeywell International Inc., No. MRS-L-1523-00
(Morris County, New Jersey).
Policyholders have also initiated litigation directly against CNA and other
insurers in four jurisdictions: Ohio, Texas, West Virginia and Montana. In the
Ohio action, plaintiffs allege the defendants negligently performed duties
undertaken to protect the public from the effects of asbestos (Varner v. Ford
Motor Co., et al., (Cuyahoga County, Ohio)). Similar lawsuits have also 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
(Boson v. Union Carbide Corp., et al., (District Court of Nueces County,
Texas)). Many of the Texas claims have been dismissed as time-barred by the
applicable statute of limitations. In other claims, the Texas court recently
ruled that the carriers did not owe any duty to the plaintiffs or the general
public to advise on the effects of asbestos thereby dismissing these claims.
The time period for filing an appeal of this ruling has not expired and it
remains uncertain whether the plaintiffs' will continue to pursue their causes
of action.
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. A direct action has also been filed in Montana (Pennock, et al.
v. Maryland Casualty, et al., First Judicial District Court of Lewis & Clark
County, Montana) by eight individual plaintiffs (all employees of W.R. Grace &
Co. (W.R. Grace)) and their spouses against CNA, Maryland Casualty and the
State of Montana. This action alleges that CNA failed to fulfill its
obligations as W.R. Grace's Workers Compensation carrier because of the
alleged negligent failure of CNA to warn of or otherwise protect W.R. Grace
employees from the dangers of asbestos at a W.R. Grace vermiculite mining
facility in Libby, Montana. This action is currently stayed as to CNA because
of W.R. Grace's pending bankruptcy. On July 23, 2003, the stay of similar
direct action litigation against Maryland Casualty was lifted by the District
Court as to Maryland Casualty. Maryland Casualty and W.R. Grace have appealed
the District Court's decision to the Third Circuit Court of Appeals. The stay
of the litigation may also be lifted as to CNA.
34
CNA is vigorously defending these and other cases and believes that it has
meritorious defenses to the claims asserted. However, there are numerous
factual and legal issues to be resolved in connection with these claims, and
it is extremely difficult to predict the outcome or ultimate financial
exposure represented by these matters. Adverse developments with respect to
any of these matters could have a material adverse effect on CNA's business,
insurer financial strength and debt ratings and the Company's equity.
As a result of the uncertainties and complexities involved, reserves for
asbestos claims cannot be estimated with traditional actuarial techniques that
rely on historical accident year loss development factors. In establishing
asbestos reserves, CNA evaluates the exposure presented by each insured. As
part of this evaluation, CNA considers the available insurance coverage;
limits and deductibles; the potential role of other insurance, particularly
underlying coverage below any CNA excess liability policies; and applicable
coverage defenses, including asbestos exclusions. Estimation of asbestos-
related claim and claim adjustment expense reserves involves a high degree of
judgment on the part of management and consideration of many complex factors,
including: inconsistency of court decisions, jury attitudes and future court
decisions; specific policy provisions; allocation of liability among insurers
and insureds; missing policies and proof of coverage; the proliferation of
bankruptcy proceedings and attendant uncertainties; novel theories asserted by
policyholders and their counsel; 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; volatility in claim numbers and
settlement demands; increases in the number of non-impaired claimants and the
extent to which they can be precluded from making claims; the efforts by
insureds to obtain coverage not subject to aggregate limits; long latency
period between asbestos exposure and disease manifestation and the resulting
potential for involvement of multiple policy periods for individual claims;
medical inflation trends; the mix of asbestos-related diseases presented and
the ability to recover reinsurance including the impact, if any, of
restructured operations of Lloyd's of London into Equitas Limited.
As of September 30, 2003 and December 31, 2002, CNA carried approximately
$1,787.0 and $1,246.0 million of claim and claim adjustment expense reserves,
net of reinsurance recoverables, for reported and unreported asbestos-related
claims. There was $642.0 million in asbestos-related net claim and claim
adjustment expense prior year unfavorable reserve development for the three
and nine months ended September 30, 2003. CNA paid asbestos-related claims,
net of reinsurance, of $101.0 million for the nine months ended September 30,
2003 and had net reinsurance recoveries of $12.0 million for the nine months
ended September 30, 2002.
Other Reserves
Unfavorable net prior year development of $2,835.0 million, including
$2,312.0 million of unfavorable claim and allocated claim adjustment expense
reserve development and $523.0 million of unfavorable premium development, was
recorded for the nine months ended September 30, 2003. The development
discussed below includes premium development due to the direct relationship of
unfavorable premium development to the corporate aggregate and other
reinsurance treaties. A brief summary of these lines of business and the
associated reserve development is discussed below.
35
Standard Lines
Unfavorable net prior year development of $1,402.0 million, including $928.0
million of unfavorable claim and allocated claim adjustment expense reserve
development and $474.0 million of unfavorable premium development, was
recorded for the nine months ended September 30, 2003. Favorable net prior
year development of $105.0 million, including $149.0 million of favorable
claim and allocated claim adjustment expense reserve development and $44.0
million of unfavorable premium development, was recorded for the same period
in 2002. The gross carried claim and claim adjustment expense reserve was
$13,153.0 and $11,576.0 million at September 30, 2003 and December 31, 2002.
The net carried claim and claim adjustment expense reserve was $8,159.0 and
$7,262.0 million at September 30, 2003 and December 31, 2002.
Approximately $495.0 million of unfavorable claim and allocated claim
adjustment expense reserve development was recorded related to construction
defect claims for the nine months ended September 30, 2003. Based on analyses
completed during the third quarter of 2003, it became apparent that the
assumptions regarding the number of claims, which were used to estimate the
expected losses, were no longer appropriate. The analyses indicated that the
actual number of claims reported during 2003 was higher than expected
primarily in states other than California. States where this activity is most
evident include Texas, Arizona, Nevada, Washington and Colorado. The number of
claims reported in states other than California during the first six months of
2003 was almost 35.0% higher than the last six months of 2002. The number of
claims reported during the last six months of 2002 increased by less than
10.0% from the first six months of 2002. In California, claims resulting from
additional insured endorsements increased throughout 2003. Additional insured
endorsements are regularly included on policies provided to subcontractors.
The additional insured endorsement names general contractors and developers as
additional insureds covered by the policy. Current California case law
(Presley Homes, Inc. v. American States Insurance Company, 01 C.D.O.S 5828
(July 10, 2001)) specifies that an individual subcontractor with an additional
insured obligation has a duty to defend the additional insured in the entire
action, subject to contribution or recovery later. In addition, the additional
insured is allowed to choose one specific carrier to defend the entire action.
These additional insured claims can remain open for a longer period of time
than other construction defect claims because the additional insured defense
obligation can continue until the entire case is resolved. The adverse reserve
development recorded related to construction defect claims was primarily
related to accident years 1999 and prior.
Unfavorable net prior year development of approximately $595.0 million,
including $518.0 million of unfavorable claim and allocated claim adjustment
expense reserve development and $77.0 million of unfavorable premium
development, was recorded for large account business including workers
compensation coverages for the nine months ended September 30, 2003. Many of
the policies issued to these large accounts include provisions tailored
specifically to the individual accounts. Such provisions effectively result in
the insured being responsible for a portion of the loss. An example of such a
provision is a deductible arrangement where the insured reimburses CNA for all
amounts less than a specified dollar amount. These arrangements often limit
the aggregate amount the insured is required to reimburse CNA. Analyses
completed during the second and third quarters of 2003, including claims
handled by third party administrators ("TPA") indicated higher losses from the
large accounts. In addition, these analyses indicated that the provisions that
result in the insured being responsible for a portion would have less of an
impact due to the larger size of claims as well as the increased number of
36
claims. The development recorded was primarily related to accident years 2000
and prior.
Approximately $98.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development recorded for the nine
months ended September 30, 2003, resulted from a program covering facilities
that provide services to developmentally disabled individuals. This net prior
year development was due to an increase in the size of known claims and
increases in policyholder defense costs. With regard to average claim size,
recent data shows the average claim increasing at an annual rate of
approximately 20.0%. Prior data had shown average claim size to be level.
Similar to the average claim size, recent data shows the average policyholder
defense cost increasing at an annual rate approximately 20.0%. Prior data had
shown average policyholder defense cost to be level. The net prior year
development recorded was primarily for accident years 2001 and prior.
Approximately $40.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development recorded for the nine
months ended September 30, 2003 was for excess workers compensation coverages
due to increasing severity. The increase in severity means that a higher
percentage of the total loss dollars will be CNA's responsibility since more
claims will exceed the point at which CNA's coverage begins. The net prior
year development recorded was primarily for accident year 2000.
Approximately $73.0 million of unfavorable development recorded for the nine
months ended September 30, 2003 was the result of a commutation of all ceded
reinsurance treaties with Gerling (Global Group of companies ("Gerling"),
related to accident years 1999 through 2001, including $41.0 million of
unfavorable claim and allocated claim adjustment expense development and $32.0
million of unfavorable premium development. Further information regarding this
commutation is provided in Note 5.
Unfavorable net prior year claim and allocated claim adjustment expense
reserve development of approximately $40.0 million recorded for the nine
months ended September 30, 2003 was related to a program covering tow truck
and ambulance operators, primarily impacting the 2001 accident year. CNA had
previously expected that loss ratios for this business would be similar to its
middle market commercial automobile liability business. During 2002, CNA
ceased writing business under this program.
Approximately $25.0 million of unfavorable net prior year premium
development recorded for the nine months ended September 30, 2003 was related
to a second quarter 2003 reevaluation of losses ceded to a reinsurance
contract covering middle market workers compensation exposures. The
reevaluation of losses led to a new estimate of the number and dollar amount
of claims that would be ceded under the reinsurance contract. As a result of
the reevaluation of losses, CNA recorded approximately $36.0 million of
unfavorable claim and allocated claim adjustment expense reserve development,
which was ceded under the contract. The net prior year development was
recorded for accident year 2000.
The following premium and claim and allocated claim adjustment expense
development was recorded in the third quarter of 2003 as a result of the
elimination of deficiencies and redundancies in reserve positions within the
segment. Unfavorable net prior year development of approximately $210.0
million related to small and middle market workers compensation exposures and
approximately $110.0 million related to E&S lines was recorded in the third
quarter of 2003. Offsetting these increases was $210.0 million of favorable
net prior year development in the property line of business in the second and
37
third quarters of 2003, including $79.0 million related to the September 11,
2001 WTC event.
Also, offsetting these unfavorable premium and claim and allocated claim
adjustment expense developments was a $215.0 million underwriting benefit from
cessions to corporate aggregate reinsurance treaties recorded in the nine
months ended September 30, 2003 of which $140.0 million was recorded in the
third quarter of 2003. The benefit is comprised of $480.0 million of ceded
losses and $265.0 million of ceded premiums for accident years 2000 and 2001.
Specialty Lines
Unfavorable net prior year development of $416.0 million, including $400.0
million of net unfavorable claim and allocated claim adjustment expense
reserve development and $16.0 million of unfavorable premium development, was
recorded for the nine months ended September 30, 2003. Unfavorable net prior
year development of $86.0 million, including $46.0 million of unfavorable
premium development and $40.0 million of unfavorable claim and allocated claim
adjustment expense reserve development, was recorded for the same period in
2002. The gross carried claim and claim adjustment expense reserve was
$6,417.0 and $5,874.0 million at September 30, 2003 and December 31, 2002. The
net carried claim and claim adjustment expense reserve was $3,965.0 and
$3,373.0 million at September 30, 2003 and December 31, 2002.
Approximately $50.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development recorded for the nine
months ended September 30, 2003 was related to increased severity in excess
coverages provided to facilities providing health care services. The increase
in reserves is based on reviews of individual accounts where claims had been
expected to be less than the point at which CNA's coverage applies. The
current claim trends indicate that the layers of coverage provided by CNA will
be impacted. The net prior year development recorded was primarily for
accident years 2001 and prior.
Approximately $68.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development recorded for the nine
months ended September 30, 2003 was for Surety coverages related to primarily
workers compensation bond exposure from accident years 1990 and prior and
large losses for accident years 1999 and 2002. Approximately $68.0 million of
unfavorable net prior year claim and allocated claim adjustment expense
reserve development was recorded in the Surety line of business in the second
quarter of 2003 as the result of recent developments on one large claim.
Approximately $86.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development recorded for the nine
months ended September 30, 2003 was related to directors and officers
exposures in CNA Pro and Global Lines. The unfavorable net prior year reserve
development was primarily due to securities class action cases related to
certain known corporate malfeasance cases and investment banking firms. This
net prior year development recorded was primarily for accident years 2000
through 2002.
Unfavorable net prior year claim and allocated claim adjustment expense
reserve development of approximately $75.0 million recorded for the nine
months ended September 30, 2003 was related to an adverse arbitration decision
in the second quarter of 2003 involving a single large property and business
interruption loss. The decision was rendered against a voluntary insurance
pool in which CNA was a participant. The loss was caused by a fire which
occurred in 1995. CNA no longer participates in this pool.
38
Approximately $47.0 million of losses was recorded for the third quarter of
2003 as the result of a commutation of ceded reinsurance treaties with
Gerling, relating to accident years 1999 through 2002. An additional $37.0
million of losses was recorded in the second quarter of 2003 as the result of
a commutation of three ceded reinsurance treaties covering CNA HealthPro,
relating to accident years 1999 through 2001. See Note 5 for further
discussion.
The following development was recorded in the third quarter of 2003 as a
result of the elimination of deficiencies and redundancies in reserve
positions within the segment. An additional $50.0 million of unfavorable net
prior year claim and allocated claim adjustment expense reserve development
was recorded related to medical malpractice and long term care facilities.
Partially offsetting this unfavorable claim and allocated claim adjustment
expense reserve development was a $27.0 million underwriting benefit from
cessions to corporate aggregate reinsurance treaties. The benefit was
comprised of $59.0 million of ceded losses and $32.0 million of ceded premiums
for accident years 2000 and 2001. See Note 5 for further discussion of CNA's
aggregate reinsurance treaties.
A $16.0 million underwriting benefit was recorded for the corporate
aggregate reinsurance treaties for the nine months ended September 30, 2002,
comprised of $55.0 million of ceded losses and $39.0 million of ceded
premiums.
CNA Re
Unfavorable net prior year development of $148.0 million, including $109.0
million of net unfavorable claim and allocated claim adjustment expense
reserve development and $39.0 million of unfavorable premium development, was
recorded for the nine months ended September 30, 2003. Unfavorable net prior
year development of $42.0 million, including $42.0 million of favorable
premium development and $84.0 million of unfavorable claim and allocated claim
adjustment expense reserve development, was recorded for the same period in
2002. The gross carried claim and claim adjustment expense reserve was
$2,336.0 and $2,264.0 million at September 30, 2003 and December 31, 2002. The
net carried claim and claim adjustment expense reserve was $1,275.0 and
$1,362.0 million at September 30, 2003 and December 31, 2002.
The unfavorable net prior year development was primarily a result of a
general change in the pattern of how losses change over time as reported by
the companies that purchase reinsurance from CNA Re. Losses have continued to
show large increases for accident years in the late 1990s and into 2000 and
2001. These increases are greater than the increases indicated by patterns
from older accident years and have a similar effect on several lines of
business. Approximately $67.0 million unfavorable net prior year development
recorded for the nine months ended September 30, 2003 was related to
proportional liability exposures, primarily from multi-line and umbrella
treaties in accident years 1997 through 2001. Approximately $32.0 million of
unfavorable net prior year development recorded for the nine months ended
September 30, 2003, was related to assumed financial reinsurance for accident
years 2001 and prior and approximately $24.0 million of unfavorable net prior
year development related to professional liability exposures in accident years
2001 and prior.
CNA Re recorded an additional $15.0 million of unfavorable development for
construction defect related exposures. Because of the unique nature of this
exposure, losses have not followed expected development patterns. The
39
continued reporting of claims in California, the increase in the number of
claims from states other than California and a review of individual ceding
companies' exposure to this type of claim resulted in an increase in the
estimated reserve.
Unfavorable net prior year claim and allocated claim adjustment expense
reserve development of approximately $25.0 million was recorded primarily for
directors and officers exposures. The reserve development was a result of a
claims review that was completed during the second quarter of 2003. The
unfavorable net prior year reserve development was primarily due to securities
class action cases related to certain known corporate malfeasance cases and
investment banking firms. The net prior year development recorded was for
accident years 2000 and 2001.
The following premium and claim and allocated claim adjustment expense
development, was recorded in the third quarter of 2003 as a result of the
elimination of deficiencies and redundancies in the reserve positions of
individual products within the segment. Unfavorable net prior year premium and
claim and allocated claim adjustment expense development of approximately
$42.0 million related to Surety exposures, $32.0 million related to excess of
loss liability exposures and $12.0 million related to facultative liability
exposures were recorded in the third quarter of 2003. Offsetting this
unfavorable premium and claim and allocated claim adjustment expense reserve
development was approximately $55.0 million of favorable development related
to the WTC event. In addition, there was a $47.0 million underwriting benefit
from cessions to corporate aggregate reinsurance treaties for the nine months
ended September 30, 2003 of which $55.0 was recorded in the third quarter of
2003. The benefit was comprised of $104.0 million of ceded losses and $57.0
million of ceded premiums for accident years 2000 and 2001. See Note 5 for
further discussion of CNA's aggregate reinsurance treaties.
A $31.0 million underwriting benefit was recorded for the corporate
aggregate reinsurance treaties for the nine months ended September 30, 2002.
The benefit was comprised of $93.0 million of ceded losses and $62.0 million
of ceded premiums.
Other Insurance
Unfavorable net prior year development of $861.0 million, including $867.0
million of net unfavorable claim and allocated claim adjustment expense
reserve development and $6.0 million of favorable premium development was
recorded for the nine months ended September 30, 2003. This unfavorable net
prior year development was principally driven by unfavorable claim and
allocated claim adjustment expense reserve development of $795.0 million
related to APMT. Unfavorable net prior year claim and allocated claim
adjustment expense reserve development of $11.0 million was recorded for the
nine months ended September 30, 2002. Unfavorable claim and allocated claim
adjustment expense reserve development of $50.0 million was recorded in the
third quarter of 2003 relating to CNA's past participation in several
insurance pools which is part of the group reinsurance run-off business. The
gross carried claim and claim adjustment expense reserve was $7,386.0 and
$4,847.0 million at September 30, 2003 and December 31, 2002. The net carried
claim and claim adjustment expense reserve was $2,758.0 and $2,002.0 million
for September 30, 2003 and December 31, 2002.
40
8. Shareholders' Equity
September 30, December 31,
2003 2002
- -----------------------------------------------------------------------------------------------
(In millions of dollars, except per share data)
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 and outstanding - 185,447,050 and 185,441,200 shares $ 185.4 $ 185.4
Carolina Group stock, $0.01 par value:
Authorized - 600,000,000 shares
Issued - 40,250,000 shares 0.4 0.4
Additional paid-in capital 1,114.4 1,114.2
Earnings retained in the business 8,289.0 9,404.6
Accumulated other comprehensive income 901.8 538.3
- ------------------------------------------------------------------------------------------------
10,491.0 11,242.9
Less treasury stock, at cost (340,000 shares of Carolina Group stock) 7.7 7.7
- -----------------------------------------------------------------------------------------------
Total shareholders' equity $10,483.3 $11,235.2
================================================================================================
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 (See Note 2).
9. Significant Transactions
Acquisition of Texas Gas Transmission, LLC
In May of 2003, the Company, through a wholly owned subsidiary, TGT
Pipeline, LLC ("TGT"), acquired Texas Gas from The Williams Companies, Inc.
("Williams"). The transaction value was approximately $1.05 billion, which
included $250.0 million of existing Texas Gas debt. The results of Texas Gas
have been included in the consolidated condensed financial statements from the
date of acquisition. The Company funded the approximately $802.3 million
balance of the purchase price, including transaction costs and closing
adjustments, with $528.3 million of its available cash and $275.0 million of
proceeds from an interim loan incurred by Texas Gas.
Upon completion of the acquisition, TGT, the immediate parent of Texas Gas,
issued $185.0 million of 5.2% Notes due 2018 and Texas Gas Transmission, LLC
issued $250.0 million of 4.6% Notes due 2015. The net offering proceeds of
approximately $431.0 million were used to repay the $275.0 million interim
loan and to retire approximately $132.7 million principal amount of Texas
Gas's existing $150.0 million of 8.625% Notes due 2004 and to pay related
tender premiums. Texas Gas intends to use the balance of the offering
proceeds, together with cash on hand, to retire the remaining 2004 notes.
41
Texas Gas owns and operates a 5,800-mile natural gas pipeline system that
transports natural gas originating in the Louisiana Gulf Coast and East Texas
and running north and east through Louisiana, Arkansas, Mississippi,
Tennessee, Kentucky, Indiana and into Ohio, with smaller diameter lines
extending into Illinois. Texas Gas has a delivery capacity of 2.8 billion
cubic feet (Bcf) per day and a working storage capacity of 55 Bcf.
The preliminary allocation of purchase price to the assets and liabilities
of Texas Gas, in millions, pending final purchase value adjustments, which are
not expected to be material, is as follows:
Current assets $ 81.6
Property, plant and equipment 663.4
Goodwill 280.0
Other non-current assets 133.0
Current liabilities (58.9)
Long-term debt, including current portion (249.0)
Other liabilities and deferred credits (46.8)
- -----------------------------------------------------------------------------
$ 803.3
=============================================================================
The following unaudited pro forma financial information is presented as if
Texas Gas had been acquired as of the beginning of each period presented. The
pro forma amounts include certain adjustments, including a reduction of
depreciation expense based on the preliminary allocation of purchase price to
property, plant and equipment; adjustment of interest expense to reflect the
issuance of debt by Texas Gas and TGT, and redemption of $132.7 million
principal amount of Texas Gas's existing notes; and the related tax effect of
these items. The pro forma amounts do not reflect any adjustments related to
the separation of Texas Gas from Williams for certain services provided by
Williams under a transition services agreement.
(In millions, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- -------------------------
2003 2002 2003 2002
-------------------------------------------------
(Restated) (Restated)
Total revenues $ 3,940.0 $4,131.3 $12,241.5 $13,691.3
(Loss) income from continuing operations (1,438.7) 251.0 (998.6) 759.0
Net (loss) income (1,382.9) 251.4 (943.2) 690.6
(Loss) income per share of Loews common stock:
(Loss) income from continuing operations (7.90) 1.11 (5.82) 3.48
Net (loss) income (7.60) 1.11 (5.52) 3.12
================================================================================================
The pro forma information does not necessarily reflect the actual results
that would have occurred had the companies been combined during the periods
presented, nor is it necessarily indicative of future results of operations.
42
Sale of Hotel
In July of 2003 Loews Hotels sold a New York City property, the Metropolitan
Hotel, for approximately $109.0 million. The Company recorded a pretax gain of
approximately $90.3 million ($56.7 million after-tax) in the third quarter of
2003. The operating results and gain on sale of the Metropolitan Hotel have
been reported in the Consolidated Condensed Statements of Operations as
discontinued operations.
Assumed Reinsurance Renewal Rights Sale
During October of 2003, CNA entered into an agreement to sell the renewal
rights for most of the treaty business, with the exception of Surety, of CNA
Re to Folksamerica Reinsurance Company ("Folksamerica"), a wholly owned
subsidiary of White Mountains Insurance Group, Ltd. of Hamilton, Bermuda.
Under the terms of the transaction, Folksamerica will compensate CNA based
upon the amount of premiums renewed by Folksamerica over the next two contract
renewals. Concurrently with the sale, CNA will be withdrawing from the assumed
reinsurance business and will manage the run-off of its retained liabilities.
Third Party Risk Management Business
During the second quarter of 2003, CNA entered into an agreement, whereby
Cunningham Lindsey, U.S. ("Cunningham Lindsey"), a subsidiary of Lindsey
Morden Group, Inc., acquired the business of RSKCo Services, Inc. ("RSKCo").
Included in the sale was the RSKCo trademarked name, as well as all claims and
other risk management services business provided by RSKCo that is not sold in
connection with insurance products of other CNA subsidiaries. CNA has recorded
an estimated, pretax loss on this sale of approximately $18.0 million. The
business sold represented annual revenues of approximately $40.0 million.
As a result of this agreement, Cunningham Lindsey assumed assets and
liabilities of $72.0 and $56.0 million. At December 31, 2002, the assets and
liabilities of the RSKCo business sold were $71.0 and $54.0 million.
National Postal Mail Handlers Union Contract Termination
During 2002, CNA sold Claims Administration Corporation and transferred the
National Postal Mail Handlers Union group benefits plan (the "Mail Handlers
Plan") to First Health Group Corporation. Revenues for the Mail Handlers Plan
were $3.0 million for the three months ended September 30, 2002 and $1,157.0
million for the nine months ended September 30, 2002.
CNA Vida Disposition
In the first quarter 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 million and the Company recorded a loss
from discontinued operations of $31.0 million (after tax and minority
interest). This loss is composed of $32.8 million realized loss on the sale of
CNA Vida and income of $1.8 million from CNA Vida's operations for 2002.
Personal Insurance Transaction
CNA entered into a retroactive reinsurance agreement as part of the sale of
CNA's personal insurance business to The Allstate Corporation ("Allstate") in
1999. CNA shares in indemnity and claim and allocated claim adjustment
43
expenses if payments related to losses incurred prior to October 1, 1999 on
the CNA policies transferred to Allstate exceed the claim and allocated claim
adjustment expense reserves of approximately $1.0 billion at the date of sale.
CNA must begin to reimburse Allstate for claim and allocated claim adjustment
expense payments when cumulative claim payments after October 1, 1999 on
losses occurring prior to that date exceed the $1.0 billion. CNA's remaining
obligation valued under this loss sharing provision as of October 1, 2003 will
be settled, under a time schedule established by the contract, by agreement of
the parties or by an independent actuarial review of the unpaid claim
liabilities as of that date. Cumulative payments of indemnity and allocated
loss adjustment expenses on such policies exceeded $1.0 billion during the
second quarter of 2003. CNA has established reserves for its estimated
liability under this loss sharing arrangement.
10. Statutory Accounting Practices
CNA's insurance subsidiaries are domiciled in various jurisdictions. These
subsidiaries prepare statutory financial statements in accordance with
accounting practices prescribed or permitted by the respective jurisdictions'
insurance regulators. Prescribed statutory accounting practices are set forth
in a variety of publications of the National Association of Insurance
Commissioners ("NAIC") as well as state laws, regulations and general
administrative rules. CNA's insurance subsidiaries follow one significant
accounting practice, related to discounting of certain non-tabular workers'
compensation claims. This practice was followed by an acquired company, and
CNA received permission to eliminate the effect of the permitted practice over
a ten-year period. The impact of this permitted practice was to increase
statutory surplus by approximately $24.0 million at December 31, 2002. At
September 30, 2003, CNA has fully eliminated the effect of this permitted
practice.
11. Business Segments
The Company's reportable segments are based on its individual operating
subsidiaries. Each of the principal 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. Investment
gains (losses) and the related income taxes, excluding those of CNA Financial,
are included in the Corporate and other segment.
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.
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. Beginning in 2003, expenses related to eBusiness were
allocated to the operating segments of CNA.
Lorillard's principal products are cigarettes 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 19 hotels, 17 of which are in the United
States and two are in Canada.
44
Diamond Offshore's business primarily consists of operating 45 offshore
drilling rigs that are chartered on a contract basis by companies engaged in
exploration and production of hydrocarbons. Offshore rigs are mobile units
that can be relocated based on market demand. As of September 30, 2003, 25 of
these rigs were located in the Gulf of Mexico, 4 were located in Brazil and
the remaining 16 were located in various other foreign markets.
Texas Gas owns and operates a 5,800-mile natural gas pipeline system that
transports natural gas originating in the Louisiana Gulf Coast and East Texas
and running north and east through Louisiana, Arkansas, Mississippi,
Tennessee, Kentucky, Indiana and into Ohio, with smaller diameter lines
extending into Illinois. Texas Gas has a delivery capacity of 2.8 billion
cubic feet ("Bcf") per day and a working storage capacity of 55 Bcf.
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. Substantially all watches and clocks are
purchased from foreign suppliers.
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, 2002. 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.
45
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,
- ------------------------------------------------------------------------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions) (Restated) (Restated)
Revenues (a):
CNA Financial:
Property and casualty $ 1,825.0 $ 1,907.9 $ 6,118.1 $ 5,957.0
Life 447.9 381.7 1,250.4 1,140.0
Group 443.0 383.1 1,220.7 2,257.9
Other Insurance 9.9 114.5 90.4 190.3
- ------------------------------------------------------------------------------------------------
Total CNA Financial 2,725.8 2,787.2 8,679.6 9,545.2
Lorillard 854.0 977.8 2,497.4 3,000.0
Loews Hotels 65.9 61.8 213.5 202.3
Diamond Offshore 185.0 186.3 504.9 594.0
Texas Gas 45.0 68.1
Bulova 37.6 41.2 112.4 115.3
Corporate and other 26.7 17.0 49.4 39.6
- ------------------------------------------------------------------------------------------------
Total $ 3,940.0 $ 4,071.3 $12,125.3 $13,496.4
================================================================================================
Pretax (loss) income (a):
CNA Financial:
Property and casualty $(1,775.1) $ (28.2) $(1,646.8) $ 197.9
Life 45.0 26.4 60.3 74.8
Group 62.5 51.4 96.5 97.9
Other Insurance (1,109.0) 30.2 (1,087.0) (75.5)
- ------------------------------------------------------------------------------------------------
Total CNA Financial (2,776.6) 79.8 (2,577.0) 295.1
Lorillard 242.4 345.5 709.8 955.9
Loews Hotels (0.1) (1.1) 17.6 15.8
Diamond Offshore (8.4) 8.3 (56.1) 44.6
Texas Gas 4.1 6.7
Bulova 2.4 4.5 9.6 12.1
Corporate and other (14.4) (24.9) (76.2) (96.0)
- ------------------------------------------------------------------------------------------------
Total $(2,550.6) $ 412.1 $(1,965.6) $ 1,227.5
================================================================================================
Net (loss) income (a):
CNA Financial:
Property and casualty $(1,007.8) $ (12.6) $ (908.6) $ 125.0
Life 28.1 15.1 38.9 43.0
Group 37.5 30.6 59.0 58.5
Other Insurance (638.6) 17.3 (616.3) (42.2)
- ------------------------------------------------------------------------------------------------
Total CNA Financial (1,580.8) 50.4 (1,427.0) 184.3
Lorillard 149.9 207.0 443.2 577.6
Loews Hotels (0.5) 11.2 10.4
Diamond Offshore (5.1) 2.8 (26.5) 13.2
Texas Gas 2.2 3.8
Bulova 1.6 2.3 6.5 6.5
Corporate and other (6.5) (23.3) (44.7) (72.9)
- ------------------------------------------------------------------------------------------------
(Loss) income from continuing operations (1,438.7) 238.7 (1,033.5) 719.1
Discontinued operations-net 55.8 0.4 55.4 (28.8)
Cumulative effect of change in
accounting principles-net (39.6)
- -----------------------------------------------------------------------------------------------
Total $(1,382.9) $ 239.1 $ (978.1) $ 650.7
===============================================================================================
46
(a) Investment gains (losses) included in Revenues, Pretax (loss) income and
Net (loss) income are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
- --------------------------------------------------------------------- -------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues and pretax income:
CNA Financial:
Property and casualty $ 92.4 $ (47.8) $ 383.8 $ (99.5)
Life 33.0 (19.6) 9.8 (61.6)
Group 25.1 5.2 (6.9) (12.1)
Other Insurance 13.8 86.1 90.2 35.8
- ------------------------------------------------------------------------------------------------
Total CNA Financial 164.3 23.9 476.9 (137.4)
Corporate and other 15.2 2.6 26.3 (7.6)
- ------------------------------------------------------------------------------------------------
Total $ 179.5 $ 26.5 $ 503.2 $(145.0)
================================================================================================
Net income:
CNA Financial:
Property and casualty $ 52.7 $ (27.1) $ 226.1 $ (55.4)
Life 19.4 (11.3) 5.8 (35.2)
Group 14.6 3.0 (4.1) (7.0)
Other Insurance 8.0 50.2 53.4 20.7
- ------------------------------------------------------------------------------------------------
Total CNA Financial 94.7 14.8 281.2 (76.9)
Corporate and other 11.8 (5.7) 19.4 (16.1)
- ------------------------------------------------------------------------------------------------
Total $ 106.5 $ 9.1 $ 300.6 $ (93.0)
================================================================================================
12. Legal Proceedings
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.
47
Some of these premiums were received from John Hancock Financial 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 IGI
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 periods may be
adversely affected by potentially significant reserve additions. Management
does not believe that any such reserve additions would be material to the
equity of the Company, although results of operations may be adversely
affected. CNA's position in relation to the IGI Program was unaffected by the
sale of CNA Re Ltd. in 2002.
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 on behalf
of purported classes of CNA employees asserting they worked hours for which
they should have been compensated at a rate of one and one-half 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, the Company 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 how the courts may interpret California law as applied to
the facts of these cases, the extent of losses beyond any amounts that may be
accrued are 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 results
of operations may be adversely affected.
Voluntary Market Premium Litigation
CNA, along with dozens of other insurance companies, is a defendant in
sixteen cases brought by large policyholders which generally allege that the
48
defendants, as part of an industry-wide conspiracy, included improper charges
in their retrospectively rated and other loss-sensitive insurance programs.
Among the claims asserted are violations of state antitrust laws, breach of
contract, fraud and unjust enrichment. Thirteen lawsuits were brought as class
actions in state courts, two lawsuits were brought as class actions in federal
courts, and one lawsuit has been filed in state court on behalf of 43
individually named plaintiffs. In three of the cases, the defendants won
dismissals on motions and, in four others, class certification was denied
after hearing. Plaintiffs have voluntarily dismissed their claims in six
states. In one of the federal court cases, Sandwich Chef of Texas, Inc. v.
Reliance National Indemnity Insurance Co., 202 F.R.D. 480 (S.D. Tex. 2001),
rev'd, 319 F.3d 205 (5th Cir. 2003), cert. denied, 72 USLW 3235 (U.S. Oct 6,
2003), the United States Court of Appeals for the Fifth Circuit reversed a
decision by the District Court for the Southern District of Texas certifying a
multi-state class. 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 are 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 results of operations may be adversely
affected.
Environmental Pollution and Mass Tort and Asbestos ("APMT") Litigation
CNA is also a party to litigation and claims related to APMT cases arising
in the ordinary course of business. See Note 7 for further discussion.
Tobacco Related
Tobacco Related Product Liability Litigation
Approximately 4,600 product liability cases are pending against cigarette
manufacturers in the United States. Lorillard is a defendant in approximately
4,000 of these cases.
The pending product liability cases are comprised of the following types of
cases:
"Conventional product liability cases" are brought by individuals who allege
cancer or other health effects caused by smoking cigarettes, by using
smokeless tobacco products, by addiction to tobacco, or by exposure to
environmental tobacco smoke. Approximately 1,800 cases are pending, including
approximately 1,235 cases against Lorillard. Included in this group are almost
1,100 cases pending in a single West Virginia court that has been consolidated
for trial. Lorillard is a defendant in nearly 1,000 of the almost 1,100
consolidated West Virginia cases.
"Flight Attendant cases" are brought by non-smoking flight attendants
alleging injury from exposure to environmental smoke in the cabins of
aircraft. Plaintiffs in these cases may not seek punitive damages for injuries
that arose prior to January 15, 1997. Lorillard is a defendant in each of the
approximately 2,800 pending Flight Attendant cases.
"Class action cases" are purported to be brought on behalf of large numbers
of individuals for damages allegedly caused by smoking. Approximately 15 of
these cases are pending against Lorillard. Lorillard is not a defendant in
approximately 25 additional class actions that are pending against other
cigarette manufacturers and assert claims on behalf of smokers or purchasers
of "light" cigarettes.
49
"Reimbursement cases" are brought by or on behalf of entities who seek
reimbursement of expenses incurred in providing health care to individuals who
allegedly were injured by smoking. Plaintiffs in these cases have included the
U.S. federal government, U.S. state and local governments, foreign
governmental entities, hospitals or hospital districts, American Indian
tribes, labor unions, private companies, and private citizens suing on behalf
of taxpayers. Lorillard is a defendant in most of the approximately 15 pending
Reimbursement cases.
"Contribution cases" are brought by private companies, such as asbestos
manufacturers or their insurers, who are seeking contribution or indemnity for
court claims they incurred on behalf of individuals injured by their products
but who also allegedly were injured by smoking cigarettes. Lorillard is a
defendant in each of the seven pending Contribution cases.
Excluding the flight attendant and the consolidated West Virginia suits,
approximately 750 product liability cases are pending against U.S. cigarette
manufacturers. Lorillard is a defendant in approximately 250 of the 750 cases.
The Company, which is not a defendant in any of the flight attendant or the
consolidated West Virginia matters, is a defendant in 10 of the actions.
Plaintiffs assert a broad range of legal theories in these cases, including,
among others, 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 statutes, injunctive relief, indemnity,
restitution, unjust enrichment, public nuisance, claims based on antitrust
laws and state consumer protection acts, and claims based on failure to warn
of the harmful or addictive nature of tobacco products.
Plaintiffs in most of the cases seek unspecified amounts of compensatory
damages and punitive damages, although some seek damages ranging into the
billions of dollars. Plaintiffs in some of the cases seek treble damages,
statutory damages, disgorgement of profits, equitable and injunctive relief,
and medical monitoring, among other damages.
During July of 2003, the first phase of trial ended in the case of Scott v.
The American Tobacco Company, et al. (District Court, Orleans Parish,
Louisiana), a class action case in which Lorillard is a defendant. The jury
found in favor of the defendants as to the primary relief sought by the
certified class, medical monitoring. The jury also rejected plaintiffs' design
defect claims. However, the jury returned findings in favor of the class as to
certain other issues, such as whether defendants failed to disclose the
addictiveness of nicotine, whether defendants marketed to children, and
whether cigarette smokers in Louisiana would benefit from smoking cessation
aids or programs. The jury was not permitted to award damages in the July
verdict and the second phase of trial is scheduled to begin during December of
2003.
During May of 2003, the Florida Third District Court of Appeal vacated the
judgment entered in favor of a class of Florida smokers in the case of Engle
v. R.J. Reynolds Tobacco Co., et al. The judgment reflected an award of
punitive damages to the class of approximately $145.0 billion, including $16.3
billion against Lorillard. The court of appeals also decertified the class
ordered during pre-trial proceedings. Plaintiffs are seeking review of the
case by the Florida Supreme Court. See "Class Action Cases."
50
The Mississippi Supreme Court has ruled that the Mississippi Product
Liability Act "precludes all tobacco cases that are based on products
liability." Lorillard intends to seek dismissal of each of the approximately
40 cases pending against it in Mississippi based on this ruling.
CONVENTIONAL PRODUCT LIABILITY CASES - Approximately 1,735 cases are pending,
including approximately 1,200 cases against Lorillard. This total includes
almost 1,100 cases pending in a single West Virginia court that have been
consolidated for trial. Lorillard is a defendant in nearly 1,000 of the almost
1,100 consolidated West Virginia cases. The Company, which is not a defendant
in any of the consolidated West Virginia cases, is a defendant in three of the
pending cases.
Since January 1, 2001 and through November 1, 2003, verdicts have been
returned in 24 matters. Lorillard was a defendant in two of the cases. Defense
verdicts were returned in 16 of the cases, including both tried against
Lorillard.
As of November 1, 2003, appeals were pending in twelve cases in which
verdicts had been returned in favor of the plaintiffs. Neither the Company nor
Lorillard were defendants in any of these cases. These twelve cases, and the
verdict amounts, are below:
Boerner v. Brown & Williamson Tobacco Corporation (U.S. District Court,
Eastern District, Arkansas). During May of 2003, plaintiffs were awarded $4.0
million in actual damages and $15.0 million in punitive damages. After first
vacating the punitive damages award, the court entered an amended final
judgment that reinstated the full amount of the jury's award. Brown &
Williamson has appealed.
Eastman v. Brown & Williamson Tobacco Corporation, et al. (Circuit Court,
Pinellas County, Florida). During April of 2003, plaintiff was awarded $6.5
million in actual damages. Defendants have appealed.
Bullock v. Philip Morris USA (Superior Court, Los Angeles County,
California). During September and October of 2002, plaintiff was awarded $5.5
million in actual damages and $28.0 billion in punitive damages. The court
reduced the punitive damages award to $28.0 million. Philip Morris and
plaintiff have appealed.
Figueroa v. R.J. Reynolds Tobacco Company (U.S. District Court, Puerto
Rico). During September of 2002, plaintiffs were awarded $1.0 million in
actual damages. The court granted the defendant's motion for judgment as a
matter of law and entered a final judgment in favor of R.J. Reynolds. The U.S.
Court of Appeals for the First Circuit affirmed the judgment during October of
2003. As of November 1, 2003, the time for plaintiffs to seek further review
had not expired.
Schwarz v. Philip Morris Incorporated (Circuit Court, Multnomah County,
Oregon). During March of 2002, plaintiff was awarded approximately $120,000 in
economic damages, $50,000 in noneconomic damages and $150.0 million in
punitive damages, although the court subsequently reduced the punitive damages
award to $100.0 million. 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. Philip Morris has appealed.
Burton v. R.J. Reynolds Tobacco Company, et al. (U.S. District Court,
Kansas). During February of 2002, plaintiff was awarded approximately $200,000
in actual damages and the jury determined that plaintiff was entitled to
51
punitive damages. During June of 2002, the court awarded plaintiff $15.0
million in punitive damages from R.J. Reynolds. R.J. Reynolds has appealed.
Kenyon v. R.J. Reynolds Tobacco Company (Circuit Court, Hillsborough County,
Florida). During December of 2001, plaintiff was awarded $165,000 in actual
damages. During 2003, the Florida Court of Appeal affirmed the judgment in
favor of the plaintiff and denied R.J. Reynolds' subsequent attempt to seek
further review of the ruling. R.J. Reynolds has paid approximately $200,000 in
damages and interest to the plaintiff. R.J. Reynolds is attempting to pursue
an appeal to the Florida Supreme Court.
Boeken v. Philip Morris Incorporated (Superior Court, Los Angeles County,
California). During June of 2001, plaintiff was awarded $5.5 million in actual
damages and $3.0 billion in punitive damages. The court reduced the punitive
damages award to $100.0 million. Philip Morris and plaintiff have appealed.
Jones v. R.J. Reynolds Tobacco Co. (Circuit Court, Hillsborough County,
Florida). During October of 2000, plaintiff was awarded $200,000 in actual
damages. The court granted the defendant's motion for new trial. The Florida
Court of Appeal affirmed this ruling. Plaintiff has filed for permission to
appeal to the Florida Supreme Court.
Whiteley v. Raybestos-Manhattan, Inc., et al. (Superior Court, San Francisco
County, California). During March of 2000, plaintiffs were awarded $1.0
million in economic damages, $500,000 in noneconomic damages, $250,000 in loss
of consortium and $20.0 million in punitive damages from Philip Morris and
R.J. Reynolds. Both defendants have appealed.
Williams v. Philip Morris USA Inc. (Circuit Court, Multnomah County,
Oregon). During March of 1999, plaintiff was awarded $21,000 in economic
damages, $800,000 in actual damages and $79.5 million in punitive damages.
Although the circuit court reduced the punitive damages award to $32.0 million
following trial, the Oregon Court of Appeals reinstated the full amount of the
punitive damages verdict in its 2002 order that otherwise affirmed the
judgment in its entirety. During October of 2003, the U.S. Supreme Court
vacated the judgment and remanded the case to the Oregon Court of Appeals for
further consideration.
Henley v. Philip Morris Incorporated (Superior Court, San Francisco County,
California). During February of 1999, plaintiff was awarded $1.5 million in
actual damages and $50.0 million in punitive damages, although the court
reduced the latter award to $25.0 million. During September of 2003, the
California Court of Appeals reduced the punitive damages award to $9.0
million, providing the plaintiff consents to the reduction. The court has
denied plaintiff's motion for rehearing. If plaintiff declines the reduced
award, a new trial limited to plaintiff's punitive damages claims will be
ordered.
Defense verdicts have been returned in the following 16 matters since
January 1, 2001. The Company was not a defendant in any of these cases. As of
November 1, 2003, either appeals were pending or all post-verdict activity had
not been concluded in five of these cases. Unless otherwise noted, Lorillard
was not a defendant in these matters:
Eiser v. Brown & Williamson Tobacco Corporation, et al. (Court of Common
Pleas, Philadelphia County, Pennsylvania). During August of 2003, the jury
returned a verdict in favor of the defendants. Plaintiff has filed a motion
for new trial.
52
Reller v. Philip Morris USA (Superior Court, Los Angeles County,
California). During July of 2003, the jury found that a smoker's lung cancer
was caused by smoking but declined to award damages. As of November 1, 2003, a
judgment reflecting the verdict had not been entered.
Welch v. Brown & Williamson Tobacco Corporation, et al. (Circuit Court,
Jackson County, Missouri). A defense verdict was returned during June of 2003.
The court denied plaintiff's motion for new trial. Plaintiff has appealed.
Lucier v. Philip Morris USA, et al. (Superior Court, Sacramento County,
California). A defense verdict was returned during February of 2003. The court
has denied plaintiffs' motion for new trial. Plaintiffs have appealed.
Carter v. Philip Morris USA (Court of Common Pleas, Philadelphia County,
Pennsylvania). A defense verdict was returned during January of 2003. The
court denied plaintiff's motion for new trial. Plaintiff has appealed.
Tompkin v. The American Tobacco Company, et al. (U.S. District Court,
Northern District, Ohio). Lorillard is a defendant in this matter. A defense
verdict was returned during October of 2001. Plaintiff has appealed.
In ten cases in which defendants prevailed at trial after January 1, 2001,
plaintiffs either chose not to appeal or have withdrawn their appeals and the
cases are concluded. These ten matters and the dates of the verdicts are Allen
v. R.J. Reynolds Tobacco Company, et al. (U.S. District Court, Southern
District, Florida, February of 2003); Inzerilla v. The American Tobacco
Company, et al. (Supreme Court, Queens County, New York, February of 2003);
Conley v. R.J. Reynolds Tobacco Co., et al. (U.S. District Court, Northern
District of California, December of 2002); Tune v. Philip Morris Incorporated
(Circuit Court of Pinellas County, Florida, May of 2002); Hyde v. Philip
Morris Incorporated (U.S. District Court, Rhode Island, March of 2002); DuJack
v. Brown & Williamson Tobacco Corporation (Superior Court of Connecticut at
Rockville, November of 2001); Mehlman v. Philip Morris, Inc., et al. (Superior
Court, Middlesex County, New Jersey, May of 2001); Grinnell v. The American
Tobacco Company (District Court, Jefferson County, Texas, March of 2001);
Little v. R.J. Reynolds Tobacco Company, et al. (U.S. District Court, South
Carolina, February of 2001) and Apostolou v. The American Tobacco Company, et
al. (Supreme Court, Kings County, New York, January of 2001). Lorillard was a
defendant in one of these ten matters, Apostolou v. The American Tobacco
Company, et al.
As of November 1, 2003, trial was proceeding in three tobacco product
liability cases in which neither Lorillard nor the Company were defendants,
Frankson v. Philip Morris Incorporated, et al., pending in the Supreme Court
of New York, Kings County; Longden v. Philip Morris, Inc., et al., pending in
the Superior Court, Northern District, Hillsborough County, New Hampshire; and
Thompson v. Brown & Williamson Tobacco Corporation, et al., pending in the
Circuit Court of Jackson County, Missouri, at Independence. Some cases against
U.S. cigarette manufacturers and manufacturers of smokeless tobacco products
are scheduled for trial during the remainder of 2003 and beyond. As of
November 1, 2003, Lorillard is not a defendant in any of the cases scheduled
for trial during 2003 and is a defendant in five cases scheduled for trial
during 2004. A consolidated trial involving the approximately 1,000 cases
pending against Lorillard in the Circuit Court of Ohio County, West Virginia,
had been scheduled for trial during 2003 but that trial date has been vacated.
A new date for the consolidated trial was not scheduled as of November 1,
2003. The Company is not a defendant in any of the cases scheduled for trial
during 2003 or 2004 as of November 1, 2003. The trial dates are subject to
change.
53
FLIGHT ATTENDANT CASES - As of November 1, 2003, approximately 2,800 Flight
Attendant cases were pending. Lorillard and three other cigarette
manufacturers are the defendants in each of these matters. The Company is not
a defendant in any of these cases. These suits were filed as a result of a
settlement agreement by the parties, including Lorillard, in 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
settlement agreement, among other things, permitted the plaintiff class
members to file these individual suits. These individuals may not seek
punitive damages for injuries that arose prior to January 15, 1997.
As of November 1, 2003, the judges that have presided over the cases that
have been tried have relied upon an order entered during October of 2000 by
the Circuit Court of Miami-Dade County, Florida. The October 2000 order has
been construed by these judges as holding 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. Defendants are continuing to seek review of the October 2000 order by
the appellate court.
Verdicts have been returned in six of the flight attendant cases. Lorillard
has been a defendant in each of these six cases. In one of the cases, the
plaintiff was awarded $5.5 million in actual damages, although the court
reduced the award to $500,000. Defendants have noticed an appeal from this
verdict and plaintiff has noticed a cross-appeal. Defendants have prevailed in
the five other cases. In one of them, the court granted plaintiff's motion for
new trial and defendants have appealed. In another, the verdict was returned
during October of 2003 and the deadline for plaintiff to seek review of the
verdict had not expired as of November 1, 2003.
As of November 1, 2003, approximately 10 flight attendant cases were
scheduled for trial during 2003 and 2004. Trial dates are subject to change.
CLASS ACTION CASES - Lorillard is a defendant in approximately 15 pending
cases. The Company is a defendant in two of these cases. In most of the
pending cases, plaintiffs purport to seek class certification on behalf of
groups of cigarette smokers, or the estates of deceased cigarette smokers, who
reside in the state in which the case was filed. Neither Lorillard nor the
Company are defendants in approximately 25 additional class action cases
pending against other cigarette manufacturers in various courts throughout the
nation. Many of these 25 cases assert claims on behalf of smokers or
purchasers of "light" cigarettes.
Cigarette manufacturers, including Lorillard, have defeated motions for
class certification in a total of 33 cases, 12 of which were in state court
and 21 of which were in federal court. These 33 cases were filed in 16 states,
the District of Columbia and the Commonwealth of Puerto Rico. In addition, a
Nevada court granted motions to deny class certification in 20 separate cases
in which the class definition asserted by the plaintiffs was identical to
those in which the court had previously ruled in defendants' favor.
The Engle Case - One of the class actions pending against Lorillard is Engle
v. R.J. Reynolds Tobacco Co., et al. (Circuit Court, Dade County, Florida,
filed May 5, 1994). During 2000, a jury awarded approximately $16.3 billion in
54
punitive damages against Lorillard as part of a $145.0 billion verdict against
all of the defendants. During May of 2003, a Florida appellate court reversed
the judgment and decertified the class. The court also held that the claims
for punitive damages asserted by Florida smokers were barred as these claims
are based on the same misconduct alleged in the case filed by the State of
Florida against cigarette manufacturers, including Lorillard, which was
concluded by a 1997 settlement agreement and judgment (see "Settlement of
State Reimbursement Litigation" below). The court subsequently denied
plaintiffs' motion for rehearing. As of November 1, 2003, the Florida Supreme
Court had not agreed to review the case, as plaintiffs have requested. Even if
the Florida Supreme Court were to rule in favor of the defendants, plaintiffs
will not have exhausted all of the appellate options available to them as they
could seek review of the case by the U.S. Supreme Court.
Engle was certified as a class action on behalf of Florida residents, and
survivors of Florida residents, who were injured or died from medical
conditions allegedly caused by addiction to cigarettes.
The case was tried between 1998-2000, and the same jury heard all phases of
the trial. The first phase, which involved certain issues deemed common to the
certified class, ended on July 7, 1999 with findings against the defendants,
including Lorillard. Among other things, the jury found 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 first portion of Phase Two of the trial ended on April 7, 2000 when the
jury awarded three plaintiffs $12.5 million in damages for their individual
claims. The jury did not consider any class-wide issues during this first
portion of Phase Two.
The second part of Phase Two considered evidence as to the punitive damages
to be awarded to the class. On July 14, 2000, the jury awarded approximately
$145.0 billion in punitive damages against all defendants, including $16.3
billion against Lorillard. The judgment provided that the jury's awards would
bear interest at the rate of 10% per year.
During May of 2000, while the trial was proceeding, legislation was enacted
in Florida that limited 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, Lorillard entered into an agreement with the
plaintiffs during May of 2001 in which it contributed $200.0 million to a fund
held for the benefit of the Engle plaintiffs (the "Engle Agreement"). The
$200.0 million contribution included the $100.0 million that Lorillard posted
as collateral for the appellate bond. Accordingly, Lorillard recorded a pretax
charge of $200.0 million in the year ended December 31, 2001. Two other
defendants executed agreements with the plaintiffs that were similar to
Lorillard's. As a result, the class agreed to a stay of execution, with
respect to Lorillard and the two other defendants on its punitive damages
judgment until appellate review is completed, including any review by the U.S.
Supreme Court.
The Engle Agreement provides that in the event that Lorillard, Inc.'s
balance sheet net worth falls below $921.2 million (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
55
terminate and the class would be free to challenge the Florida legislation. As
of September 30, 2003, Lorillard, Inc. had a balance sheet net worth of
approximately $1.3 billion.
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. It is not clear how the Engle Agreement is affected
by the decertification of the class and by the order vacating the judgment.
Lorillard is a defendant in eleven separate cases 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. Prior to the May 2003 appellate ruling that
vacated the Engle judgment and decertified the class, Lorillard opposed 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. Additional cases with similar contentions are pending against
other cigarette manufacturers. In one of the matters in which Lorillard was
not a party, a jury in the Circuit Court of Miami-Dade County, Florida
returned a verdict in favor of the plaintiffs during June of 2002 in the case
of Lukacs v. Brown & Williamson Tobacco Corporation, et al. and awarded them
$500,000 in economic damages, $24.5 million in noneconomic damages and $12.5
million in damages for loss of consortium. The court has reduced the loss of
consortium award to $125,000. No post-trial motions are scheduled to be filed
in Lukacs as a final judgment reflecting the verdict will not be entered until
the Engle appeal is resolved. None of the cases in which plaintiffs contend
they are members of the Engle class are now expected to proceed until all
appellate activity in Engle is concluded.
Other Class Action Cases - In six additional class actions in which Lorillard
is a defendant, courts have granted plaintiffs' motions for class
certification. Two of these matters have been resolved in favor of the
defendants and plaintiffs' claims in a third case were resolved through a
settlement agreement. These six matters are listed below in alphabetical
order:
Blankenship v. American Tobacco Company, et al. (Circuit Court, Ohio County,
West Virginia, filed January 31, 1997). During 2000, the court certified a
class comprised of certain West Virginia cigarette smokers who sought, among
other things, medical monitoring. During November of 2001, the jury returned a
verdict in favor of the defendants, including Lorillard. Plaintiffs have
noticed an appeal.
Broin v. Philip Morris Companies, Inc., et al. (Circuit Court, Dade County,
Florida, filed October 31, 1991). This is the matter concluded by a settlement
agreement and discussed under "Flight Attendant Cases" above.
Brown v. The American Tobacco Company, Inc., et al. (Superior Court, San
Diego County, California, filed June 10, 1997). During 2001, the court
certified a class comprised of residents of California who smoked at least one
of defendants' cigarettes between June 10, 1993 and April 23, 2001 and who
were exposed to defendants' marketing and advertising activities in
California.
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Daniels v. Philip Morris, Incorporated, et al. (Superior Court, San Diego
County, California, filed August 2, 1998). During 2000, the court certified a
class comprised of California residents who, while minors, smoked at least one
cigarette between April of 1994 and December 31, 1999. During 2002, the court
granted defendants' motion for summary judgment and entered final judgment in
their favor. Plaintiffs have appealed.
In re: Simon II Litigation v. R.J. Reynolds Tobacco Company, et al. (U.S.
District Court, Eastern District, New York, filed September 6, 2000). During
2002, the case was certified as 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. Certain
individuals, including those who allege membership in the class certified in
Engle v. R.J. Reynolds Tobacco Company, et al., were excluded from the class.
Defendants are appealing the ruling.
Scott v. The American Tobacco Company, et al. (District Court, Orleans
Parish, Louisiana, filed May 24, 1996). The court certified a class comprised
of certain cigarette smokers resident in 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. During July of 2003, the jury returned a verdict in the
first phase of trial that resolved some of plaintiffs' claims in favor of the
defendants but found in favor of the class as to certain other matters. See
above for a discussion of the jury's findings. The second phase of trial is
scheduled to begin during December of 2003.
In addition to the above, motions for class certification have been granted
in some cases in which Lorillard is not a defendant. One of these is the case
of Price v. Philip Morris USA (Circuit Court, Madison County, Illinois, filed
February 10, 2000, and formerly known as Miles). Plaintiffs in Price contended
they were defrauded by Philip Morris' marketing of its cigarettes labeled as
"light" or "ultra light." Price was certified as a class comprised of Illinois
residents who purchased certain of Philip Morris' "light" brands. During March
of 2003, the court returned a verdict in favor of the class and awarded it
$7.1 billion in actual damages. The court also awarded $3.0 billion in
punitive damages to the State of Illinois, which was not a party to the suit,
and awarded plaintiffs' counsel approximately $1.8 billion in fees and costs.
Pursuant to Illinois law and according to the final judgment that reflected
these awards, Philip Morris USA would have been required to post a bond of
approximately $12.0 billion in order to pursue an appeal from the judgment.
The Illinois Supreme Court permitted Philip Morris USA to post a bond in the
amount of approximately $6.0 billion and accepted direct appellate review of
the appeal. Philip Morris USA has initiated a separate action in the Circuit
Court of Cook County, Illinois, in which it seeks a declaration that the state
has released any right or interest in the punitive damages award. Lorillard is
not a defendant in any of the pending class actions asserting claims solely
regarding exclusive use or purchase of "light" cigarettes.
REIMBURSEMENT CASES - The cases settled by the State Settlement Agreements
described below are concluded. Approximately 15 other suits are pending in
which Lorillard is a defendant. The Company is a defendant in two of the
pending cases. The plaintiffs in the pending cases include the U.S. federal
government, several U.S. county or city governments, foreign governments that
have filed suits in U.S. courts, American Indian tribes, hospitals or hospital
districts, private companies and private citizens suing on behalf of
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taxpayers. Plaintiffs in some of these cases seek certification as class
actions.
Excluding the cases settled by the State Settlement Agreements, cigarette
manufacturers have successfully defended many of the Reimbursement Cases. More
than 75 cases filed by labor union health and welfare funds as well as more
than 30 cases filed by foreign governments in U.S. courts have been dismissed,
either due to orders that granted defendants' dispositive motions or as the
result of plaintiffs' voluntary dismissal of their claims. Each of the courts
of appeal that reviewed these dismissals have affirmed the trial courts'
orders.
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
court has dismissed plaintiff's Medical Care Recovery Act and the Medicare as
Secondary Payer provisions of the Social Security Act claims. In a recent
filing, the government stated that it is seeking an aggregate of $289.0
billion in disgorgement of profits from the defendants, including Lorillard,
as well as injunctive relief.
Reimbursement Cases filed by Foreign Governments in U.S. Courts - As of
November 1, 2003, four cases were pending in U.S. courts in which the
plaintiffs were foreign governments. Lorillard was a defendant in two of these
four matters. Most of the cases filed by foreign governments have been
dismissed in favor of the defendants, including approximately 25 during 2003.
Since January 1, 2001, one of the Reimbursement cases has been tried. During
June of 2001, a jury in the U.S. District Court for the Eastern District of
New York returned a verdict in Blue Cross and Blue Shield of New Jersey, Inc.,
et al. v. Philip Morris, Incorporated, et al., and awarded 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 verdict, the jury found in favor of
the defendants on some of Empire's claims, one of which precluded the jury
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, a final judgment was entered in which Empire was awarded a total of
approximately $17.8 million in actual damages, including approximately $1.5
million attributable to Lorillard. Empire was awarded approximately $55,000 in
pre-judgment interest for a total award against Lorillard of approximately
$1.6 million. The court has awarded plaintiff's counsel approximately $38.0
million in attorneys' fees. The defendants 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. The Court of Appeals heard
argument of defendants' appeal during February of 2003. The court has
certified questions to the New York Court of Appeals in order to assist it in
ruling on issues of New York law. The New York Court of Appeals has accepted
the certified questions.
In addition to the above, the District Court of Jerusalem, Israel, has
permitted a private insurer in Israel, Clalit Health Services, to make service
outside the jurisdiction 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
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separately moved to set aside the order that permitted service outside the
jurisdiction. As of November 1, 2003, the court had not ruled on the motions
to set aside the attempted service.
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 $214.6, $255.2, $592.2 and $842.9
million ($132.5, $153.7, $369.6 and $510.6 million after taxes), for the three
and nine months ended September 30, 2003 and 2002, respectively, to accrue its
obligations under the State 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 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: 2003,
$10.9 billion; 2004 through 2007, $8.4 billion; and thereafter, $9.4 billion.
In addition, the domestic tobacco industry is required to pay settling
plaintiffs' attorneys' fees, subject to an annual cap of $500.0 million, as
well as an additional amount of $250.0 million in 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 $5.2 billion 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 $5.2 billion, a total of
$1.8 billion was paid since 1999 through September 30, 2003, $146.0 million of
59
which was paid by Lorillard. Lorillard believes its remaining payments under
the agreement will total approximately $348.0 million. 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.
CONTRIBUTION CLAIMS - Approximately 10 cases are pending against Lorillard.
The Company is a defendant in one of these cases. Plaintiffs 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.
FILTER CASES - Claims have been brought against Lorillard by smokers as well
as former employees of Lorillard seeking damages resulting from alleged
exposure to asbestos fibers that were incorporated into filter material used
in one brand of cigarettes manufactured by Lorillard for a limited period of
time, ending almost 50 years ago. Approximately 70 such matters are pending
against Lorillard. The Company is a defendant in one of these matters. Since
January 1, 2000 and through November 1, 2003, Lorillard has paid, or has
reached agreement to pay, a total of approximately $20.0 million in payments
of judgments and settlements to finally resolve approximately 55 previously
pending claims. In Sachs v. Lorillard Tobacco Co., the only filter case tried
to a verdict since January 1, 2001, the jury found in favor of Lorillard.
Other Tobacco - Related
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 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 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. On September 22, 2003, the U.S.
Court of Appeals for the Eleventh Circuit affirmed the decision granting
summary judgment and dismissal as to all defendants, including Lorillard.
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
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consumer fraud statutes. Approximately 18 states permit such suits. Lorillard
is a defendant in all but one of these indirect purchaser cases. Three
indirect purchaser suits in New York, Florida, and Michigan, have been
dismissed in their entirety and plaintiffs have withdrawn (or agreed to
withdraw) their appeals. The Arizona indirect purchaser suit was dismissed by
the trial court, the dismissal was reversed on appeal, and the Arizona Supreme
Court affirmed and remanded the suit to the trial court. While two state
courts in Kansas and New Mexico have granted plaintiffs' motions to certify a
class of consumers, two other state 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. The decision granting
certification in New Mexico is being appealed by the defendants. In Kansas, a
motion to compel defendants to produce certain documents was granted in August
of 2003. Discovery is proceeding and the parties are scheduled to litigate
certain privilege issues well into the first quarter of 2004. 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 class action lawsuit that, after several
amendments, alleges only antitrust violations. The other major domestic
tobacco companies and the major leaf buyers are also defendants. The
plaintiffs' class consists 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. Lorillard, along with all of the other defendants with the
exception of R.J. Reynolds, has settled the litigation, and the settlement was
approved by the court on October 1, 2003. Pursuant to the settlement
agreement, Lorillard has paid the class $12.5 million, and it will pay an
additional $7.5 million immediately before any trial against R.J. Reynolds or
five days after any settlement with R.J. Reynolds has been approved by the
court. In addition, Lorillard has committed to buy 20 million pounds of
domestic tobacco each year through 2013. Lorillard has also committed to
purchase at least 35% of its annual total requirements for flue-cured and
burley tobacco domestically for the same period. Lorillard will also be
responsible for 10% of the plaintiffs' attorneys' fees, to be determined by
the court.
REPARATION CASES - During 2002, the Company was 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 various other entities. 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.
Defenses
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. While Lorillard intends to defend vigorously
all tobacco products liability litigation, 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
61
unfavorably. Lorillard may enter into discussions in an attempt to settle
particular cases if it believes it is appropriate to do so.
In addition, some developments on health issues related to tobacco products
have received widespread media attention, which could have adverse effects on
the ability of Lorillard to prevail in smoking and health litigation. These
developments also could prompt the filing of additional litigation. These
developments include, but are not limited to, the release of industry
documents beginning in 1998 and the adverse outcomes in some of the cases
tried during the past few years, some of which have resulted in awards to the
plaintiffs for billions of dollars.
Except for the impact of the State Settlement Agreements as described above,
management is unable to make a meaningful estimate of the amount or range of
loss that could result from an unfavorable outcome of pending litigation and,
therefore, no provision has been made in the consolidated condensed financial
statements for any unfavorable outcome. 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 adversely affected by an
unfavorable outcome of certain pending litigation.
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.
13. Contingencies
Guarantees
CNA has provided guarantees related to irrevocable standby letters of credit
for certain of its subsidiaries. Certain of these subsidiaries have been sold;
however, the irrevocable standby letter of credit guarantees remain in effect.
CNA would be required to remit prompt payment on the letters of credit if the
primary obligor drew down on these letters of credit and failed to repay such
loans in accordance with the terms of the letters of credit. The maximum
potential amount of future payments that CNA could be required to pay under
these guarantees is approximately $30.0 million at September 30, 2003.
CNA holds an investment in a real estate joint venture. In the normal course
of business, CNA, on a joint and several basis with other unrelated insurance
company shareholders, has committed to continue funding the operating deficits
of this joint venture. Additionally, CNA and the other unrelated shareholders,
on a joint and several basis, have guaranteed an operating lease for an office
building, which expires in 2016.
The guarantee of the operating lease is a parallel guarantee to the
commitment to fund operating deficits; consequently, the separate guarantee to
the lessor is not expected to be triggered as long as the joint venture
continues to be funded by its shareholders and continues to make its annual
lease payments.
In the event that the other parties to the joint venture are unable to meet
their commitments in funding the operations of this joint venture, CNA would
be required to assume the obligation for the entire office building operating
lease. The maximum potential future lease payments at September 30, 2003 that
CNA could be required to pay under this guarantee are approximately $320.0
million. If CNA were required to assume the entire lease obligation, CNA would
62
have the right to pursue reimbursement from the other shareholders and would
have the right to all sublease revenues.
CNA has recorded a liability of approximately $9.0 and $10.0 million as of
September 30, 2003 and December 31, 2002 for its share of estimated future
operating deficits of this joint venture through 2016.
CNA has provided guarantees of the indebtedness of certain of its
independent insurance producers. These guarantees expire in 2008. CNA would be
required to remit prompt and complete payment when due, should the primary
obligor default. In the event of default on the part of the primary obligor,
CNA has a right to any and all shares of common stock of the primary obligor.
The maximum potential amount of future payments that CNA could be required to
pay under these guarantees is approximately $7.0 million at September 30,
2003.
CNA Surety
CCC provided an excess of loss reinsurance contract to the insurance
subsidiaries of CNA Surety Corporation ("CNA Surety"), a 64.0% owned and
consolidated subsidiary of CNA, over a period that expired on December 31,
2000 (the "stop loss contract"). The stop loss contract limits the net loss
ratios for CNA Surety with respect to certain accounts and lines of insurance
business. In the event that CNA Surety's accident year net loss ratio exceeds
24% for 1997 through 2000 (the "contractual loss ratio"), the stop loss
contract requires CCC to pay amounts equal to the amount, if any, by which CNA
Surety's actual accident year net loss ratio exceeds the contractual loss
ratio multiplied by the applicable net earned premiums. The minority
shareholders of CNA Surety do not share in any losses that apply to this
contract. There were no reinsurance balances payable under this stop loss
contract as of September 30, 2003 and December 31, 2002.
Effective October 1, 2002, CCC provides an excess of loss protection for new
and renewal bonds for CNA Surety for per principal exposures that exceed $60.0
million since October 1, 2002 in two parts - a) $40.0 million excess of $60.0
million and b) $50.0 million excess of $100.0 million for CNA Surety. This
excess of loss protection is necessary primarily to support new and renewal
bonds for contract surety accounts with bonded backlogs or work-in-process in
excess of $60.0 million. In consideration for the reinsurance coverage
provided by the $40.0 million excess of $60.0 million contract, CNA Surety
paid a quarterly premium equal to $3.0 million to CCC. In consideration for
the reinsurance coverage provided by the $50.0 million excess of $100.0
million, the insurance subsidiaries of CNA Surety paid $6.0 million in premium
to CCC.
Effective October 1, 2003, pending state insurance department regulatory
approval CCC entered into a $3.0 million excess of $12.0 million reinsurance
contract with CNA Surety. The reinsurance premium for the coverage provided by
the $3.0 million excess of $12.0 million contract is $0.3 million plus, if
applicable, additional premium based on paid losses. This contract expires on
December 31, 2004.
In March of 2003, CNA entered into a credit agreement with a large national
contractor, which undertakes projects for the construction of government and
private facilities, to provide loans to the contractor in a maximum aggregate
amount of $84.3 million (the "Credit Facility") as of September 30, 2003. Of
the $84.3 million capacity, $74.8 million, including accrued interest, was
outstanding at September 30, 2003. The Credit Facility and all related loans
will mature in March of 2006. Advances under the Credit Facility bear interest
63
at the prime rate plus 6.0%. Payment of 3.0% of the interest is deferred until
the Credit Facility matures, and the remainder is to be paid monthly in cash.
Loans under the credit facility are secured by a pledge of substantially all
of the assets of the contractor and certain of its affiliates.
In addition, in June of 2003, CNA and one of its subsidiaries provided
repayment guarantees to certain creditors of the contractor and a subsidiary
of the contractor. Such guarantees were provided in order to allow the
contractor to receive financial accommodations from a creditor and in order to
comply with certain regulatory requirements. Under the terms of the
guarantees, any payments made by CNA, or any of its subsidiaries, would be
considered a draw under the Credit Facility. As of September 30, 2003, these
guarantees amounted to $7.4 million.
CNA Surety has provided significant surety bond protection for projects by
this contractor through surety bonds underwritten by CCC or its affiliates.
The loans were provided by CNA to help the contractor meet its liquidity
needs.
In March of 2003, CNA also purchased the contractor's outstanding bank debt
for $16.4 million. The contractor retired the bank debt by paying CNA $16.4
million, with $11.4 million of the payoff amount being funded under the new
Credit Facility and $5.0 million from money loaned to the contractor by its
shareholders. Under its purchase agreement with the banks, CNA was also
required to reimburse the banks for any draws upon approximately $6.5 million
in outstanding letters of credit issued by the banks for the contractor's
benefit that were due to expire between May and August of 2003. One of those
letters of credit in the amount of $3.4 million was extended, but expired on
November 1, 2003. Any amounts paid by CNA to the banks as reimbursements for
draws upon the banks' letters of credit would become obligations of the
contractor to CNA as draws upon the Credit Facility.
The Company has purchased a participation interest in one-third of the loans
and commitments under the new Credit Facility, on a dollar-for-dollar basis,
up to a maximum of $25.0 million. Although the Company does not have rights
against the contractor directly under the participation agreement, it shares
recoveries and certain fees under the Credit Facility proportionally with CNA.
The contractor has initiated a restructuring plan that is intended to reduce
costs and improve cash flow, and a chief restructuring officer has been
appointed to manage execution of the plan. CNA, through its affiliate CNA
Surety, intends to continue to provide surety bonds on behalf of the
contractor during this restructuring period, subject to the contractor's
initial and ongoing compliance with CNA Surety's underwriting standards. Any
losses arising from bonds issued or assumed by the insurance subsidiaries of
CNA Surety to the contractor are excluded from CNA Surety's $45.0 million
excess of $15.0 million per principal reinsurance program with unaffiliated
reinsurers in place in 2003. As a result, CNA Surety retains the first $60.0
million of losses on bonds written with an effective date of September 30,
2002 and prior, and CCC will incur 100% of losses above that retention level
on bonds with effective dates prior to September 30, 2002. Through facultative
reinsurance contracts with CCC, CNA Surety's exposure on bonds written from
October 1, 2002 through September 30, 2003 has been limited to $20.0 million
per bond.
Indemnification and subrogation rights, including rights to contract
proceeds on construction projects in the event of default, exist that reduce
CNA Surety's and ultimately CNA's exposure to loss. While CNA believes that
the contractor's restructuring efforts are expected to be successful and
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provide sufficient cash flow for its operations and repayment of its
borrowings under the credit facility, the contractor's failure to achieve its
restructuring plan or perform its contractual obligations under the credit
facility and underlying all of CNA's surety bonds could have a material
adverse effect on CNA's future results of operations. If such failures occur,
CNA estimates the surety loss, net of indemnification and subrogation
recoveries, and minority interest could be up to $200.0 million.
Other
As of September 30, 2003 and December 31, 2002, CNA had committed
approximately $189.0 and $141.0 million for future capital calls from various
third-party limited partnership investments in exchange for an ownership
interest in the related partnership.
CNA invests in multiple bank loan participations as part of its overall
investment strategy and has committed to additional future purchases and
sales. The purchase and sale of these investments are recorded on the date
that the legal agreements are finalized and cash settlement is made. As of
September 30, 2003, CNA had commitments to purchase $72.0 million and
commitments to sell $37.0 million of various bank loan participations.
In the normal course of investing activities, CCC had committed
approximately $51.0 million as of September 30, 2003 to future capital calls
from certain of its unconsolidated affiliates in exchange for an ownership
interest in such affiliates.
In the normal course of business, CNA has obtained letters of credit in
favor of various unaffiliated insurance companies, regulatory authorities and
other entities. As of September 30, 2003 and December 31, 2002 there were
approximately $201.0 and $222.0 million of outstanding letters of credit.
CNA has a commitment to purchase up to a $100.0 million floating rate note
issued by the California Earthquake Authority in the event of an earthquake
during calendar year 2003 that results in California earthquake related losses
greater than $4.2 billion.
CNA is obligated to make future payments totaling $500.5 million for non-
cancelable operating leases expiring from 2003 through 2014 primarily for
office space and data processing, office and transportation equipment.
Estimated future minimum payments under these contracts are as follows: $25.9
million in 2003; $81.1 million in 2004; $70.3 million in 2005; $59.4 million
in 2006; $50.0 million in 2007; and $213.8 million in 2008 and beyond.
Additionally, CNA has entered into a limited number of guaranteed payment
contracts, primarily relating to telecommunication services, amounting to
approximately $22.0 million. Estimated future minimum purchases under these
contracts are as follows: $4.0 million in 2003; $13.0 million in 2004; and
$5.0 million in 2005.
In the ordinary course of selling business entities and assets to third
parties, CNA has agreed to indemnify purchasers for losses arising out of
breaches of representation and warranties with respect to the business
entities or assets being sold, including, in certain cases, losses arising
from undisclosed liabilities or certain named litigation. Such indemnification
provisions generally survive for periods ranging from nine months following
the applicable closing date to the expiration of the relevant statutes of
limitation. As of September 30, 2003, the aggregate amount of quantifiable
indemnification agreements in effect for sales of business entities and assets
was $375.0 million.
65
In addition, CNA has agreed to provide indemnification to third party
purchasers for certain losses associated with sold business entities or assets
that are not limited by a contractual monetary amount. As of September 30,
2003, CNA had outstanding unlimited indemnifications in connection with the
sales of certain of its business entities or assets for tax liabilities
arising prior to a purchaser's ownership of an entity or asset, defects in
title at the time of sale, employee claims arising prior to closing and in
some cases losses arising from certain litigation and undisclosed liabilities.
These indemnification agreements survive until the applicable statutes of
limitation expire, or until the agreed upon contract terms expire. As of
September 30, 2003, CNA has recorded approximately $15.0 million of
liabilities related to these indemnification agreements.
14. Consolidating Financial Information
The following schedules present the Company's consolidating balance sheet
information at September 30, 2003 and December 31, 2002, and consolidating
statements of operations information for the nine months ended September 30,
2003 and 2002. These schedules present the individual subsidiaries of the
Company and their contribution to the consolidated financial statements.
Amounts presented will not necessarily be the same as those in the individual
financial statements of the Company's subsidiaries due to adjustments for
purchase accounting, income taxes and minority interests. In addition, many of
the Company's subsidiaries use a classified balance sheet which also leads to
differences in amounts reported for certain line items. This information also
does not reflect the impact of the Company's issuance of Carolina Group stock.
Lorillard is reported as a 100% owned subsidiary and does not include any
adjustments relating to the tracking stock structure. See Note 4 for
consolidating information of the Carolina Group and Loews Group.
The Corporate and Other column primarily reflects the parent company's
investment in its subsidiaries, invested cash portfolio and corporate long-
term debt. The elimination adjustments are for intercompany assets and
liabilities, interest and dividends, the parent company's investment in
capital stocks of subsidiaries, and various reclasses of debit or credit
balances to the amounts in consolidation. Purchase accounting adjustments have
been pushed down to the appropriate subsidiary.
66
Loews Corporation
Consolidating Balance Sheet Information
CNA Loews Diamond Texas Corporate Elimin-
September 30, 2003 Financial Lorillard Hotels Offshore Gas Bulova and Other ations Total
- ------------------------------------------------------------------------------------------------------------------------
(In millions)
Assets:
Investments $37,822.4 $ 1,978.4 $ 211.2 $ 566.9 $ 38.2 $ 1.7 $ 2,098.1 $42,716.9
Cash 178.0 1.7 9.1 14.2 2.7 5.9 21.8 233.4
Receivables 19,641.6 31.1 20.5 168.5 38.1 84.3 105.0 $ (197.1) 19,892.0
Property, plant and
equipment 268.5 206.8 371.2 2,308.9 659.2 15.5 32.2 3,862.3
Deferred income taxes 538.0 457.0 23.2 10.9 (603.5) 425.6
Goodwill 136.0 2.6 24.3 280.0 442.9
Investments in capital
stocks of subsidiaries 10,804.1 (10,804.1)
Other assets 3,027.2 415.9 99.1 85.5 180.4 82.9 167.7 (32.8) 4,025.9
Deferred acquisition costs
of insurance subsidiaries 2,662.0 2,662.0
Separate account business 3,532.6 3,532.6
- ------------------------------------------------------------------------------------------------------------------------
Total assets $67,806.3 $ 3,090.9 $ 713.7 $ 3,168.3 $1,198.6 $ 213.5 $ 13,239.8 $(11,637.5)$77,793.6
========================================================================================================================
Liabilities and Shareholders'
Equity:
Insurance reserves $46,053.8 $46,053.8
Payable for securities
purchased 973.8 $ 249.4 $ 0.2 $ 210.7 1,434.1
Securities sold under
agreements to repurchase 880.6 880.6
Long-term debt, less
unamortized discounts 2,152.5 146.4 $ 930.0 $ 548.0 2,298.3 6,075.2
Reinsurance balances payable 3,285.9 3,285.9
Deferred income taxes 37.9 346.4 1.3 217.9 $ (603.5)
Other liabilities 2,530.8 1,529.9 223.9 137.0 125.5 $ 61.2 91.9 (362.3) 4,337.9
Separate account business 3,532.6 3,532.6
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities 59,410.0 1,779.3 408.4 1,413.4 674.8 61.2 2,818.8 (965.8) 65,600.1
Minority interest 916.8 0.2 788.2 5.0 1,710.2
Shareholders' equity 7,479.5 1,311.6 305.1 966.7 523.8 147.3 10,421.0 (10,671.7) 10,483.3
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $67,806.3 $ 3,090.9 $ 713.7 $ 3,168.3 $1,198.6 $ 213.5 $ 13,239.8 $(11,637.5)$77,793.6
========================================================================================================================
67
Loews Corporation
Consolidating Balance Sheet Information
CNA Loews Diamond Corporate
December 31, 2002 Financial Lorillard Hotels Offshore Bulova and Other Eliminations Total
- ------------------------------------------------------------------------------------------------------------------------
(In millions)
Assets:
Investments $35,271.2 $ 1,640.7 $ 104.6 $ 794.1 $ 1.4 $ 2,324.7 $40,136.7
Cash 126.2 2.0 4.8 18.4 8.7 25.3 185.4
Receivables 16,262.1 30.2 24.2 147.0 87.6 52.7 $ (2.8) 16,601.0
Property, plant and equipment 292.4 197.8 391.2 2,207.5 16.3 33.0 3,138.2
Deferred income taxes 772.2 437.0 22.6 0.3 (604.9) 627.2
Goodwill 140.8 2.6 34.4 177.8
Investments in capital stocks
of subsidiaries 11,451.2 (11,451.2)
Other assets 3,130.1 469.2 95.5 92.2 74.3 160.0 (22.1) 3,999.2
Deferred acquisition costs of
insurance subsidiaries 2,551.4 2,551.4
Separate account business 3,102.7 3,102.7
- ------------------------------------------------------------------------------------------------------------------------
Total assets $61,649.1 $ 2,776.9 $ 622.9 $3,293.6 $210.9 $14,047.2 $(12,081.0) $70,519.6
========================================================================================================================
Liabilities and Shareholders' Equity:
Insurance reserves $40,178.9 $40,178.9
Payable for securities
purchased 531.2 $ 4.0 $ 263.9 799.1
Securities sold under
agreements to repurchase 552.4 552.4
Long-term debt, less
unamortized discounts 2,292.1 145.8 $ 917.8 2,296.2 5,651.9
Reinsurance balances payable 2,763.3 2,763.3
Deferred income taxes 47.1 374.0 183.8 $ (604.9)
Other liabilities 2,659.7 $ 1,352.1 195.7 141.3 $ 67.5 87.3 (162.8) 4,340.8
Separate account business 3,102.7 3,102.7
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities 52,080.3 1,352.1 392.6 1,433.1 67.5 2,831.2 (767.7) 57,389.1
Minority interest 1,055.0 0.2 835.4 4.7 1,895.3
Shareholders' equity 8,513.8 1,424.8 230.1 1,025.1 138.7 11,216.0 (11,313.3) 11,235.2
- ------------------------------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $61,649.1 $ 2,776.9 $ 622.9 $3,293.6 $210.9 $14,047.2 $(12,081.0) $70,519.6
========================================================================================================================
68
Loews Corporation
Consolidating Statement of Operations Information
Nine Months Ended CNA Loews Diamond Texas Corporate Elimin-
September 30, 2003 Financial Lorillard Hotels Offshore Gas Bulova and Other ations Total
- ------------------------------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $ 6,703.8 $ (2.8) $ 6,701.0
Investment income, net 1,211.3 $ 29.7 $ 1.5 $ 10.2 $ 0.2 $ 22.3 1,275.2
Intercompany interest
and dividends 575.5 (575.5)
Investment gains (losses) 476.9 (10.6) (7.3) 44.2 503.2
Manufactured products 2,467.9 111.6 (1.1) 2,578.4
Other 287.6 (0.2) 212.0 494.7 $ 68.1 0.6 4.7 1,067.5
- ------------------------------------------------------------------------------------------------------------------------
Total 8,679.6 2,486.8 213.5 497.6 68.1 112.4 645.6 (578.3) 12,125.3
- ------------------------------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 7,968.9 7,968.9
Amortization of deferred
acquisition costs 1,433.7 1,433.7
Cost of manufactured
products sold 1,435.4 54.0 0.2 1,489.6
Other operating expenses 1,754.5 352.3 188.7 543.6 49.8 48.8 33.5 (2.8) 2,968.4
Interest 99.5 7.2 17.4 11.6 94.6 230.3
- ------------------------------------------------------------------------------------------------------------------------
Total 11,256.6 1,787.7 195.9 561.0 61.4 102.8 128.3 (2.8) 14,090.9
- ------------------------------------------------------------------------------------------------------------------------
(2,577.0) 699.1 17.6 (63.4) 6.7 9.6 517.3 (575.5) (1,965.6)
- ------------------------------------------------------------------------------------------------------------------------
Income tax (benefit) expense (976.0) 262.8 6.4 (11.6) 2.9 2.9 (22.7) (735.3)
Minority interest (174.0) (23.0) 0.2 (196.8)
- ------------------------------------------------------------------------------------------------------------------------
Total (1,150.0) 262.8 6.4 (34.6) 2.9 3.1 (22.7) (932.1)
- -----------------------------------------------------------------------------------------------------------------------
(Loss) income from
continuing operations (1,427.0) 436.3 11.2 (28.8) 3.8 6.5 540.0 (575.5) (1,033.5)
Discontinued operations-
net 55.4 55.4
- ------------------------------------------------------------------------------------------------------------------------
Net (loss) income $(1,427.0) $ 436.3 $ 66.6 $ (28.8) $ 3.8 $ 6.5 $ 540.0 $(575.5) $ (978.1)
========================================================================================================================
69
Loews Corporation
Consolidating Statement of Operations Information
Nine Months Ended CNA Loews Diamond Corporate
September 30, 2002 Financial Lorillard Hotels Offshore Bulova and Other Eliminations Total
- ------------------------------------------------------------------------------------------------------------------------
(In millions) (Restated) (Restated)
Revenues:
Insurance premiums $ 7,925.5 $ (2.6) $ 7,922.9
Investment income, net 1,292.4 $ 34.8 $ 1.5 $ 23.9 $ 0.3 $ 46.8 1,399.7
Intercompany interest
and dividends 466.3 (466.3)
Investment gains (losses) (137.4) 32.7 34.0 0.1 (74.4) (145.0)
Manufactured products 2,963.4 113.8 3,077.2
Other 464.7 1.9 200.8 570.1 1.2 2.9 1,241.6
- ------------------------------------------------------------------------------------------------------------------------
Total 9,545.2 3,032.8 202.3 628.0 115.4 441.6 (468.9) 13,496.4
- ------------------------------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 6,542.4 6,542.4
Amortization of deferred
acquisition costs 1,349.2 1,349.2
Cost of manufactured
products sold 1,707.0 54.4 1,761.4
Other operating expenses 1,246.1 337.1 179.4 531.6 48.8 43.7 (2.6) 2,384.1
Interest 112.4 7.1 17.8 94.5 231.8
- ------------------------------------------------------------------------------------------------------------------------
Total 9,250.1 2,044.1 186.5 549.4 103.2 138.2 (2.6) 12,268.9
- ------------------------------------------------------------------------------------------------------------------------
295.1 988.7 15.8 78.6 12.2 303.4 (466.3) 1,227.5
- ------------------------------------------------------------------------------------------------------------------------
Income tax expense (benefit) 78.1 389.7 5.4 28.2 5.4 (57.6) 449.2
Minority interest 32.7 26.3 0.2 59.2
- ------------------------------------------------------------------------------------------------------------------------
Total 110.8 389.7 5.4 54.5 5.6 (57.6) 508.4
- ------------------------------------------------------------------------------------------------------------------------
Income from continuing
operations 184.3 599.0 10.4 24.1 6.6 361.0 (466.3) 719.1
Discontinued operations-net (31.0) 2.2 (28.8)
Cumulative effect of change
in accounting principle-net (39.6) (39.6)
- ------------------------------------------------------------------------------------------------------------------------
Net income $ 113.7 $ 599.0 $ 12.6 $ 24.1 $ 6.6 $ 361.0 $ (466.3) $ 650.7
========================================================================================================================
70
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
- ------------------------------------------------------------------------------
OVERVIEW
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); the operation of an interstate natural gas transmission pipeline
system (Texas Gas Transmission, LLC ("Texas Gas"), a wholly 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," "Loews" and "Registrant" as used herein mean Loews
Corporation excluding its subsidiaries.
Management's discussion and analysis of financial condition and results of
operations is comprised of the following sections:
Page No.
--------
Consolidated Financial Results 72
Classes of Common Stock 75
Parent Company Structure 77
Critical Accounting Estimates 77
Results of Operations by Business Segment
CNA Financial
Third Quarter of 2003 Results of Operations and Capital Plan 79
Reserves - Estimates and Uncertainties 81
Reinsurance 84
Terrorism Exposure 87
Restructuring 88
Expense Initiatives 88
Non-GAAP Financial Measures 89
Property and Casualty Segment 91
Group Segment 99
Life Segment 100
Other Insurance Segment 101
APMT Reserves 102
Lorillard 113
Loews Hotels 119
Diamond Offshore 119
Texas Gas 121
Bulova 121
Corporate 121
Liquidity and Capital Resources
CNA Financial 122
Lorillard 126
Loews Hotels 128
Diamond Offshore 128
Texas Gas 129
Bulova 130
Majestic Shipping 130
Corporate 130
71
Investments 131
Accounting Standards 142
Forward-Looking Statements Disclaimer 142
The following discussion should be read in conjunction with the Company's
Consolidated Condensed Financial Statements and Notes thereto.
CONSOLIDATED FINANCIAL RESULTS
The Company reported a consolidated net loss (including both the Loews Group
and Carolina Group) for the 2003 third quarter of $1,382.9 million, compared
to net income of $239.1 million for the third quarter of 2002. Consolidated
net loss for the nine months ended September 30, 2003 amounted to $978.1
million, compared to net income of $650.7 million for the nine months ended
September 30, 2002.
The 2003 third quarter results include significant charges by CNA following
its recently completed reserve reviews. CNA announced a plan to strengthen its
capital base, which includes significant financial support from Loews as
described below.
The third quarter of 2003 results include the following charges at CNA, net
of tax and minority interest:
. Net prior year development of $1,345.8 million, which includes premium
and claim and allocated claim adjustment expense development.
. Increase in bad debt reserves for insurance and reinsurance receivables
of $298.9 million.
The net prior year development consists of $880.4 million related to core
reserves and $465.4 million related to asbestos, environmental pollution and
mass tort ("APMT") reserves (after tax and minority interest). The primary
factors that led to the net prior year development were CNA's previously
announced third quarter of 2003 comprehensive reserve reviews, which included
construction defect and other volatile exposures, and a ground up analysis of
APMT exposures. The net prior year development also resulted in additional
cessions to CNA's reinsurance contracts, including the corporate aggregate
reinsurance treaties. These additional cessions resulted in $60.3 million of
interest expense (after tax and minority interest), which is recorded as a
reduction in investment income. See "Results of Operations by Business Segment
- - CNA Financial" section of this Management's Discussion and Analysis of
Financial Condition and Results of Operations ("MD&A") for a detailed
discussion of these charges.
Capital Plan
To support statutory capital adversely impacted by the significant third
quarter charges, CNA has developed a capital plan, which includes substantial
support from Loews and possible sales or other dispositions of businesses and
assets. Under agreements entered into and approved in November of 2003 as to
fairness to minority shareholders by a Special Review Committee of independent
members of CNA's Board of Directors, Loews has agreed to purchase $750.0
million of a new series of CNA non-voting convertible preferred stock, having
terms that make it economically equivalent to CNA common stock. Proceeds from
the preferred stock sale will be applied by CNA to increase the statutory
surplus of CNA's principal insurance subsidiary, Continental Casualty Company
("CCC").
72
The preferred stock will automatically convert into a number of shares of
CNA common stock determined by dividing $750.0 million by the weighted average
of the daily trading prices of CNA's common stock, as reported by Bloomberg
Financial, L.P., for the five trading days from and including November 17,
2003 through November 21, 2003. Conversion will take place upon CNA's
compliance with, or receipt of a waiver of, applicable shareholder approval
requirements of the New York Stock Exchange.
Under the agreement, Loews has also committed up to $500.0 million of
additional capital support through the purchase of surplus notes of CCC in the
event that certain additions to CCC's statutory capital are not achieved by
February 26, 2004 from business or asset sales and related actions. The
obligation of Loews to consummate this agreement is subject to certain
customary closing conditions. In addition, Loews has indicated its commitment
to provide up to an additional $150.0 million by March 31, 2004, in a form to
be determined, to support the statutory capital of CCC in the event of
additional shortfalls in relation to business and asset sales. Other elements
of the capital plan include the October of 2003 sale of CNA Re renewal rights
and withdrawal from the assumed reinsurance business, CNA's previously
announced initiative to reduce operating expenses by $200.0 million and
planned changes in the ownership structure of certain insurance subsidiaries
to align statutory capital more efficiently.
Surplus notes issued under the capital plan, if any, will have a 20-year
term, bear interest at the one year London Interbank Offering Rate ("LIBOR")
plus 350 basis points, reset annually, and be mandatorily prepayable in the
event of certain additions to CCC's statutory surplus from business or asset
sales after the issuance of the notes. Surplus notes are financial instruments
with a stated maturity date and scheduled interest payments, issued by
insurance enterprises with the approval of the insurer's domiciliary state.
All payments of interest and principal on these notes are subject to the prior
approval of the Illinois Insurance Department. Surplus notes are included as
surplus for statutory accounting purposes, but are classified as debt
instruments under GAAP. See the Liquidity and Capital Resources - Corporate
section of this MD&A.
Three Months Ended September 30, 2003 Compared With 2002
The consolidated net loss for the three months ended September 30, 2003 was
$1,382.9 million, compared to net income of $239.1 million for the three
months ended September 30, 2002.
Consolidated net loss in the third quarter of 2003 includes a gain from
discontinued operations of $55.8 million or $0.30 per share of Loews common
stock related to the sale of a hotel property, as compared to $0.4 million in
the prior year related to the operating results for that property.
Consolidated loss from continuing operations for the third quarter of 2003
was $1,438.7 million, compared to income of $238.7 million in the comparable
period of the prior year. Loss from continuing operations includes net
investment gains of $106.5 million (after tax and minority interest), compared
to $9.1 million (after tax and minority interest) in the comparable period of
the prior year. The net loss reflects the unfavorable net prior year premium
and loss development and increase in bad debt reserves recorded in the third
quarter of 2003 as discussed above and lower results from Lorillard, partially
offset by the improvement in net investment gains.
Loss from continuing operations attributable to Loews common stock for the
third quarter of 2003 amounted to $1,465.5 million or $7.90 per share,
73
compared to income of $194.3 million or $1.05 per share in the comparable
period of the prior year. Loss from continuing operations in the third quarter
of 2003 includes net investment gains attributable to Loews common stock of
$107.8 million, compared to $5.8 million in the comparable period of the prior
year.
Net investment gains increased $102.0 million (after tax and minority
interest) in the third quarter of 2003 as compared with the same period in
2002. This increase was due primarily to increased gains related to derivative
securities and a decrease in investment related impairment charges for other-
than-temporary declines in market values of fixed maturity and equity
securities, partially offset by decreased gains on sales of fixed maturity
securities. Investment related impairment losses (after tax and minority
interest) were $9.0 million for the third quarter of 2003 as compared with
$129.6 million for the same period in 2002.
Net income attributable to Carolina Group stock for the third quarter of
2003 was $26.8 million or $0.67 per Carolina Group share, compared to $44.4
million, or $1.10 per Carolina Group share in the third quarter of 2002. The
Company is issuing a separate press release reporting the actual and pro forma
results of the Carolina Group for the quarter and nine months ended September
30, 2003 and 2002.
Nine Months Ended September 30, 2003 Compared With 2002
The consolidated net loss for the nine months ended September 30, 2003 was
$978.1 million, compared to net income of $650.7 million for the nine months
ended September 30, 2002.
Net loss for the first nine months of 2003 includes a gain from discontinued
operations of $55.4 million or $0.30 per share of Loews common stock related
to the sale of a hotel property, as compared to a loss from discontinued
operations of $28.8 million or $0.15 per share of Loews common stock in the
prior year primarily related to CNA's sale of its life operations in Chile.
Net income in 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 at CNA.
Consolidated loss from continuing operations for the first nine months of
2003 was $1,033.5 million, compared to income of $719.1 million in the
comparable period of the prior year. Loss from continuing operations includes
net investment gains of $300.6 million (after tax and minority interest),
compared to a loss of $93.0 million (after tax and minority interest) in the
comparable period of the prior year. The net loss reflects the unfavorable net
prior year premium and loss development and increase in bad debt reserves
recorded in the third quarter of 2003 as discussed above and lower results
from Lorillard, partially offset by the improvement in net investment gains.
Loss from continuing operations attributable to Loews common stock for the
first nine months of 2003 amounted to $1,113.9 million or $6.01 per share,
compared to income of $615.3 million or $3.26 per share in the comparable
period of the prior year. Loss from continuing operations includes net
investment gains attributable to Loews common stock of $302.2 million,
compared to losses of $97.8 million in the comparable period of the prior
year.
Net income attributable to Carolina Group stock for the first nine months of
2003 amounted to $80.4 million or $2.01 per Carolina Group share, compared to
$103.8 million or $2.58 per share in the comparable period of the prior year.
74
Components of Net (Loss) Income
The following table provides a summary of net (loss) income attributable to
Loews common stock:
September 30,
- ------------------------------------------------------------------------------
Three Months Nine Months
- ------------------------------------------------------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------
(In millions)
(Loss) income before net investment
gains (losses) attributable to
Loews common stock $(1,573.3) $ 188.5 $(1,416.1) $ 713.1
Net investment gains (losses) 107.8 5.8 302.2 (97.8)
- ------------------------------------------------------------------------------
(Loss) income from continuing
operations (1,465.5) 194.3 (1,113.9) 615.3
Discontinued operations-net (a) 55.8 0.4 55.4 (28.8)
Cumulative effect of changes
in accounting principle-net (b) (39.6)
- ------------------------------------------------------------------------------
Net (loss) income attributable
to Loews common stock $(1,409.7) $ 194.7 $(1,058.5) $ 546.9
==============================================================================
(a) Includes a gain of $56.7 in the quarter and nine months ended September
30, 2003 from the sale of a hotel property. The nine months ended
September 30, 2002 includes a $31.0 loss from CNA's sale of its life
operations in Chile.
(b) Represents the effect of the adoption of SFAS No. 142, which was a change
in accounting for goodwill and other intangible assets at CNA.
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
initially consisted of (a) the Company's 100% stock ownership interest in
Lorillard, Inc.; (b) notional, intergroup debt owed by the Carolina Group to
the Loews Group; and (c) any and all liabilities, costs and expenses arising
out of or related to tobacco or tobacco-related businesses.
As of September 30, 2003, 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 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 ($2.2 billion outstanding at September 30, 2003, after debt
repayments of $61.9 million in 2002 and $274.9 million in 2003), bearing
75
interest at the annual rate of 8.0% and, subject to optional prepayment, due
December 31, 2021.
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.
Distribution of Dividends from Lorillard, Inc.
The Carolina Group policy statement currently provides that all dividends
paid by Lorillard, Inc. to the Company will be allocated to the Carolina
Group. Lorillard Inc.'s principal source of cash is dividends from its wholly
owned subsidiary, Lorillard Tobacco Company.
It is the Company's intention to apply all of the cash from any dividends it
receives from Lorillard, Inc. in the following order of priority until the
notional, intergroup debt is repaid:
first, to satisfy or make provision for any intergroup or other
obligations of the Carolina Group, other than with respect to the
notional, intergroup debt;
second, to satisfy accrued interest on the Carolina Group's notional,
intergroup debt;
third, to pay any regularly-declared quarterly dividends on Carolina
Group stock and to make proportional distributions to the Loews Group in
respect of its intergroup interest in the Carolina Group;
fourth, to maintain up to $150.0 million for general corporate purposes,
including for investments, on behalf of the Carolina Group; and
fifth, to reduce the principal of the Carolina Group's notional,
intergroup debt.
76
PARENT COMPANY STRUCTURE
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, (i) the availability of
sufficient funds in such subsidiaries, (ii) applicable state laws, (iii) in
the case of the insurance subsidiaries of CNA, laws and rules governing the
payment of dividends by regulated insurance companies (see Liquidity and
Capital Resources - CNA, below), and (iv) any agreements by the subsidiaries
restricting the payment of dividends. 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.
At September 30, 2003, the book value per share of Loews common stock was
$57.48, compared to $61.68 at December 31, 2002.
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America ("GAAP")
requires management to make estimates and assumptions that affect the amounts
reported in the consolidated condensed financial statements and the related
notes. Actual results could differ from those estimates.
The consolidated condensed financial statements and accompanying notes have
been prepared in accordance with GAAP, applied on a consistent basis. The
Company continually evaluates the accounting policies and estimates used to
prepare the consolidated condensed financial statements. In general,
management's estimates are based on historical experience, evaluation of
current trends, information from third party professionals and various other
assumptions that are believed to be reasonable under the known facts and
circumstances.
The accounting estimates discussed below are considered by management to be
critical to an understanding of the Company's financial statements as their
application places the most significant demands on management's judgment. Due
to the inherent uncertainties involved with this type of judgment, actual
results could differ significantly from estimates and have a material adverse
impact on the Company's results of operations or equity.
Insurance Reserves
Insurance reserves are established for both short and long-duration
insurance contracts. Short-duration contracts are primarily related to
property and casualty policies where the reserving process is based on
actuarial estimates of the amount of loss, including amounts for known and
unknown claims. Long-duration contracts typically include traditional life
insurance and long term care products and are estimated using actuarial
estimates about mortality and morbidity as well as assumptions about expected
investment returns. The inherent risks associated with the reserving process
are discussed below, in Reserves - Estimates and Uncertainties. Additionally,
a review of Results of Operations for CNA's segment results, Environmental
Pollution and Mass Tort and Asbestos Reserves, and Third Quarter Reserve
77
Development sections is necessary to understand the sensitivity of
management's estimate.
Reinsurance
Amounts recoverable from reinsurers are estimated in a manner consistent
with claim and claim adjustment expense reserves or future policy benefits
reserves and are reported as a receivable in the Consolidated Condensed
Balance Sheets. The cost of reinsurance related to long-duration contracts is
accounted for over the life of the underlying reinsured policies using
assumptions consistent with those used to account for the underlying policies.
The ceding of insurance does not discharge the primary liability of CNA. An
estimated allowance for doubtful accounts is recorded on the basis of
periodic evaluations of balances due from reinsurers, reinsurer solvency,
management's experience and current economic conditions. Further information
on reinsurance is provided in the Reinsurance section that follows.
Tobacco Litigation
Lorillard and other cigarette manufacturers continue to be confronted with
substantial litigation. Plaintiffs in most of the cases seek unspecified
amounts of compensatory damages and punitive damages, although some seek
damages ranging into the billions of dollars. Plaintiffs in some of the cases
seek treble damages, statutory damages, disgorgement of profits, equitable and
injunctive relief, and medical monitoring, among other damages.
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, 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. While Lorillard intends to defend vigorously all tobacco products
liability litigation, 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. Lorillard may enter
into discussions in an attempt to settle particular cases if it believes it is
appropriate to do so.
On May 21, 2003 the Florida Third District Court of Appeal vacated the
judgment entered in favor of a class of Florida smokers in the case of Engle
v. R.J. Reynolds Tobacco Co., et al. The judgment reflected an award of
punitive damages to the class of approximately $145.0 billion, including $16.3
billion against Lorillard. The court of appeals also decertified the class
ordered during pre-trial proceedings. Plaintiffs are seeking review of the
case by the Florida Supreme Court. The Company and Lorillard believe that the
panel's decision should be upheld on further appeals.
Except for the impact of the State Settlement Agreements as described in
Note 12 of the Notes to Consolidated Condensed Financial Statements included
in Item 1 of this Report, management is unable to make a meaningful estimate
of the amount or range of loss that could result from an unfavorable outcome
of pending litigation and, therefore, no provision has been made in the
consolidated condensed financial statements for any unfavorable outcome. It is
possible that the Company's results of operations, cash flows and its
financial position could be materially adversely affected by an unfavorable
outcome of certain pending or future litigation.
78
Valuation of Investments and Impairment of Securities
The Company classifies its holdings of fixed maturity securities (bonds and
redeemable preferred stocks) and equity securities, which are held principally
by insurance subsidiaries, as available-for-sale, and are carried at fair
value. Changes in fair value are recorded as a component of accumulated other
comprehensive income in shareholders' equity, net of applicable deferred
income taxes and participating policyholders' and minority interest. The
amortized cost of fixed maturity securities is adjusted for amortization of
premiums and accretion of discounts to maturity, which are included in
investment income.
The Company's investment portfolio is subject to market declines below book
value that may be other-than-temporary. CNA has an Impairment Committee, which
reviews its investment portfolio on a quarterly basis with ongoing analysis as
new information becomes available. Any decline that is determined to be other-
than-temporary is recorded as an impairment loss in the period in which the
determination occurred. See "Investments - CNA" in this MD&A and Note 2 of the
Notes to Consolidated Condensed Financial Statements included in Item 1 for
information related to the Company's impairment charges.
Securities in the parent company's investment portfolio that are not part of
its cash management activities are classified as trading securities in order
to reflect the Company's investment philosophy. These investments are carried
at fair value with the net unrealized gain or loss included in the
Consolidated Condensed Statements of Income.
Individual Long-term Care Products
CNA's reserves and deferred acquisition costs for its individual long term
care product offerings are based on certain assumptions including morbidity,
policy persistency and interest rates. Actual experience may differ from these
assumptions. The recoverability of deferred acquisition costs and the adequacy
of the reserves are contingent on actual experience related to these key
assumptions and other factors including potential future premium increases and
future health care cost trends. The results of operations and/or equity may be
materially, adversely affected if actual experience varies significantly from
these assumptions.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
CNA Financial
CNA conducts its operations through five operating groups: Standard Lines,
Specialty Lines and CNA Re (these groups comprise the Company's Property and
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 is principally comprised of
losses and expenses related to the centralized adjusting and settlement of
APMT claims, certain run-off insurance operations and other operations
including CNA's interest expense on its corporate borrowings.
Third Quarter of 2003 Results of Operations and Capital Plan
CNA reported a net loss for the third quarter of 2003 of $1,580.8 million
compared to net income of $50.4 million for the same period in 2002. The third
quarter of 2003 net loss included significant reserve strengthening as a
result of CNA's recently completed reserve reviews. Significant items that
79
contributed to CNA's third quarter of 2003 net loss (after-tax and minority
interest) include:
. Net prior year development of $1,345.8 million after-tax and minority
interest, which includes premium and claim and allocated claim adjustment
expense development. Of this amount, $880.4 million was recorded for core
reserves and $465.4 million was recorded for environmental pollution and
mass tort and asbestos ("APMT") reserves.
. Increase in the bad debt reserve for reinsurance receivables in the
amount of $180.1 million. This increase was recorded based on continuing
deterioration of reinsurer financial strength ratings. See the
Reinsurance section of this MD&A for a detailed discussion of this
charge.
. Increase in the bad debt reserve for insurance receivables in the amount
of $118.8 million in Standard Lines. See the Standard Lines discussion of
results in the MD&A for a discussion of this charge.
. Increase in unallocated claim and claim adjustment expense ("ULAE")
reserves of $58.5 million. The increase was recorded in Standard Lines
($2.7 million), Specialty Lines ($16.2 million) and the Other Insurance
($39.6 million) segments.
To support statutory capital impacted by the significant third quarter
charges, CNA has developed a capital plan as detailed in the Consolidated
Financial Results - Capital Plan section of this MD&A.
Adverse trends in APMT and certain property and casualty exposures continue
to impact CNA. As noted in Reserves - Estimates and Uncertainties below, CNA
reviews its Insurance Reserves on a regular basis. As previously announced in
the Company's Form 10-Q for the period ended June 30, 2003, comprehensive
reviews of construction defect claims and other volatile exposures, and a
ground up analysis of APMT exposures, were conducted in the third quarter of
2003. In addition, an independent actuarial firm is in the process of
completing a review of the property and casualty Insurance Reserves as of
December 31, 2002 of CCC and The Continental Insurance Company ("CIC"). The
indications from these independent reviews have been considered as part of
CNA's reserving process and provide corroboration for CNA management's
conclusions regarding the required level of reserves.
Based on these third quarter of 2003 reserve reviews, CNA recorded $2,299.0
million of pretax ($1,345.8 after tax and minority interest) net unfavorable
prior year development, including $1,941.0 million of pretax net unfavorable
claim and allocated claim adjustment expense reserve development and $358.0
million of pretax unfavorable premium development for the three months ended
September 30, 2003.
80
The pretax third quarter of 2003 net unfavorable prior year development is
detailed by segment in the following table.
Property
and Other
Casualty Insurance Total
- ------------------------------------------------------------------------------------------------
(In millions)
Pretax net unfavorable prior year claim
and allocated claim adjustment expense
development excluding the impact of
the corporate aggregate reinsurance
treaties:
Core (Non-APMT) $1,533.0 $ 52.0 $1,585.0
APMT 795.0 795.0
- ------------------------------------------------------------------------------------------------
Total 1,533.0 847.0 2,380.0
Premium development, excluding the
impact of corporate aggregate
reinsurance treaties 123.0 123.0
- ------------------------------------------------------------------------------------------------
Pretax third quarter of 2003 net prior
year unfavorable development before
impact of corporate aggregate reinsurance
treaties 1,656.0 847.0 2,503.0
Pretax underwriting benefit from
corporate aggregate reinsurance
treaties on accident years 2000 and 2001 (204.0) (204.0)
- ------------------------------------------------------------------------------------------------
Total pretax third quarter of 2003
net unfavorable prior year development $1,452.0 $847.0 $2,299.0
================================================================================================
Reserves - Estimates and Uncertainties
CNA maintains reserves to cover its estimated ultimate unpaid liability for
claim and claim adjustment expenses and future policy benefits, 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. Claim and claim adjustment expense and future policy benefit
reserves are reflected as liabilities on the Consolidated Condensed Balance
Sheets under the heading "Insurance Reserves." Adjustments to prior year
reserve estimates, if necessary, are reflected in the results of operations in
the period that the need for such adjustments is determined.
The level of Insurance 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. Insurance Reserves are not an
exact calculation of liability but instead are complex 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.
Among the many uncertain future events about which CNA makes assumptions and
estimates, many of which have become increasingly unpredictable, are claims
severity, frequency of claims, mortality, morbidity, expected interest rates,
inflation, claims handling and case reserving policies and procedures,
underwriting and pricing policies, changes in the legal and regulatory
81
environment 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." These factors must be individually considered in relation to CNA's
evaluation of each type of business. Many of these uncertainties are not
precisely quantifiable, particularly on a prospective basis, and require
significant management judgment.
Given the factors described above, it is not possible to quantify precisely
the ultimate exposure represented by claims and related litigation. As a
result, CNA regularly reviews the adequacy of its reserves and reassesses its
reserve estimates as historical loss experience develops, additional claims
are reported and settled and additional information becomes available in
subsequent periods.
In addition, CNA is subject to the uncertain effects of emerging or
potential claims and coverage issues that arise as industry practices and
legal, judicial, social and other environmental conditions change. These
issues have had, and may continue to 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. Recent examples of emerging or
potential claims and coverage issues include:
. increases in the number and size of water damage claims, including those
related to expenses for testing and remediation of mold conditions;
. increases in the number and size of claims relating to injuries from
medical products, and exposure to lead;
. changes in interpretation of the named insured provision with respect to
the uninsured/underinsured motorist coverage in commercial automobile
policies;
. the effects of recently uncovered accounting and financial reporting
scandals and other major corporate governance failures which have
resulted in an increase in the number and size of claims, including
director and officer and errors and omissions insurance claims;
. a growing trend of plaintiffs targeting insurers in class action
litigation relating to claims handling and other practices;
. increases in the number of construction defect claims, including claims
arising under a broad range of additional insured endorsements on
policies; and
. increases in the number of claims alleging abuse by members of the
clergy.
The future impact of these and other unforeseen emerging or potential claims
and coverage issues is difficult to predict and could materially adversely
affect the adequacy of CNA's claim and claim adjustment expense reserves and
could lead to future reserve additions. See CNA's Segment Results for a
discussion of changes in reserve estimates and the impact on CNA's results of
operations.
CNA's experience has been that establishing reserves for casualty coverages
relating to APMT claim and claim adjustment expenses is subject to
uncertainties that are greater than those presented by other claims.
Estimating the ultimate cost of both reported and unreported APMT claims is
82
subject to a higher degree of variability due to a number of additional
factors, including among others:
. coverage issues, including whether certain costs are covered under the
policies and whether policy limits apply;
. allocation of liability among numerous parties some of whom may be in
bankruptcy proceedings and, in particular, the application of "joint and
several" liability to specific insurers on a risk;
. inconsistent court decisions and developing legal theories;
. increasingly aggressive tactics of plaintiffs' lawyers;
. increased filings of claims in certain states to avoid the application of
tort reform statute effective dates;
. the risks and lack of predictability inherent in major litigation;
. a further increase or decrease in asbestos and environmental claims which
cannot now be anticipated;
. continued increase in mass tort claims relating to silica and silica-
containing products, and the outcome of ongoing disputes as to coverage
in relation to these claims;
. the role the exhaustion of primary limits for certain accounts and
increased demands on any umbrella or excess policies CNA has issued;
. the number and outcome of direct actions against CNA; and
. future developments pertaining to CNA's ability to recover reinsurance
for asbestos and environmental claims.
It is also not possible to predict changes in the legal and legislative
environment and the impact on the future development of APMT claims. This
development will be affected by future court decisions and interpretations, as
well as changes in applicable legislation. It is difficult to predict the
ultimate outcome of large coverage disputes until settlement negotiations near
completion and significant legal questions are resolved or, failing
settlement, until the dispute is adjudicated. This is particularly the case
with policyholders in bankruptcy where negotiations often involve a large
number of claimants and other parties and require court approval to be
effective. A further uncertainty exists as to whether a national privately
financed trust to replace litigation of asbestos claims with payments to
claimants from the trust will be established and approved through federal
legislation, and, if established and approved, whether it will contain funding
requirements in excess of CNA's carried loss reserves.
Due to the factors described above, among others, establishing reserves for
APMT claim and claim adjustment expenses is subject to uncertainties that are
greater than those presented by other claims. Traditional actuarial methods
and techniques employed to estimate the ultimate cost of claims for more
traditional property and casualty exposures are less precise in estimating
claim and claim adjustment reserves for APMT, particularly in an environment
of emerging or potential claims and coverage issues that arise from industry
practices and legal, judicial and social conditions. Therefore, these
traditional actuarial methods and techniques are necessarily supplemented with
additional estimating techniques and methodologies, many of which involve
83
significant judgments that are required of management. Due to the inherent
uncertainties in estimating reserves for APMT claim and claim adjustment
expenses and the degree of variability due to, among other things, the factors
described above, CNA may be required to record material changes in its claim
and claim adjustment expense reserves in the future, should new information
become available or other developments emerge. See the Environmental Pollution
and Mass Tort and Asbestos Reserves section of the MD&A for additional
information relating to APMT claims and reserves.
CNA's recorded Insurance Reserves, including APMT reserves, reflect
management's best estimate as of a particular point in time based upon known
facts, current law and management's judgment. In light of the many
uncertainties associated with establishing the estimates and making the
assumptions necessary to establish reserve levels, CNA reviews its reserve
estimates on a regular basis and makes adjustments in the period that the need
for such adjustments is determined. These reviews have resulted in CNA
identifying information and trends that have caused CNA to increase its
reserves in prior periods and could lead to the identification of a need for
additional material increases in claim and claim adjustment expense reserves,
which could materially adversely affect CNA's results of operations, equity,
business, insurer financial strength and debt ratings (see the Ratings section
of this MD&A).
Reinsurance
CNA assumes and cedes reinsurance with other insurers, reinsurers and
members of various reinsurance pools and associations. See Note 9 for
discussion of CNA's sale of the renewal rights for its treaty business. 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.
Interest cost on reinsurance contracts accounted for on a funds withheld
basis is incurred during all periods in which a funds withheld liability
exists. Interest cost, which is included in net investment income, was $148.0
and $53.0 million for the three months ended September 30, 2003 and 2002 and
$288.0 and $168.0 million for the nine months ended September 30, 2003 and
2002. The amount subject to interest crediting rates on such contracts was
$2,892.0 and $2,766.0 million at September 30, 2003 and December 31, 2002.
Certain funds withheld reinsurance contracts, including the corporate
aggregate reinsurance treaties, require interest on additional premiums
arising from ceded losses as if those premiums were payable at the inception
of the contract. The amount of retroactive interest, included in the totals
above, for the three months ended September 30, 2003 was $103.0 million as
compared with $5.0 million in the same period of 2002. The amount of
retroactive interest, included in the totals above, for the nine months ended
September 30, 2003 was $147.0 million as compared with $10.0 million in the
same period of 2002.
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.
84
In certain circumstances, including significant deterioration of a
reinsurer's financial strength ratings, CNA may engage in commutation
discussions with individual reinsurers. The outcome of such discussions may
result in a lump sum settlement that is less than the recorded receivable, net
of any applicable allowance for doubtful accounts. Losses arising from
commutations could have a material adverse impact on the Company's results of
operations or equity.
As previously reported in the Company's Annual Report on Form 10-K for the
year ended December 31, 2002, CNA has reinsurance receivables from several
reinsurers who have recently experienced multiple downgrades of their
financial strength ratings, have announced that they will no longer accept new
business and are placing their books of business into run-off. One of CNA's
principal credit exposures from these recent events arose from reinsurance
receivables from Gerling Global Group of companies ("Gerling").
In the second quarter of 2003, CNA commuted three CNA HealthPro treaties
with Gerling which resulted in a $37.0 million pretax loss. CNA estimates that
these commutations will reduce pretax interest expense related to these
treaties by approximately $4.0 million over the balance of 2003 and $11.0
million in 2004.
In the third quarter of 2003, CNA commuted all remaining ceded and assumed
reinsurance contracts with four Gerling entities. The commutations resulted in
a pretax loss of $72.0 million which is net of a previously established
allowance for doubtful accounts of $47.0 million. CNA has no further exposure
to the Gerling companies that are in run-off.
CNA has established an allowance for doubtful accounts to provide for
estimated uncollectible reinsurance receivables. The reinsurance receivable
balances were $15,116.7 million as of September 30, 2003 and $12,695.3 million
at December 31, 2002. The increase in reinsurance receivables was primarily
due to ceded and allocated claim adjustment expenses related to APMT and
corporate aggregate reinsurance treaties. The allowance for doubtful accounts
was $547.6 and $195.7 million at September 30, 2003 and December 31, 2002. CNA
increased the allowance by $308.0 million for the three months ended September
30, 2003 and $348.0 million for the nine months ended September 30, 2003 in
recognition of deterioration of the financial strength ratings of several
reinsurers including Trenwick Group Ltd. ("Trenwick") and Commercial Risk
Reinsurance Company Ltd. In addition, in the third quarter of 2003 CNA updated
its reinsurance bad debt model based on recently published studies of
reinsurer insolvencies. While CNA believes the allowance for doubtful accounts
is adequate based on existing collateral and information currently available,
failure of reinsurers to meet their obligations could have a material adverse
impact on the Company's results of operations and equity.
CNA has an aggregate reinsurance treaty related to the 1999 through 2001
accident years that covers substantially all of CNA's property and casualty
lines of business (the "Aggregate Cover"). The Aggregate Cover provides for
two sections of coverage. 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 treaty, has a $500.0
million limit per accident year of ceded losses and an aggregate limit of $1.0
billion of ceded losses for the three accident years. The ceded premiums
associated with the first section 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 only relates to 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
85
charges on the funds withheld liability accrue at 8.0% per annum. The
aggregate loss ratio for the three-year period has exceeded certain thresholds
which requires additional premiums to be paid and an increase in the rate at
which interest charges are accrued. This rate will increase to 8.25% per annum
commencing in 2006.
During the second and third quarters of 2003, as a result of the unfavorable
development recorded related to accident years 2000 and 2001, the $500.0
million limit related to the 2000 and 2001 accident years under the first
section was fully utilized and losses of $500.0 million were ceded under the
first section of the Aggregate Cover. In 2001, as a result of reserve
additions including those related to accident year 1999, the $500.0 million
limit related to the 1999 accident year under the first section was fully
utilized and losses of $510.0 million were ceded under the second section as a
result of losses related to the September 11, 2001 World Trade Center Disaster
and related events ("WTC event").
The pretax impact of the Aggregate Cover was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions)
Ceded earned premiums $(223.0) $(251.0)
Ceded claim and claim adjustment expense 422.0 500.0
Interest charges (88.0) $(13.0) (123.0) $ (38.0)
- ------------------------------------------------------------------------------------------------
Pretax benefit (expense) $ 111.0 $(13.0) $ 126.0 $ (38.0)
================================================================================================
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 $761.0 million of ceded losses. The ceded premiums are a
percentage of ceded losses. The ceded premium related to full utilization of
the $761.0 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. As of September
30, 2003, the CCC Cover has been fully utilized.
86
The pretax impact of the CCC Cover was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions)
Ceded earned premiums $ (10.0) $(39.0) $(100.0) $(100.0)
Ceded claim and claim adjustment expense 17.0 55.0 143.0 148.0
Interest charges (13.0) (11.0) (48.0) (27.0)
- ------------------------------------------------------------------------------------------------
Pretax benefit (expense) $ (6.0) $ 5.0 $ (5.0) $ 21.0
================================================================================================
The pretax impact by operating segment of the Aggregate Cover and the CCC
Cover was as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions)
Property and casualty $ 105.0 $ (8.0) $ 122.0 $ (17.0)
Other Insurance (1.0)
- ------------------------------------------------------------------------------------------------
Pretax benefit (expense) $ 105.0 $ (8.0) $ 121.0 $ (17.0)
================================================================================================
Terrorism Exposure
CNA and the insurance industry incurred substantial losses related to the
WTC event. For the most part, 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 Terrorism Risk Insurance Act of 2002 (the Act), has established a
program within the Department of the Treasury under which the federal
government will share the risk of loss by commercial property and casualty
insurers arising from future terrorist attacks with the insurance industry.
The Act expires on December 31, 2005. Each participating insurance company
must pay a deductible, ranging from 7.0% of direct earned premiums from
commercial insurance lines in 2003 to 15.0% in 2005, before federal government
assistance becomes available. For losses in excess of a company's deductible,
the federal government will cover 90.0% of the excess losses, while companies
retain the remaining 10.0%. Losses covered by the program will be capped
annually at $100.0 billion; above this amount, insurers are not liable for
covered losses and Congress is to determine the procedures for and the source
of any payments. Amounts paid by the federal government under the program over
certain phased limits are to be recouped by the Department of the Treasury
through policy surcharges, which cannot exceed 3.0%of annual premium.
87
CNA is required to participate in the program, but it does not cover life or
health insurance products. State law limitations applying to premiums and
policies for terrorism coverage are not generally affected under the program,
but they are pre-empted in relation to prior approval requirements for rates
and forms. The Act has required insurers to offer terrorism coverage through
2004. The Secretary of the Department of the Treasury has discretion to extend
this offer requirement until December 31, 2005.
While the Act provides the property and casualty industry with an increased
ability to withstand the effect of a terrorist event through 2005, given the
unpredictability of the nature, targets, severity or frequency of potential
terrorist events, the Company's results of operations or equity could
nevertheless be materially adversely impacted by them. CNA is attempting to
mitigate this exposure through its underwriting practices, policy terms and
conditions (where applicable) and the use of reinsurance. In addition, under
state laws, CNA is generally prohibited from excluding terrorism exposure from
its primary workers compensation, individual life and group life and health
policies. In those states that mandate property insurance coverage of damage
from fire following a loss, CNA is also prohibited from excluding terrorism
exposure under such coverage.
Reinsurers' obligations for terrorism-related losses under reinsurance
agreements are not covered by the Act. CNA's current reinsurance arrangements
either exclude terrorism coverage or significantly limit the level of
coverage.
Restructuring
As previously recorded in the Company's Annual Report on Form 10-K for the
year ended December 31, 2002, CNA finalized and approved two separate
restructuring plans in 2001. 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").
No restructuring and other related charges related to the IT Plan were
incurred for the three and nine months ended September 30, 2003 and 2002.
During 2003, $1.0 million in payments were charged against the liability. As
of September 30, 2003, the accrued liability relating to employee termination
and related benefit costs was $4.0 million. The remaining accrual is expected
to be paid through 2004.
No restructuring and other related charges related to the 2001 Plan were
incurred for the three and nine months ended September 30, 2003 and 2002.
During 2003, $14.0 million in payments for occupancy and employee related
costs and $1.0 million of loss on disposal of property costs were charged
against the liability. As of September 30, 2003, the accrued liability,
relating primarily to lease termination costs, was $22.0 million. Of which,
approximately $3.0 million is expected to be paid in the fourth quarter of
2003.
Expense Initiatives
CNA announced a $200.0 million expense reduction initiative in the second
quarter of 2003. The primary components of the initiative are a reduction of
the workforce by approximately five percent, lower commissions and other
acquisition costs, principally related to workers compensation, and reduced
spending in other areas. Strategies expected to realize such savings have
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begun to be implemented and will continue through 2004. Approximately $16.0
million of severance and related costs has been recorded for the nine months
ended September 30, 2003 related to the expense reduction initiatives.
Non-GAAP Financial Measures
This MD&A discusses certain GAAP and non-GAAP financial measures in order to
provide information used by CNA management to monitor CNA's operating
performance. Management utilizes various financial measures to monitor CNA's
insurance operations and investment portfolio. Underwriting results, which are
derived from certain income statement amounts, are considered non-GAAP
financial measures and are used by management to monitor performance of CNA's
insurance operations. CNA's investment portfolio is monitored through analysis
of various quantitative and qualitative factors and certain decisions related
to the sale or impairment of investments that produce realized gains and
losses. Net realized investment gains and losses, which are comprised of
after-tax realized investment gains and losses net of participating
policyholders' and minority interest are a non-GAAP financial measure.
Underwriting results are computed as net earned premiums less net incurred
claims and the cost incurred to settle these claims, acquisition expenses,
underwriting expenses, and dividend expenses. CNA's management uses
underwriting results to monitor its insurance operations' results without the
impact of certain factors, including investment income, other revenues, other
expenses, minority interest, income tax benefit (expense) and net realized
investment gains or losses. Management excludes these factors in order to
analyze the direct relationship between the net earned premiums and the
related claims and the cost incurred to settle these claims, acquisition
expenses, underwriting expenses and dividend expenses.
Management excludes after-tax net realized investment gains or losses when
analyzing the insurance operations because net realized investment gains or
losses related to CNA's available-for-sale investment portfolio are largely
discretionary, except for losses related to other-than-temporary impairments,
and are generally driven by economic factors that are not necessarily
consistent with key drivers of underwriting performance.
Operating ratios are calculated using insurance results and are used by the
insurance industry and regulators such as state departments of insurance and
the National Association of Insurance Commissioners for financial regulation
and as a basis of comparison among companies. The ratios discussed in this
MD&A are calculated using GAAP financial results and include the loss and loss
adjustment expense ratio ("loss ratio") as well as the expense, dividend and
combined ratios. 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. The
combined ratio is the sum of the loss, expense and dividend ratios.
CNA's investment portfolio is monitored by management through analyses of
various factors including unrealized gains and losses on securities, portfolio
duration and exposure to interest rate, market and credit risk. Based on such
analyses, CNA may impair an investment security in accordance with its policy,
or sell a security. Such activities will produce realized gains and losses.
While management uses various non-GAAP financial measures to monitor various
aspects of CNA's performance, relying on any measure other than net income,
which is the most directly comparable GAAP measure to underwriting results and
89
realized gains and losses, is not a complete representation of financial
performance. Management believes that its process of evaluating performance
through the use of these non-GAAP financial measures provides a basis for
understanding the operations and the impact to net income as a whole.
Management also believes that investors find these non-GAAP financial measures
described above useful to help interpret the underlying trends and
performance, as well as to provide visibility into the significant components
of net income.
Throughout the MD&A, CNA's business segment results are discussed using
Underwriting income (loss), which as described above is a non-GAAP measure.
The following reconciliations are provided in order to understand the
differences between Underwriting Results and net income (loss).
Three Months Ended Nine Months Ended
September 30, September 30,
- --------------------------------------------------------------------- -------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions)
Underwriting loss $(1,986.0) $(130.0) $(2,555.0) $(359.0)
Net investment income 115.0 144.0 504.0 597.0
Other revenues 70.0 114.0 247.0 365.0
Other expenses (67.0) (108.0) (227.0) (305.0)
- ------------------------------------------------------------------------------------------------
(Loss) income, before income tax
benefit (expense), minority interest
and net realized investment gains (losses) (1,868.0) 20.0 (2,031.0) 298.0
Income tax benefit (expense) 676.0 (4.0) 761.0 (84.0)
Minority interest 131.5 (1.5) 135.3 (33.6)
- ------------------------------------------------------------------------------------------------
Operating (loss) income (1,060.5) 14.5 (1,134.7) 180.4
Realized investment gains (losses), net of
participating policyholders' and
minority interest 86.5 (44.7) 358.7 (93.0)
Income tax (expense) benefit on realized
investment gains (losses) (33.8) 17.6 (132.6) 37.6
- ------------------------------------------------------------------------------------------------
(Loss) income from continuing operations (1,007.8) (12.6) (908.6) 125.0
Cumulative effect of change in accounting
principle-net (33.3)
- ------------------------------------------------------------------------------------------------
Net (loss) income $(1,007.8) $ (12.6) $ (908.6) $ 91.7
================================================================================================
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Operating Results
Property and Casualty
CNA conducts its property and casualty operations through the following
operating segments: Standard Lines, Specialty Lines and CNA Re.
The following table summarizes key components of the Property and Casualty
segment results of operations for the three and nine months ended September
30, 2003 and 2002:
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions)
Net written premiums $ 1,662.0 $ 1,828.0 $ 5,329.0 $ 5,406.0
Net earned premiums 1,546.0 1,700.0 4,983.0 5,096.0
Underwriting loss (1,986.0) (130.0) (2,555.0) (359.0)
(Loss) income before net realized
investment gains (losses) (1,060.5) 14.5 (1,134.7) 180.4
Net realized investment gains (losses) 52.7 (27.1) 226.1 (55.4)
(Loss) income from continuing operations (1,007.8) (12.6) (908.6) 125.0
Ratios
Loss and loss adjustment expense 159.6% 75.4% 105.4% 74.6%
Expense 64.8 30.7 44.1 31.2
Dividend 4.0 1.5 1.8 1.2
- ------------------------------------------------------------------------------------------------
Combined 228.4% 107.6% 151.3% 107.0%
================================================================================================
During October of 2003, CNA sold the renewal rights for all treaty business
to Folksamerica Holding Company, Inc. ("Folksamerica"), a wholly owned
subsidiary of White Mountains Insurance Group, Ltd. of Hamilton, Bermuda.
Under the terms of the transaction, Folksamerica will compensate CNA based
upon the amount of premiums renewed by Folksamerica over the next two contract
renewals. Concurrent with the sale, CNA announced its withdrawal from the
assumed reinsurance business. CNA will manage the run-off of its retained
liabilities. The guaranteed minimum under the renewal rights contract will be
recorded in the fourth quarter.
Three Months Ended September 30, 2003 Compared with 2002
Net written premiums for the Property and Casualty segment decreased $166.0
million and net earned premiums decreased $154.0 million for the three months
ended September 30, 2003 as compared with the same period in 2002. The
decrease in premiums was due primarily to additional ceded premiums to
corporate aggregate reinsurance treaties and other reinsurance treaties
resulting from unfavorable net prior year reserve development. Partially
offsetting these items were rate increases and new business in Standard Lines
and Specialty Lines.
Standard Lines averaged rate increases of 16.0% and 28.0% for the three
months ended September 30, 2003 and 2002 for the contracts that renewed during
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the period. Retention rates of 71.0% and 68.0% were achieved for those
contracts that were up for renewal.
Specialty Lines averaged rate increases of 21.0% and 30.0% for the three
months ended September 30, 2003 and 2002 for the contracts that renewed during
the period. Retention rates of 80.0% and 77.0% were achieved for those
contracts that were up for renewal.
Net results decreased $995.2 million for the three months ended September
30, 2003 as compared with the same period in 2002. The decline in net results
was due principally to increased net unfavorable prior year development of
$841.7 million after-tax and minority interest ($1,439.0 million pretax), a
$198.0 million after-tax and minority interest ($339.0 million pretax)
increase in the bad debt provision for insurance and reinsurance receivables,
and a $52.2 million after-tax and minority interest ($89.0 million pretax)
increase in insurance related assessments. Net results also include an $18.9
million after-tax and minority interest ($33.0 million pretax) increase in
unallocated loss adjustment expense reserves, increased dividend development
of $23.4 million after-tax and minority interest ($40.0 million pretax), and
increased interest expense of $57.6 million after-tax and minority interest
($98.0 million pretax) related to additional cessions to the corporate
aggregate and other reinsurance treaties. These declines were partially offset
by a $79.8 million increase in net realized investment gains.
During the third quarter of 2003, CNA recorded an increase in the liability
for certain insurance related assessments of $58.0 million pretax for the
Property and Casualty segment. The increase was in recognition of the growing
level of guaranty fund assessments, increased estimates for the Reliance
National Indemnity Insurance Company, et al., insolvency exposure, and
exposure to additional insolvencies that impact the assessment calculation.
The combined ratio increased 120.8 points and underwriting results decreased
$1,856.0 million for the three months ended September 30, 2003 as compared
with the same period in 2002. This change was due to increases in the loss,
expense and dividend ratios. The loss ratio increased 84.2 points due
principally to the unfavorable net prior year development, discussed below,
and an $18.0 million increase in catastrophe losses for the three months ended
September 30, 2003 as compared with the same period in 2002. Catastrophe
losses were $57.0 million for the three months ended September 30, 2003
compared with $39.0 million for the three months ended September 30, 2002.
Additionally, the loss ratio was negatively impacted by a $33.0 million
increase in unallocated loss adjustment expense ("ULAE") reserves. Partially
offsetting this decline was an improvement in the current accident year loss
ratio.
Unfavorable net prior year development, including premium and claim and
allocated claim adjustment expense reserve development, of $1,452.0 million,
including $1,094.0 million of unfavorable claim and allocated claim adjustment
expense reserve development and $358.0 million of unfavorable premium
development, was recorded for the three months ended September 30, 2003.
Unfavorable net prior year development of $13.0 million, including $38.0
million of favorable claim and allocated claim adjustment expense reserve
development and $51.0 million of unfavorable premium development, was recorded
for the same period in 2002.
Approximately $495.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development was recorded related to
construction defect claims in Standard Lines. Based on analyses completed
during the third quarter of 2003, it became apparent that the assumptions
92
regarding the number of claims, which were used to estimate the expected
losses, were no longer appropriate. The analyses indicated that the actual
number of claims reported during 2003 was higher than expected primarily in
states other than California. States where this activity is most evident
include Texas, Arizona, Nevada, Washington and Colorado. The number of claims
reported in states other than California during the first six months of 2003
was nearly 35.0% higher than the last six months of 2002. The number of claims
reported during the last six months of 2002 increased by less than 10.0% from
the first six months of 2002. In California, claims resulting from additional
insured endorsements increased throughout 2003. Additional insured
endorsements are regularly included on policies provided to subcontractors.
The additional insured endorsement names general contractors and developers as
additional insureds covered by the policy. Current California case law
(Preseley Holmes, Inc. v. American States Insurance Copany, 01 C.D.O.S. (July
10, 2001)) specifies that an individual subcontractor with an additional
insured obligation has a duty to defend the additional insured in the entire
action, subject to contribution or recovery later. In addition, the additional
insured is allowed to choose one specific carrier to defend the entire action.
These additional insured claims can remain open for a longer period of time
than other construction defect claims because the additional insured defense
obligation can continue until the entire case is resolved. The recorded net
prior year development related to construction defect claims was primarily for
accident years 1999 and prior. CNA Re recorded an additional $15.0 million of
unfavorable development for construction defect related exposures in the third
quarter of 2003. Because of the unique nature of this exposure, losses will
not follow normal development patterns. The continued reporting of claims in
California, the increase in the number of claims from states other than
California and a review of individual ceding companies' exposure to this type
of claim resulted in an increase in the estimated reserve.
Unfavorable net prior year claim and allocated claim adjustment expense
reserve development of approximately $285.0 million was recorded for large
account business including workers compensation coverages. Many of the
policies issued to these large accounts include provisions tailored
specifically to the individual accounts. Such provisions effectively result in
the insured being responsible for a portion of the loss. An example of such a
provision is a deductible arrangement where the insured reimburses CNA for all
amounts less than a specified dollar amount. These arrangements often limit
the aggregate amount the insured is required to reimburse CNA. Analyses
completed during the third quarter of 2003 included claims handled by third
party administrators ("TPA"), which indicated higher losses from the large
accounts including an increase in the amounts of losses in excess of
policyholder deductibles. In addition, these analyses indicated that the
provisions that result in the insured being responsible for a portion would
have less of an impact due to the larger size of claims as well as the
increased number of claims. The net prior year development was recorded
primarily in accident years 2000 and prior.
Unfavorable net prior year development of $136.0 million, including $99.0
million of unfavorable claim and allocated claim adjustment expense reserve
development and $37.0 million of unfavorable premium development, was recorded
for CNA Re.
For CNA Re, this unfavorable net prior year development in 2003 is largely
driven by a general change in the pattern of losses as reported by the
companies that purchase reinsurance from CNA Re. Losses have continued to show
large increases for accident years in the late 1990s and into 2000 and 2001.
These increases are greater than the increases indicated by patterns from
older accident years and have a similar effect on several lines of businesses.
93
Approximately $67.0 million of unfavorable net prior year development was
recorded for proportional liability exposures, primarily from multi-line and
umbrella treaties in accident years 1997 through 2002. Approximately $38.0
million of unfavorable net prior year development related to assumed financial
reinsurance covers in accident years 2001 and prior and approximately $24.0
million of unfavorable net prior year development related to professional
liability exposures in accident years 2001 and prior.
Approximately $120.0 million of losses were recorded as the result of a
commutation of all ceded reinsurance treaties with Gerling, relating to
accident years 1999 through 2002. Further information regarding this
commutation is provided in the Reinsurance section of the MD&A.
Approximately $77.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development resulted from a program
covering facilities that provide services to developmentally disabled
individuals in Standard Lines. This net prior year development was due to an
increase in the size of known claims and increases in policyholder defense
costs. Recent data shows the average claim increasing at an annual rate of
approximately 20%. Prior data had shown average claim size to be level.
Similar to the average claim size, recent data shows the average policyholder
defense cost increasing at an annual rate of approximately 20%. Prior data had
shown average policyholder defense cost to be level. The net prior year
reserve development recorded was primarily for accident years 2001 and prior.
Approximately $50.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development was recorded relating
to increased severity in excess coverages provided to facilities providing
health care services in Specialty Lines. The development was based on reviews
of individual accounts where claims had been expected to be less than the
point at which CNA's coverage applies. The current claim trends now indicate
that the layers of coverage provided by CNA will be impacted. The net prior
year reserve development recorded was primarily for accident years 2001 and
prior.
Approximately $47.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development was recorded for Surety
for workers compensation bond exposure from accident years 1990 and prior and
large losses for accident years 1999 and 2002.
The following development was recorded in the third quarter of 2003 as a
result of the elimination of deficiencies and redundancies in reserve
positions of individual products within CNA Re. Unfavorable net prior year
development of approximately $42.0 million related to surety exposures, $32.0
million related to excess of loss liability exposures and $12.0 million
related to facultative liability exposures were recorded in the third quarter
of 2003.
Approximately $40.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development resulted from excess
workers compensation coverages due to increasing severity. The increase in
severity means that a higher percentage of the total loss dollars will be
CNA's responsibility since more claims will exceed the point at which CNA's
coverage begins. The net prior year reserve development recorded was primarily
for accident year 2000.
Approximately $36.0 million of unfavorable net prior year claim and
allocated claim adjustment expense development was recorded for directors and
officers exposures in CNA Pro and Global Lines. The unfavorable net prior year
94
reserve development was primarily due to securities class action cases related
to certain known corporate malfeasance cases and investment banking firms. The
reserve development was recorded primarily in accident years 2000 and 2001.
The following net prior year development was recorded as a result of the
elimination of deficiencies and redundancies in reserve positions of
individual products within the segment, as discussed in the Third Quarter
Reserve Development section of this MD&A. Unfavorable net prior year
development of approximately $210.0 million related to small and middle market
workers compensation exposures and approximately $110.0 million related to E&S
lines was recorded in the third quarter of 2003. An additional $50.0 million
of unfavorable net prior year claim and allocated claim adjustment expense
reserve development was recorded related to medical malpractice and long term
care facilities. Partially offsetting these reserve increases was favorable
development of approximately $210.0 million in the property line of business,
including $79.0 million related to the September 11, 2001 WTC event. An
additional $55.0 million of favorable development related to the WTC event was
recorded in CNA Re.
Also, offsetting the unfavorable reserve development was a $204.0 million
underwriting benefit from cessions to corporate aggregate reinsurance
treaties. The benefit was comprised of $439.0 million of ceded losses and
$235.0 million of ceded premiums for accident years 2000 and 2001. A $14.0
million underwriting benefit was recorded for the corporate aggregate
reinsurance treaties for the three months ended September 30, 2002, comprised
of $55.0 million of ceded losses and $41.0 million of ceded premiums. See the
Reinsurance section of this MD&A for further discussion of CNA's aggregate
reinsurance treaties.
The expense ratio increased 34.1 points as a result of increased expenses
and the decreased net earned premium base. Expenses were unfavorably impacted
by an increase in the bad debt provision for reinsurance receivables of $136.0
million and in bad debt reserves for insurance receivables of $203.0 million.
Based on recent experience with troubled companies, an increase in the bad
debt reserve for reinsurance receivables was deemed appropriate. See the
Reinsurance section of this MD&A for additional information regarding the
increase in reinsurance receivables. The increase for insurance receivables
was primarily the result of a review of Professional Employer Organization
("PEO") accounts as well as certain accounts that have been turned over to
third parties for collection. During 2002, Standard Lines ceased writing
coverages for PEO businesses, with the last contracts expiring on June 30,
2003. The review analyzed ultimate amounts collectable and the associated
collateral held by CNA. Upon completion of the review, it was determined that
an increase in the reserve was appropriate.
Additionally, expenses increased as a result of an increase in the accrual
for certain insurance related assessments of $58.0 million which was recorded
in the third quarter of 2003. In addition, a $31.0 million reduction in the
accrual for certain insurance-related assessments resulting from changes, due
to legislation, in the basis on which the assessments were calculated was
recorded in the third quarter of 2002. Also increasing the expense ratio was
approximately $19.0 million of expenses related to eBusiness initiatives in
2003. The 2002 eBusiness expenses were included in the Other Insurance
segment.
The dividend ratio increased 2.5 points for the three months ended September
30, 2003 as compared with the same period in 2002 due to increased net prior
year unfavorable dividend development. Unfavorable dividend development of
$46.0 million was primarily related to workers compensation products for the
95
three months ended September 30, 2003. A review was completed in the third
quarter indicating paid dividend development that was higher than prior
expectations. This development was recorded for accident years 2002 and prior.
Nine Months Ended September 30, 2003 Compared with 2002
Net written premiums for the Property and Casualty segment decreased $77.0
million and net earned premiums decreased $113.0 million for the nine months
ended September 30, 2003 as compared with the same period in 2002. The
decrease in premiums was due to additional ceded premiums to corporate
aggregate reinsurance treaties and other reinsurance treaties resulting from
unfavorable net prior year reserve development. Partially offsetting these
items were rate increases and new business primarily in Standard Lines and
Specialty Lines.
Standard Lines averaged rate increases of 18.0% and 29.0% for the nine
months ended September 30, 2003 and 2002 for the contracts that renewed during
the period. Retention rates of 72.0% and 67.0% were achieved for those
contracts that were up for renewal.
Specialty Lines averaged rate increases of 25.0% for both the nine months
ended September 30, 2003 and 2002 for the contracts that renewed during the
period. Retention rates of 79.0% and 77.0% were achieved for those contracts
that were up for renewal.
Net results decreased $1,033.6 million for the nine months ended September
30, 2003 as compared with the same period in 2002. The decline in net results
was due primarily to increased unfavorable net prior year development of
$1,134.2 million after-tax and minority interest ($1,943.0 million pretax), a
$48.6 million after-tax and minority interest increase in catastrophe losses,
a $220.5 million after-tax and minority interest ($378.0 million pretax)
increase in the bad debt provision for insurance and reinsurance receivables,
and a $52.2 million after-tax and minority interest ($89.0 million pretax)
increase in insurance related assessments. Net results also include an $18.9
million after-tax and minority interest ($33.0 million pretax) increase in
unallocated loss adjustment expense reserves, increased dividend development
of $23.4 million after-tax and minority interest ($40.0 million pretax),
increased interest expense of $81.0 million after-tax and minority interest
($137.0 million pretax) related to additional cessions to the corporate
aggregate and other reinsurance treaties. These items were partially offset by
a $281.5 million increase in net realized investment results and improved
current accident year results.
In addition, net results for the first quarter of 2002 include a non-
recurring currency translation gain on U.S. dollar denominated investments
held by an Argentine subsidiary. The Argentine government changed its local
currency and required conversion of all U.S. denominated investments to
Argentine Pesos. This conversion resulted in a translation gain of $18.0
million, which was partially offset by a write-off of the goodwill of that
entity in the amount of $10.0 million.
The combined ratio increased 44.3 points and underwriting results decreased
$2,196.0 million for the nine months ended September 30, 2003 as compared with
the same period in 2002. The change was due to increases in the loss, expense
and dividend ratios. The loss ratio increased 30.8 points due principally to
increased unfavorable net prior year development, as discussed below, and
$132.0 million of catastrophe losses, primarily related to Hurricanes Isabel
and Claudette, Texas tornados, and Midwest rain storms for the nine months
ended September 30, 2003. Catastrophe losses were $50.0 million for the nine
96
months ended September 30, 2002. Partially offsetting these declines were
improvements in the current net accident year loss ratio.
Unfavorable net prior year development of $1,966.0 million, including
$1,437.0 million of unfavorable claim and allocated claim adjustment expense
reserve development and $529.0 million of unfavorable premium development, was
recorded for the nine months ended September 30, 2003. Unfavorable net prior
year reserve development of $23.0 million, including $25.0 million of
favorable claim and allocated claim adjustment expense reserve development and
$48.0 million of unfavorable premium development, was recorded for the same
period in 2002. The gross carried claim and claim adjustment expense reserve
was $21,906.0 and $19,714.0 million at September 30, 2003 and December 31,
2002. The net carried claim and claim adjustment expense reserve was $13,398.0
and $11,997.0 million at September 30, 2003 and December 31, 2002.
In addition to the development recorded in the third quarter of 2003 as
discussed in the three month comparison, unfavorable net prior year
development of approximately $310.0 million, including $233.0 million of
unfavorable claim and allocated claim adjustment expense reserve development
and $77.0 million of unfavorable premium development, was recorded for large
account business in the second quarters of 2003, driven by workers
compensation exposures. This development resulted from the completion of
reserve reviews for large account business where the insured is often
responsible for a portion of the losses, and claims are handled by CNA.
Initial reserves for this business are set based on the expected losses
associated with the individual accounts covered and the terms of the
individual plans. Based on analyses completed during the second quarter of
2003, it became apparent that the assumptions regarding the number and size of
the losses, which were used to estimate the expected losses, were no longer
appropriate. The analyses showed that the actual number of claims and the
average claim size were larger than expected. The recorded development was for
accident years prior to 2002.
Unfavorable net prior year claim and allocated claim adjustment expense
reserve development of approximately $75.0 million was recorded related to a
recent adverse arbitration decision involving a single large property and
business interruption loss. The decision was rendered against a voluntary
insurance pool in which CNA was a participant. The loss was caused by a fire
which occurred in 1995. CNA no longer participates in this pool.
In addition to the unfavorable net prior year development recorded in the
third quarter of 2003 recorded for directors and officers exposures,
approximately $50.0 million of unfavorable net prior year claim and allocated
claim adjustment expense reserve development was recorded in the second
quarter of 2003. The unfavorable net prior year reserve development was a
result of a claims review that was completed during the second quarter of
2003. The unfavorable net prior year reserve development was primarily due to
securities class action cases related to certain known corporate malfeasance
cases and investment banking firms. The recorded reserve development was
primarily for accident years 2001 and 2002.
Unfavorable net prior year claim and allocated claim adjustment expense
reserve development of approximately $40.0 million was recorded for a program
covering tow truck and ambulance operators, primarily impacting the 2001
accident year of which, $36.0 million was recorded in the second quarter of
2003 and $4.0 million was recorded in the third quarter of 2003. CNA had
previously expected that loss ratios for this business would be similar to its
middle market commercial automobile liability business. During 2002, CNA
ceased writing business under this program.
97
Approximately $25.0 million of unfavorable net prior year premium
development was recorded related to a second quarter 2003 reevaluation of
losses ceded to a reinsurance contract covering middle market workers
compensation exposures recorded in the second quarter of 2003. The
reevaluation of losses led to a new estimate of the number and dollar amount
of claims that would be ceded under the reinsurance contract. As a result of
the reevaluation of losses, CNA recorded approximately $36.0 million of
unfavorable claim and allocated claim adjustment expense reserve development,
which was ceded under this contract. The net prior year development recorded
was for accident year 2000.
Approximately $21.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development resulted from a program
covering facilities that provide services to developmentally disabled
individuals during the first and second quarters of 2003. This development was
due to an increase in the size of known claims and increases in policyholder
defense costs. The reserve development was recorded in accident years prior to
2001.
Approximately $21.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development was recorded in the
Surety line of business as the result of recent developments on one large
claim in the second quarter of 2003.
Favorable prior year claim and allocated claim adjustment expense reserve
development was also recorded in property lines primarily in the first quarter
of 2003. The favorable reserve development was principally for accident years
2001 and 2002 and was the result of the lower than expected number of large
losses in recent years.
Approximately $37.0 million of losses were recorded in the second quarter of
2003 as the result of a commutation of three ceded reinsurance treaties
covering CNA HealthPro, related to accident years 1999 through 2001. Further
information regarding this commutation is provided in the Reinsurance section
of this MD&A.
In addition to the unfavorable development recorded in the third quarter of
2003 as discussed above, unfavorable net prior year claim and allocated claim
adjustment expense reserve development of approximately $25.0 million was
recorded primarily for directors and officers exposures in the second quarter
of 2003. The unfavorable net prior year reserve development was a result of a
claims review in the second quarter of 2003 of securities class action cases
related to certain known corporate malfeasance cases and investment banking
firms. The net prior year reserve development recorded was for accident years
2000 and 2001.
Offsetting this unfavorable reserve development was a $289.0 million
underwriting benefit from cessions to corporate aggregate reinsurance treaties
for the nine months ended September 30, 2003. The benefit was comprised of
$643.0 million of ceded losses and $354.0 million of ceded premiums for
accident years 2000 and 2001. See the Reinsurance section of the MD&A for
further discussion of CNA's aggregate reinsurance treaties. A $41.0 million
underwriting benefit was recorded for the corporate aggregate reinsurance
treaties for the nine months ended September 30, 2002. The benefit was
comprised of $148.0 million of ceded losses and $107.0 million of ceded
premiums.
98
The expense ratio increased 12.9 points due to increased expenses and the
decreased net earned premium base. Expenses were unfavorably impacted by an
increase in bad debt expense reserves for reinsurance receivables of $136.0
million and insurance receivables of $242.0 million. Based on recent
experience with troubled companies, an increase in the bad debt reserve was
deemed appropriate. See the Reinsurance section of this MD&A for additional
information regarding the increase in reinsurance receivables.
Additionally, expenses increased as a result of an increase in the accrual
for certain insurance related assessments of $58.0 million which were recorded
in the third quarter of 2003. In addition, a $31.0 million reduction in the
accrual for certain insurance-related assessments resulting from changes in
the basis on which the assessments were calculated was recorded in the third
quarter of 2002. Also increasing the expense ratio was approximately $58.0
million of expenses related to eBusiness in 2003. The 2002 eBusiness expenses
were included in the Other segment.
The dividend ratio increased 0.6 points for the nine months ended September
30, 2003 as compared with the same period in 2002 due to increased net prior
year unfavorable dividend development. Unfavorable dividend development of
$46.0 million was primarily related to workers compensation products for the
three months ended September 30, 2003. A review was completed in the third
quarter indicating paid dividend development that was higher than prior
expectations. This development was recorded for accident years 2002 and prior.
Group
Three Months Ended September 30, 2003 Compared with 2002
Net earned premiums for Group Operations increased $46.0 million for the
three months ended September 30, 2003 as compared with the same period in
2002. The increase in net earned premiums was due primarily to growth in
disability, specialty medical, life and accident, and long term care products
within Group Benefits due to new sales and rate increases.
Group Operations achieved rate increases that averaged approximately 5.0%
for both the three months ended September 30, 2003 and 2002 for the
disability, accident and life lines of business within Group Benefits for
those contracts that were renewed during the period. Premium persistency rates
of approximately 86.0% and 87.0% were achieved for those contracts that were
up for renewal for the three months ended September 30, 2003 and 2002.
Net income increased by $6.9 million for the three months ended September
30, 2003 as compared with the same period in 2002. The increase in net income
related primarily to increased net realized investment gains, favorable
development related to a $9.0 million after-tax release of WTC event reserves,
favorable results in the specialty medical line, and the impact of growth in
Group Benefits premiums. These items were partially offset by a change in the
discount rate on prior year disability and life waiver of premium reserves
from 6.5% to 6.0%, resulting in a $12.6 million after-tax decrease in net
income. The change in discount rate reflects the decreasing portfolio yield
and the current investment environment. The third quarter of 2003 also
reflects the absence of $8.1 million after-tax of non-recurring fee income
received in the third quarter of 2002 related to transfer of the Mail Handlers
Plan. See the Investments section of this MD&A for further discussion on net
realized investment gains (losses).
99
Nine Months Ended September 30, 2003 Compared with 2002
Net earned premiums for Group Operations decreased $1,035.0 million for the
nine months ended September 30, 2003 as compared with the same period in 2002.
The decrease in net earned premiums was due primarily to the transfer of the
Mail Handlers Plan. The Mail Handlers Plan contributed $1,151.0 million of
premiums for the nine months ended September 30, 2002. This was partially
offset by premium growth in the disability, specialty medical, life and
accident and long term care products within Group Benefits due to increased
new sales and rate increases.
Group Operations achieved rate increases that averaged approximately 6.0%
and 5.0% for the nine months ended September 30, 2003 and 2002 for the
disability, accident and life lines of business within Group Benefits for
those contracts that were renewed during the period. Premium persistency rates
of approximately 86.0% and 82.0% were achieved for those contracts that were
up for renewal for the nine months ended September 30, 2003 and 2002.
Net income increased by $0.5 million for the nine months ended September 30,
2003 as compared with the same period in 2002. The increase in net income
related primarily to decreased net realized investment losses, the absence of
unfavorable net results related to the variable products business which was
sold to The Phoenix Companies, Inc. in the third quarter of 2002, improved
operating results in the single premium group annuity ("SPGA") product,
favorable development related to a $9.0 million after-tax release of WTC event
reserves, favorable results in the specialty medical line, and the impact of
premium growth within Group Benefits. These items were partially offset by the
absence of net income related to the Mail Handlers Plan, including the non-
recurring fee income received in the third quarter of 2002 and a change in the
discount rate on prior year disability and life waiver of premium reserves
from 6.5% to 6.0%, resulting in a $12.6 million after-tax decrease in net
income. The change in discount rate reflects the decreasing portfolio yield
and the current investment environment. See the Investments section of this
MD&A for further discussion on net investment income and net realized gains
(losses).
Life
Three Months Ended September 30, 2003 Compared with 2002
Net earned premiums for Life Operations increased $28.0 million for the
three months ended September 30, 2003 as compared with the same period in
2002. The increase in net earned premiums was due primarily to higher sales of
structured settlement annuities, and an increase in renewal premiums due to
inforce growth in long term care products partially offset by reduced first
year premiums as a result of exiting the individual long term care market, as
discussed below.
Net income increased by $13.0 million for the three months ended September
30, 2003 as compared with the same period in 2002. The increase in net income
related primarily to increased net realized investment results and a $1.8
million improvement in net results for life settlement contracts. Partially
offsetting these items was unfavorable individual long term care morbidity due
to the increased frequency of claims during the third quarter of 2003, the
write-off of capitalized software costs of $2.7 million, and decreased net
investment income. See the Investments section of this MD&A for further
discussion on net investment income and net realized gains (losses).
100
Nine Months Ended September 30, 2003 Compared with 2002
Net earned premiums for Life Operations increased $73.0 million for the nine
months ended September 30, 2003 as compared with the same period in 2002. The
increase in net earned premiums was due primarily to higher sales of
structured settlement annuities, growth in life insurance products and
individual long term care product inforce blocks, partially offset by declines
in new business due to exiting the individual long term care market.
During the second quarter of 2003, CNA completed a review of its individual
long term care product offerings. The focus of the review was to determine
whether the current products provide adequate pricing flexibility under the
range of reasonably possible claims experience levels. Based on the review and
current market conditions, CNA decided to significantly reduce new sales of
this product and certain infrastructure costs, and recorded $4.0 million
pretax of associated severance costs in the second quarter of 2003. Premium
will continue to be received on inforce business, but the actions to reduce
new business will lower the rate of overall premium growth for this line. CNA
does not expect these actions to have a material adverse impact on the results
of operations.
Net income decreased by $4.1 million for the nine months ended September 30,
2003 as compared with the same period in 2002. The decrease in net income was
primarily due to unfavorable individual long term care morbidity due to
increased severity and claim frequency, the write-off of capitalized software
costs of $7.2 million and lower net investment income offset by a $5.4 million
improvement in net results for life settlement contracts. Also contributing to
the decrease were severance costs related to the individual long term care
product. See the Investments section of this MD&A for further discussion on
net investment income and net realized gains (losses).
Other Insurance
Three Months Ended September 30, 2003 Compared with 2002
Revenues decreased $102.0 million for the three months ended September 30,
2003 as compared with the same period in 2002. The decrease in revenues was
due primarily to decreased pretax realized investment gains and reduced net
earned premiums in group reinsurance due to the exit of this business in 2002.
Net results decreased $655.9 million for the three months ended September
30, 2003 as compared with the same period in 2002. The decrease in net results
was due primarily to a $490.6 after-tax increase in unfavorable net prior year
development, a $39.6 million after-tax and minority interest increase in ULAE
reserves, a $100.8 million after-tax and minority interest increase in the bad
debt provision for reinsurance receivables, a $9.0 million after-tax and
minority interest increase in certain insurance related assessments, and a
decrease in net realized investment gains. The 2003 net results were favorably
impacted by the absence of eBusiness expenses, which beginning in 2003 were
included in the property and casualty operating segments of the Company. See
the Investments section of this MD&A for further discussion on net investment
income and net realized gains (losses).
Unfavorable net prior year claim and allocated claim adjustment expense
reserve development of $847.0 million was recorded for the three months ended
September 30, 2003. This development was primarily driven by $795.0 million of
unfavorable net prior year claim and allocated claim adjustment expense
reserve development related to APMT. See the APMT Reserves section of this
MD&A for a further discussion of APMT development. Unfavorable net prior year
101
claim and allocated claim adjustment expense reserve development of $50.0
million was recorded related to CNA's past participation in several insurance
pools which is part of the group reinsurance run-off business. Unfavorable net
prior year claim and allocated claim adjustment expense reserve development of
$8.0 million was recorded for the three months ended September 30, 2002.
Nine Months Ended September 30, 2003 Compared with 2002
Revenues decreased $108.0 million for the nine months ended September 30,
2003 as compared with the same period in 2002. The decrease in revenues was
due primarily to reduced revenues from CNA UniSource and reduced net earned
premiums in group reinsurance, partially offset by increased pretax realized
investment gains.
Net results declined $574.1 million for the nine months ended September 30,
2003 as compared with the same period in 2002. The decrease in net results was
due primarily to a $496.9 million increase in unfavorable net prior year
development, $39.6 million increase in ULAE reserves, a $9.0 million increase
in certain insurance related assessments, and a $124.2 million increase in the
bad debt provision for reinsurance receivables (after tax and minority
interest). The 2003 net results were favorably impacted by increased net
realized investment gains and the absence of eBusiness expenses. See the
Investments section of this MD&A for further discussion on net investment
income and net realized gains (losses).
Unfavorable net prior year development of $861.0 million, including $867.0
million of unfavorable claim and allocated claim adjustment expense reserve
development and $6.0 million of favorable premium development was primarily
driven by unfavorable development of $795.0 million related to APMT. See the
APMT Reserves section of this MD&A for a further discussion of APMT
development. The gross carried claim and claim adjustment expense reserve was
$7,386.0 and $4,847.0 million at September 30, 2003 and December 31, 2002. The
net carried claim and claim adjustment expense reserve was $2,758.0 and
$2,002.0 million for September 30, 2003 and December 31, 2002.
CNA entered into a retroactive reinsurance agreement as part of the sale of
CNA's personal insurance business to The Allstate Corporation ("Allstate") in
1999. CNA shares in indemnity and claim and allocated claim adjustment
expenses if payments related to losses incurred prior to October 1, 1999 on
the CNA policies transferred to Allstate exceed the claim and allocated claim
adjustment expense reserves of approximately $1.0 billion at the date of sale.
CNA must begin to reimburse Allstate for claim and allocated claim adjustment
expense payments when cumulative claim payments after October 1, 1999 on
losses occurring prior to that date exceed the $1.0 billion. CNA's remaining
obligation valued under this loss sharing provision as of October 1, 2003 will
be settled, under a time schedule established by the parties, by agreement of
the parties or by an independent actuarial review of the unpaid claim
liabilities as of that date. Cumulative payments of indemnity and allocated
loss adjustment expenses on such policies exceeded $1.0 billion during the
second quarter of 2003. CNA has established reserves for its estimated
liability under this loss sharing arrangement.
APMT Reserves
CNA's property and casualty insurance subsidiaries have actual and potential
exposures related to APMT claims.
Establishing reserves for APMT claim and claim adjustment expenses is
subject to uncertainties that are greater than those presented by other
102
claims. Traditional actuarial methods and techniques employed to estimate the
ultimate cost of claims for more traditional property and casualty exposures
are less precise in estimating claim and claim adjustment expense reserves for
APMT, particularly in an environment of emerging or potential claims and
coverage issues that arise from industry practices and legal, judicial, and
social conditions. Therefore, these traditional actuarial methods and
techniques are necessarily supplemented with additional estimating techniques
and methodologies, many of which involve significant judgments that are
required of management. Accordingly, a high degree of uncertainty remains for
CNA's ultimate liability for APMT claim and claim adjustment expenses.
In addition to the difficulties described above, estimating the ultimate
cost of both reported and unreported APMT claims is subject to a higher degree
of variability due to a number of additional factors, including among others:
the number and outcome of direct actions against CNA; coverage issues,
including whether certain costs are covered under the policies and whether
policy limits apply; allocation of liability among numerous parties, some of
whom may be in bankruptcy proceedings, and in particular the application of
"joint and several" liability to specific insurers on a risk; inconsistent
court decisions and developing legal theories; increasingly aggressive tactics
of plaintiffs' lawyers; the risks and lack of predictability inherent in major
litigation; increased filings of claims in certain states to avoid the
application of tort reform statute effective dates; a further increase in
asbestos and environmental claims which cannot now be anticipated; continued
increase in mass tort claims relating to silica and silica-containing
products, and the outcome of ongoing disputes as to coverage in relation to
these claims; a further increase of claims and claims payment that may exhaust
underlying umbrella and excess coverage at accelerated rates; and future
developments pertaining to CNA's ability to recover reinsurance for asbestos
and environmental claims.
Since 1999, CNA has performed semi-annual ground up reviews of all open APMT
claims to evaluate the adequacy of CNA's APMT reserves. The completion of a
comprehensive ground up analysis of its APMT exposures that was previously
scheduled for the second quarter was completed in the third quarter of 2003.
During the second quarter of 2003 significant resources were dedicated to the
proposed national asbestos reform litigation and to support regulatory
reviews. CNA completed its formal and comprehensive analysis of all open APMT
claims in the third quarter of 2003. In performing its comprehensive ground up
analysis, CNA considers input from its 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, 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.
Due to the inherent uncertainties in estimating reserves for APMT claim and
claim adjustment expenses and due to the significant uncertainties previously
described related to APMT claims, the ultimate liability for these cases, both
individually and in aggregate, may exceed the recorded reserves. Any such
potential additional liability, or any range of potential additional amounts,
cannot be reasonably estimated currently, but could be material to CNA's
business, the Company's results of operations, equity, and CNA's insurer
financial strength and debt ratings. Due to, among other things, the factors
described above, it may be necessary for CNA to record material changes in its
103
APMT claim and claim adjustment expense reserves in the future, should new
information become available or other developments emerge.
The following table provides data related to CNA's APMT claim and claim
adjustment expense reserves.
September 30, 2003 December 31, 2002
- ------------------------------------------------------------------------------------------------
Environmental Environmental
Pollution and Pollution and
Mass Tort Asbestos Mass Tort Asbestos
- ------------------------------------------------------------------------------------------------
(In millions)
Gross reserves $ 872.0 $ 3,434.0 $ 830.0 $1,758.0
Ceded reserves (270.0) (1,647.0) (313.0) (512.0)
- ------------------------------------------------------------------------------------------------
Net reserves $ 602.0 $ 1,787.0 $ 517.0 $1,246.0
================================================================================================
Environmental Pollution and Mass Tort
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 1,244 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.
104
A number of proposals to reform Superfund have been made by various parties.
However, no reforms were enacted by Congress during 2002 or during the first
nine months of 2003, 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 possible effect upon the
Company's results of operations or equity.
As of September 30, 2003 and December 31, 2002, CNA carried approximately
$602.0 and $517.0 million of claim and claim adjustment expense reserves, net
of reinsurance recoverables, for reported and unreported environmental
pollution and mass tort claims. There was $153.0 million of environmental
pollution and mass tort net unfavorable prior year claim and claim adjustment
expense reserve development for the three and nine months ended September 30,
2003 and no environmental pollution and mass tort net claim and claim
adjustment expense reserve development, net of reinsurance, for the three and
nine months ended September 30, 2002. CNA paid environmental pollution-related
claims and mass tort-related claims, net of reinsurance recoveries, of $68.0
and $91.0 million for the nine months ended September 30, 2003 and 2002.
CNA has increased its net environmental pollution reserves to $405.0 million
reflecting $72.0 million in unfavorable net prior year environmental pollution
reserve development in the third quarter of 2003. This increase was in part
due to the emergence of certain negative legal developments, including several
court decisions which have reduced the effectiveness of the absolute pollution
exclusion by limiting its application to traditional industrial pollution, and
which have increased the scope of damages compensable under policies of
insurance. In addition, management has noted the potential emergence of
Natural Resource Damages claims under the Comprehensive Environmental Response
Compensation and Liability Act of 1980 and other federal statutes.
CNA has made settlement of large environmental pollution exposures a
management priority. CNA has resolved a number of its large environmental
accounts by negotiating favorable settlement agreements. In its settlements,
CNA sought to resolve those exposures and obtain the broadest release language
to avoid future claims from the same policyholders seeking coverage for sites
or claims that had not emerged at the time CNA settled with its policyholder.
While the terms of each settlement agreement vary, CNA sought to obtain broad
environmental releases that include known and unknown sites, claims and
policies. The broad release provisions contained in those settlement
agreements should, in many cases, prevent future exposure from settled
policyholders. It remains uncertain, however, whether a court interpreting the
language of the settlement agreements will uphold the broad language of the
agreements.
In the third quarter of 2003 CNA began to classify its environmental
pollution accounts into several categories which include structured
settlements coverage in place and active accounts. CNA has a structured
settlement agreement with one of its policyholders for which it has future
payment obligations. Structured settlement agreements provide for payments of
sums certain over multiple years as set forth in each individual agreement. As
to the one structured settlement agreement existing at September 30, 2003, CNA
has a reserve of $12.0 million, net of reinsurance.
105
CNA has also used coverage in place agreements to resolve large pollution
exposures. Coverage in place agreements are typically agreements between CNA
and its policyholders identifying the policies and the terms for payment of
pollution related liabilities. Claims payments are contingent on presentation
of adequate documentation of damages during the policy periods and other
documentation supporting the demand for claims payment. Coverage in place
agreements may have annual payment caps. CNA had negotiated five such
agreements in which CNA committed coverage for payment of claims and claim
related adjustment expenses subject to documentation requirements as set forth
in the terms of each specific agreement. CNA has evaluated these commitments
and has a $12.0 million reserve, net of reinsurance, as of September 30, 2003
for these five coverage in place agreements.
CNA categorizes active accounts in the pollution area as large or small
accounts. CNA defined a large account as an active account with more than
$100,000 cumulative paid losses. CNA has 148 large accounts with a collective
reserve of $101.0 million, net of reinsurance at September 30, 2003. CNA has
made closing large accounts a significant management priority. Small accounts
are defined as active accounts with $100,000 or less cumulative paid losses.
CNA has 427 small accounts with a collective reserve of $60.0 million, net of
reinsurance at September 30, 2003.
CNA also evaluates its environmental pollution exposures arising from
assumed reinsurance and its participation in reinsurance pools, including
Excess & Casualty Reinsurance Association (ECRA). At September 30, 2003, CNA
has a reserve of $38.0 million related to these liabilities.
At September 30, 2003, CNA's unassigned reserve for claims that are incurred
but not reported ("IBNR") for environmental pollution was $182.0 million, net
of reinsurance. This IBNR reserve relates to potential development on accounts
that have not settled and potential future claims from unidentified
policyholders.
The chart below depicts CNA's overall pending pollution accounts and
associated reserves at September 30, 2003.
Total Paid Pollution Percent of
Number of 2003 Reserves Pollution
Policyholders (Net) (Net) Reserve
- ------------------------------------------------------------------------------------------------
Policyholders with Settlement Agreements
Structured Settlements 1 $ 16.0 $ 12.0 3.0%
Coverage in Place 5 12.0 3.0
- ------------------------------------------------------------------------------------------------
Total with Settlement Agreements 6 16.0 24.0 6.0
- ------------------------------------------------------------------------------------------------
Other Policyholders with Active Accounts
Large Pollution Accounts 148 19.0 101.0 24.9
Small Pollution Accounts 427 9.0 60.0 14.8
- ------------------------------------------------------------------------------------------------
Total Other Policyholders 575 28.0 161.0 39.7
Assumed Reinsurance & Pools 2.0 38.0 9.4
Unassigned IBNR 182.0 44.9
- ------------------------------------------------------------------------------------------------
Total 581 $ 46.0 $ 405.0 100.0%
================================================================================================
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CNA has also increased its mass tort net reserves to $197.0 million
reflecting $81.0 million in unfavorable mass tort prior year reserve
development, due in part to the elevated volume of silica claims. In 2003, CNA
observed a marked increase in silica claims frequency in Mississippi, where
plaintiff attorneys appear to have filed claims to avoid the effect of a tort
reform. The most significant silica exposures identified to date include a
relatively small number of accounts with significant numbers of new claims and
substantial insurance limits issued by CNA. Establishing claim and claim
adjustment expense reserves for silica claims is subject to uncertainties
because of disputes concerning medical causation with respect to certain
diseases, including lung cancer, geographical concentration of the lawsuits
asserting the claims, and the large rise in the total number of claims without
underlying epidemiological developments suggesting an increase in disease
rates or plaintiffs.
CNA's ultimate liability for its environmental pollution and mass tort
claims is impacted by several factors including ongoing disputes with
policyholders over scope and meaning of coverage terms and, in the area of
environmental pollution, court decisions that continue to restrict the scope
and applicability of the absolute pollution exclusion contained in policies
issued by CNA after 1989. Due to the inherent uncertainties described above,
including the inconsistency of court decisions, the number of waste sites
subject to cleanup, and in the area of environmental pollution, the standards
for cleanup and liability, the ultimate liability of CNA for environmental
pollution and mass tort claims may vary substantially from the amount
currently recorded.
Asbestos
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.
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.
107
Several factors are, in management's view, negatively impacting asbestos
claim trends. Plaintiff attorneys who previously sued entities who are now
bankrupt are seeking other viable targets. As a result, companies with few or
no previous asbestos claims are becoming targets in asbestos litigation and,
although they may have little or no liability, nevertheless must be defended
by their insurers. Additionally, plaintiff attorneys and trustees for future
claimants are demanding that policy limits be paid lump-sum into the
bankruptcy asbestos trusts prior to presentation of valid claims and medical
proof of these claims. The ultimate impact or success of this tactic remains
uncertain. Plaintiff attorneys and trustees for future claimants are also
attempting to devise claims payment procedures for bankruptcy trusts that
would allow asbestos claims to be paid under lax standards. This also presents
the potential for exhausting policy limits in an accelerated fashion.
In addition, management has observed an increase in the total number of
policyholders with current asbestos claims as additional defendants are added
to existing lawsuits and are named in new asbestos bodily injury lawsuits. New
asbestos bodily injury claims have also increased substantially in 2003.
Following the third quarter ground up review, CNA has increased its gross
asbestos reserves to $3,434.0 million and its net asbestos reserves to
$1,787.0 million at September 30, 2003 reflecting $1,805.0 million and $642.0
million in gross and net asbestos unfavorable prior year reserve development
principally due to potential losses from policies issued by CNA with high
attachment points, which previous exposure analysis indicated would not be
reached. As part of its semi-annual review, CNA examined the claims filing
trends and the projected erosion rates of underlying primary and lower excess
insurance on open asbestos accounts to determine timeframes within which high
excess policies issued by CNA could be reached. Elevated claims volumes,
together with certain adverse court decisions affecting the rapidity by which
asbestos claims are paid, supported the conclusion that excess policies with
high attachment points previously thought not to be exposed may now
potentially be exposed.
CNA has resolved a number of its large asbestos accounts by negotiating
favorable settlement agreements. CNA has structured settlement agreements with
seven of its policyholders for which it has future payment obligations.
Structured settlement agreements provide for payments of over multiple years
as set forth in each individual agreement. At December 31, 2002, CNA had four
structured settlement agreements reserved at $118.0 million, net of
reinsurance. Since December 31, 2002, CNA has resolved three additional
asbestos accounts through structured settlement agreements. As to the seven
structured settlement agreements existing at September 30, 2003, payment
obligations under those settlement agreements are projected to terminate in
2016. CNA has evaluated its exposure and the expected reinsurance recoveries
under these agreements and has a reserve of $160.0 million, net of reinsurance
at September 30, 2003, related to remaining payment obligations under these
agreements.
CNA, through its acquisition of CIC in 1995, assumed obligations under the
Wellington Agreement. In 1985, 47 asbestos producers and their insurers,
including CIC, executed the Wellington Agreement. The agreement intended to
resolve all issues and litigation related to coverage for asbestos exposures.
Under this agreement, signatory insurers committed scheduled policy limits and
made the limits available to pay asbestos claims based upon coverage blocks
designated by the policyholders in 1985, subject to extension by
policyholders. CIC was a signatory insurer to the Wellington Agreement. At
December 31, 2002, CNA had fulfilled its Wellington Agreement obligations as
to all but five accounts and had a reserve of $28.0 million, net of
108
reinsurance, related to its remaining Wellington obligations. At September 30,
2003, with respect to these five remaining unpaid Wellington obligations, CNA
has evaluated its exposure and the expected reinsurance recoveries under these
agreements and has a $23.0 million reserve, net of reinsurance.
CNA has also used coverage in place agreements to resolve large asbestos
exposures. Coverage in place agreements are typically agreements between CNA
and its policyholders identifying the policies and the terms for payment of
asbestos related liabilities. Claims payments are contingent on presentation
of adequate documentation showing exposure during the policy periods and other
documentation supporting the demand for claims payment. Coverage in place
agreements may have annual payment caps. At September 30, 2003, CNA had
negotiated 27 such agreements in which CNA committed coverage for payment of
claims and claim related adjustment expenses subject to documentation
requirements as set forth in the terms of each specific agreement. Coverage in
place agreements are evaluated based on claims filings trends and severities.
Due to adverse claims trends described in this section, management has
increased its estimate of exposure under current coverage in place agreements.
At December 31, 2002, CNA had estimated its exposure for its twenty-four
coverage in place agreements at $66.0 million, net of reinsurance. Since year
end 2002, CNA resolved four additional asbestos exposures through coverage in
place agreements and has also evaluated the possibility that high excess
coverages it issued could become impaired under these agreements. CNA has
evaluated these commitments and the expected reinsurance recoveries under
these agreements and has a $106.0 million reserve, net of reinsurance, related
to coverage in place agreements.
CNA categorizes active asbestos accounts as large or small accounts. CNA
defines a large account as an active account with more than $100,000
cumulative paid losses. CNA made closing large accounts a significant
management priority. At December 31, 2002, CNA had 150 large accounts and has
a reserve of $220.0 million, net of reinsurance. At September 30, 2003, CNA
has 156 large accounts with a collective reserve of $388.0 million, net of
reinsurance. Large accounts are typically accounts that have been long
identified as significant asbestos exposures. In its most recent ground up
reserve study, CNA observed that underlying layers of primary, umbrella and
lower layer excess policies were exhausting at accelerated rates due to
increased claims volumes, claims severities and increased defense expense
incurred in litigating claims for certain policyholders. Those accounts where
CNA had issued high excess policies were evaluated in the study to determine
potential impairment of the high excess layers of coverage. Management
concluded that high excess coverage previously thought not to be exposed could
potentially be exposed should current adverse claim trends continue.
Small accounts are defined as active accounts with $100,000 or less
cumulative paid losses. At December 31, 2002, CNA had 939 small accounts with
a reserve of $90.0 million, net of reinsurance. At September 30, 2003, CNA has
1,028 small accounts, approximately 84.0% of its total active asbestos
accounts. Small accounts are typically representative of policyholders with
limited connection to asbestos. As entities who were historic targets in
asbestos litigation continue to file for bankruptcy protection, plaintiffs'
attorneys are seeking other viable targets. As a result, companies with few or
no previous asbestos claims are becoming targets in asbestos litigation and,
although they may have little or no liability, nevertheless must be defended
by their insurers. As claims filings continue to increase, costs incurred in
defending small accounts are expected to increase. CNA has evaluated small
accounts and has increased its collective reserve of $155.0 million, net of
reinsurance, as of September 30, 2003.
109
CNA also evaluates its asbestos liabilities arising from assumed reinsurance
business and its participation in various pools. At December 31, 2002, CNA had
a $91.0 million reserve related to these asbestos liabilities arising from
CNA's assumed reinsurance obligations and CNA's participation in pools,
including ECRA. At September 30, 2003, CNA has a $158.0 million net reserve
related to these liabilities.
At September 30, 2003, CNA's unassigned IBNR reserve for asbestos was $742.0
million, net of reinsurance. This IBNR reserve relates to potential
development on accounts that have not settled and potential future claims from
unidentified policyholders. At December 31, 2002, the unassigned IBNR reserve
was $584.0 million, net of reinsurance.
The chart below depicts CNA's overall pending asbestos accounts and
associated reserves at September 30, 2003.
Asbestos Percent
2003 Reserves of
Number of Paid 9/30/03 Asbestos
Policyholders (Net) (Net) Reserve
- ------------------------------------------------------------------------------------------------
Policyholders with Settlement Agreements
Structured Settlements 7 $ 5.0 $ 160.0 9.0%
Wellington 5 2.0 23.0 1.3
Coverage in Place 27 30.0 106.0 5.9
Fibreboard 1 55.0 3.1
- ------------------------------------------------------------------------------------------------
Total with Settlement Agreements 40 37.0 344.0 19.3
- ------------------------------------------------------------------------------------------------
Other Policyholders with Active Accounts
Large Pollution Accounts 156 48.0 388.0 21.7
Small Pollution Accounts 1,028 11.0 155.0 8.7
- ------------------------------------------------------------------------------------------------
Total Other Policyholders 1,184 59.0 543.0 30.4
Assumed Reinsurance & Pools 5.0 158.0 8.8
Unassigned IBNR 742.0 41.5
- ------------------------------------------------------------------------------------------------
Total 1,224 $101.0 $1,787.0 100.0%
================================================================================================
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
has attempted to manage its asbestos exposure by aggressively seeking to
settle claims on acceptable terms. There can be no assurance that any of these
settlement efforts will be successful, or that any such claims can be settled
on terms acceptable to CNA. Where CNA cannot settle a claim on acceptable
terms, CNA aggressively litigates the claim. Adverse developments with respect
110
to such matters could have a material adverse effect on the Company's results
of operations or equity.
Certain asbestos litigations in which CNA is currently engaged are described
below:
On February 13, 2003, CNA announced it had resolved asbestos related
coverage litigation and claims involving A.P. Green Industries, A.P. Green
Services and Bigelow - Liptak Corporation. Under the agreement, CNA will be
required to pay $74.0 million, net of reinsurance recoveries, over a ten year
period. The settlement resolves CNA's liabilities for all pending and future
asbestos claims involving A.P. Green Industries, Bigelow - Liptak Corporation
and related subsidiaries, including alleged "non-products" exposures. The
settlement has received initial bankruptcy court approval and CNA expects to
procure confirmation of a bankruptcy plan containing a channeling injunction
to protect CNA from any future claims.
CNA is engaged in insurance coverage litigation with underlying plaintiffs
who have asbestos bodily injury claims against the former Robert A. Keasbey
Company ("Keasbey") in New York State court (Continental Casualty Co. v.
Nationwide Indemnity Co. et al., No. 601037/03 (N.Y. County)). Keasbey, a
currently dissolved corporation, was a seller and installer of asbestos-
containing insulation products in New York and New Jersey. Thousands of
plaintiffs have filed bodily injury claims against Keasbey; however, Keasbey's
involvement at a number of work sites is a highly contested issue. Therefore,
the defense disputes the percentage of valid claims against Keasbey. CNA
issued Keasbey primary policies for 1970-1987 and excess policies for 1972-
1978. CNA has paid an amount substantially equal to the policies' aggregate
limits for products and completed operations claims. Claimants against Keasbey
allege, among other things, that CNA owes coverage under sections of the
policies not subject to the aggregate limits, an allegation CNA vigorously
contests in the lawsuit.
CNA has insurance coverage disputes related to asbestos bodily injury claims
against Burns & Roe Enterprises, Inc. ("Burns & Roe"). Originally raised in
litigation, now stayed, these disputes are currently part of In re: Burns &
Roe Enterprises, Inc., pending in the U.S. Bankruptcy Court for the District
of New Jersey, No. 00-41610. Burns & Roe provided engineering and related
services in connection with construction projects. At the time of its
bankruptcy filing, Burns & Roe faced approximately 11,000 claims alleging
bodily injury resulting from exposure to asbestos as a result of construction
projects in which Burns & Roe was involved. CNA allegedly provided primary
liability coverage to Burns & Roe from 1956-1969 and 1971-1974, along with
certain project-specific policies from 1964-1970.
CIC issued certain primary and excess policies to Bendix Corporation
("Bendix"), now part of Honeywell International Inc. ("Honeywell"). Honeywell
faces approximately 71,000 pending asbestos bodily injury claims resulting
from alleged exposure to Bendix friction products. CIC's primary policies
allegedly covered the period from at least 1939 (when Bendix began to use
asbestos in its friction products) to 1983, although the parties disagree
about whether CIC's policies provided product liability coverage before 1940
and from 1945 to 1956. CIC asserts that it owes no further material
obligations to Bendix under any primary policy. Honeywell alleges that two
primary policies issued by CIC covering 1969-1975 contain occurrence limits
but not product liability aggregate limits for asbestos bodily injury claims.
CIC has asserted, among other things, which even if Honeywell's allegation is
correct, which CNA denies, its liability is limited to a single occurrence
limit per policy or per year, and in the alternative, a proper allocation of
111
losses would substantially limit its exposure under the 1969-1975 policies to
asbestos claims. These and other issues are being litigated in Continental
Insurance Co., et al. v. Honeywell International Inc., No. MRS-L-1523-00
(Morris County, New Jersey).
Policyholders have also initiated litigation directly against CNA and other
insurers in four jurisdictions: Ohio, Texas, West Virginia and Montana. In the
Ohio action, plaintiffs allege the defendants negligently performed duties
undertaken to protect the public from the effects of asbestos (Varner v. Ford
Motor Co., et al., (Cuyahoga County, Ohio)). Similar lawsuits have also 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
(Boson v. Union Carbide Corp., et al., (District Court of Nueces County,
Texas)). Many of the Texas claims have been dismissed as time-barred by the
applicable statute of limitations. In other claims, the Texas court recently
ruled that the carriers did not owe any duty to the plaintiffs or the general
public to advise on the effects of asbestos thereby dismissing these claims.
The time period for filing an appeal of this ruling has not expired and it
remains uncertain whether the plaintiffs' will continue to pursue their causes
of action.
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. A direct action has also been filed in Montana (Pennock, et al.
v. Maryland Casualty, et al., First Judicial District Court of Lewis & Clark
County, Montana) by eight individual plaintiffs (all employees of W.R. Grace &
Co. ("W.R. Grace")) and their spouses against CNA, Maryland Casualty and the
State of Montana. This action alleges that CNA failed to fulfill its
obligations as W.R. Grace's Workers Compensation carrier because of the
alleged negligent failure of CNA to warn of or otherwise protect W.R. Grace
employees from the dangers of asbestos at a W.R. Grace vermiculite mining
facility in Libby, Montana. This action is currently stayed as to CNA because
of W.R. Grace's pending bankruptcy. On July 23, 2003, the stay of similar
direct action litigation against Maryland Casualty was lifted by the District
Court as to Maryland Casualty. Maryland Casualty and W.R. Grace have appealed
the District Court's decision to the Third Circuit Court of Appeals. The stay
of the litigation may also be lifted as to CNA.
CNA is vigorously defending these and other cases and believes that it has
meritorious defenses to the claims asserted. However, there are numerous
factual and legal issues to be resolved in connection with these claims, and
it is extremely difficult to predict the outcome or ultimate financial
exposure represented by these matters. Adverse developments with respect to
any of these matters could have a material adverse effect on CNA's business,
insurer financial strength and debt ratings and equity.
As a result of the uncertainties and complexities involved, reserves for
asbestos claims cannot be estimated with traditional actuarial techniques that
rely on historical accident year loss development factors. In establishing
asbestos reserves, CNA evaluates the exposure presented by each insured. As
part of this evaluation, CNA considers the available insurance coverage;
limits and deductibles; the potential role of other insurance, particularly
underlying coverage below any CNA excess liability policies; and applicable
coverage defenses, including asbestos exclusions. Estimation of asbestos-
related claim and claim adjustment expense reserves involves a high degree of
judgment on the part of management and consideration of many complex factors,
including:
112
. inconsistency of court decisions, jury attitudes and future court
decisions
. specific policy provisions
. allocation of liability among insurers and insureds
. missing policies and proof of coverage
. the proliferation of bankruptcy proceedings and attendant uncertainties
. novel theories asserted by policyholders and their counsel
. 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
. volatility in claim numbers and settlement demands
. increases in the number of non-impaired claimants and the extent to which
they can be precluded from making claims
. the efforts by insureds to obtain coverage not subject to aggregate
limits
. long latency period between asbestos exposure and disease manifestation
and the resulting potential for involvement of multiple policy periods
for individual claims
. medical inflation trends
. the mix of asbestos-related diseases presented and
. the ability to recover reinsurance including the impact, if any, of
restructured operations of Lloyd's of London into Equitas Limited.
CNA is also monitoring possible legislative reforms, including the possible
creation of a national privately financed trust, which if established and
approved through federal legislation, could replace litigation of asbestos
claims with payments to claimants from the trust. It is uncertain at the
present time whether such a trust will be created or, if it is, what will be
the terms and conditions of its establishment or its impact on CNA.
As of September 30, 2003 and December 31, 2002, CNA carried approximately
$1,787.0 and $1,246.0 million of claim and claim adjustment expense reserves,
net of reinsurance recoverables, for reported and unreported asbestos-related
claims. There was $642.0 million in asbestos-related net claim and claim
adjustment expense prior year unfavorable reserve development for the three
and nine months ended September 30, 2003. CNA paid asbestos-related claims,
net of reinsurance, of $101.0 million for the nine months ended September 30,
2003 and had net reinsurance recoveries of $12.0 million for the nine months
ended September 30, 2002.
Lorillard
Revenues decreased by $123.8 and $502.6 million, or 12.7% and 16.8%, and net
income decreased by $57.1 and $134.4 million, or 27.6% and 23.3%, for the
113
three and nine months ended September 30, 2003, respectively, as compared to
the corresponding periods of the prior year.
Net income for the nine months ended September 30, 2003 included charges of
$16.8 million in the second quarter of 2003 and $17.1 million in the first
quarter of 2003 (in each case, net of taxes) related to the tobacco growers
settlement and an agreement with the Brown & Williamson Corporation (the "B&W
Agreement"). Excluding these charges, net income would have decreased by
$100.5 million, or 17.4%, for the nine months ended September 30, 2003, as
compared to the corresponding period of the prior year.
The decline in revenues and net income for the three months ended September
30, 2003, as compared to the comparable period of the prior year, is primarily
due to lower net sales of $120.6 million. Net sales revenue declined due to
lower effective unit prices reflecting higher sales promotion expenses,
partially offset by increased unit sales volume of approximately $65.7
million, assuming prices were unchanged from the prior year, and higher
average wholesale unit prices due to price/sales mix, which increased revenues
by approximately $8.6 million. In March of 2002, Lorillard increased its net
wholesale price of cigarettes, before the impact of any promotional
activities, by an average of $1.74 per thousand cigarettes ($0.03 per pack of
20 cigarettes), or 1.4%. Unit sales volume increased 5.9% and sales promotion
expenses increased as compared to the comparable period of the prior year.
Lorillard's third quarter of 2003 share of domestic wholesale shipments
compared favorably with the prior year's quarter due to wholesale inventory
reductions in the third quarter of 2002 following heavy second quarter of 2002
purchases in advance of multiple state tax increases, which tend to affect
cigarette brands with large market shares, such as Newport, more than others.
The decreased unit prices reflect the increase in promotional expenses,
mostly in the form of retail/price promotions and other discounts provided to
retailers and passed through to consumers, partially offset by the increased
average net wholesale prices in 2003 related to the March of 2002 price
increase.
The decline in revenues and net income for the nine months ended September
30, 2003, as compared to the comparable period of the prior year, is primarily
due to lower net sales of $495.5 million. Net sales revenue declined due to
lower effective unit prices reflecting higher sales promotion expenses and
lower unit sales volume of approximately $155.6 million, assuming prices were
unchanged from the prior year, partially offset by higher average wholesale
unit prices due to price/sales mix, which increased revenues by approximately
$47.2 million. Unit sales volume decreased 4.4% as compared to the comparable
period of the prior year. Lorillard increased promotional expenses for the
three and nine month periods of 2003 in response to higher competitive premium
brand promotional spending and price pressure due to the continued increases
in state excise taxes.
The decline in net income for the nine month ended September 30, 2003, as
compared to 2002, also reflects charges for the tobacco growers settlement and
the B&W Agreement, partially offset by reduced tobacco settlement costs. The
$40.6 million pretax decrease in tobacco settlement costs for the three months
ended September 30, 2003, as compared to the comparable period of the prior
year, is due to the expiration of up-front payments ($36.1 million) and other
adjustments ($12.4 million), partially offset by increased charges for higher
unit sales volume ($7.9 million). The $250.7 million pretax decrease in
tobacco settlement costs for the nine months ended September 30, 2003, as
compared to the comparable period of the prior year, is due to the expiration
114
of up-front payments ($128.4 million), reduced charges for lower unit sales
volume ($34.3 million) and other adjustments ($88.0 million).
Lorillard's total (U.S. domestic, Puerto Rico and certain U.S. Territories)
gross unit sales volume increased 4.9% for the three months and decreased 5.3%
for the nine months ended September 30, 2003, as compared to the comparable
periods of the prior year. Domestic wholesale volume increased 6.1% for the
three months and decreased 5.6% for the nine months ended September 30, 2003,
as compared to the corresponding periods in 2002. Total Newport unit sales
volume increased by 7.4% for the three months and decreased 3.1% for the nine
months ended September 30, 2003, and domestic U.S. volume increased 8.8% for
the three months and decreased 3.3% for the nine months ended September 30,
2003, as compared to the corresponding periods in 2002. In addition to pricing
pressure due to the increases in state excise taxes and the competitive impact
of deep discount brands, Lorillard's volume for the nine months ended
September 30, 2003 was affected by generally weak economic conditions and
ongoing limitations imposed by Philip Morris' retail merchandising
arrangements.
On May 5, 2003, Lorillard lowered the wholesale list price of its discount
brand, Maverick, by $55.00 per thousand cigarettes ($1.10 per pack of 20
cigarettes) in an effort to reposition the brand to be more competitive in the
deep discount price cigarette segment. Maverick accounted for 0.5% of
Lorillard's net sales for the nine months ended September 30, 2003, as
compared to 0.9% for the comparable period of the prior year.
Management believes that deep discount price brands produced by
manufacturers who are not subject to the same payment obligations under the
State Settlement Agreements, which results in lower payments, can price their
brands at a significant advantage, by as much as 68%, compared with premium
brand offerings from the major cigarette manufacturers. Deep discount price
brands increased their market share for the nine month period ended September
30, 2003 by 0.90 share points to 7.84%.
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------
Lorillard's share of the domestic market (1) 9.52% 8.57% 9.29% 9.18%
Lorillard's premium segment as a percentage of its
total domestic volume (1) 95.3% 94.6% 95.6% 94.5%
Newport share of the domestic market (1) 8.6% 7.5% 8.4% 8.1%
Newport share of the premium segment (1) 11.6% 10.5% 11.3% 11.0%
Total menthol segment market share for the industry (2) 26.9% 26.1% 26.7% 26.1%
Newport's share of the menthol segment 30.7% 28.8% 30.3% 29.7%
Newport as a percentage of Lorillard's (3):
Total volume 90.2% 88.1% 90.2% 88.1%
Net sales 91.1% 88.8% 91.3% 89.0%
Sources:
(1) Management Science Associates, Inc.
(2) Lorillard proprietary data
(3) Lorillard Shipment Reports
115
Unless otherwise specified, market share data is based on data made
available by Management Science Associates, Inc. ("MSAI"), an independent
third-party database management organization that collects wholesale shipment
data from various cigarette manufacturers and provides analysis of market
share, unit sales volume and premium versus discount mix for individual
companies and the industry as a whole. MSAI's information relating to unit
sales volume and market share of certain of the smaller, primarily deep
discount, cigarette manufacturers is based on estimates derived by MSAI.
Lorillard management believes that volume and market share information for
these manufacturers are understated and, correspondingly, share information
for the larger manufacturers, including Lorillard, are overstated by MSAI.
Total Lorillard and Newport third quarter of 2003 share of domestic
wholesale shipments compared favorably with the prior year's quarter due to
wholesale inventory reductions in the third quarter of 2002 following heavy
second quarter of 2002 purchases in advance of multiple state tax increases,
which tend to affect cigarette brands with large market shares, such as
Newport, more than others.
Lorillard's premium products sold as a percent of its total domestic volume
remained relatively flat for the three and nine months ended September 30,
2003 as compared to the same periods of 2002.
Menthol cigarettes as a percent of the total industry remained relatively
flat. Newport's, the industry's largest menthol brand, share of the menthol
segment increased to 30.7% in the third quarter of 2003, versus 28.8% in the
comparable period of 2002. Newport had an approximate 30.3% share of the
menthol segment for the first nine months of 2003, compared to 29.7% in the
comparable period of the prior year.
Newport, a premium brand, accounted for approximately 90% of Lorillard's
unit sales for the three and nine months ended September 30, 2003, as compared
to approximately 88% for the comparable periods of 2002.
Overall, domestic industry unit sales volume decreased 4.5% and 6.7% for the
three and nine months ended September 30, 2003, as compared with the
corresponding periods of 2002. Industry sales for premium brands were 74.1%
and 73.6% of the total domestic market for the three and nine months ended
September 30, 2003, as compared to 72.5% and 73.0% of the total domestic
market in the comparable periods of 2002. Lorillard domestic unit sales volume
increased 6.1% and declined 5.6% for the three and nine months ended September
30, 2003 as compared with corresponding periods of 2002. Industry and
Lorillard unit volume comparisons for the nine months ended September 30, 2003
were impacted due to wholesaler inventory adjustments during the same nine
months of 2002. Wholesale inventories increased in the first quarter of 2002
in anticipation of a price increase that occurred in March of 2002, following
an inventory reduction in the fourth quarter of 2001. While the industry unit
volume for the three month period ended September 30, 2003 declined as
compared to 2002, Lorillard unit volume for this same time period increased as
a result of lower than normal wholesale purchases in the third quarter of 2002
following the heavy wholesale purchases in the second quarter of 2002 in
anticipation of the multiple state tax increases that occurred in the third
quarter of 2002.
Lorillard recorded pretax charges of $214.6, $255.2, $592.2 and $842.9
million ($132.5, $153.7, $369.6 and $510.6 million after taxes) for the three
and nine months ended September 30, 2003 and 2002, respectively, to record its
obligations under various settlement agreements. Lorillard's portion of
ongoing adjusted settlement payments and related legal fees are based on its
116
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.
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
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 segment, and the effect of any resulting cost advantage
of manufacturers not subject to all of the payments of the State Settlement
Agreements.
The tobacco industry in the United States, including Lorillard, continues to
be faced with a number of issues that have impacted or may adversely impact
the business, results of operations and financial condition of Lorillard and
the Company, including the following:
. A substantial volume of litigation seeking compensatory and punitive
damages ranging into the billions of dollars, as well as equitable and
injunctive relief, arising out of allegations of cancer and other health
effects resulting from the use of cigarettes, addiction to smoking or
exposure to environmental tobacco smoke, including claims for
reimbursement of health care costs allegedly incurred as a result of
smoking, as well as other alleged damages.
. A $16.3 billion punitive damage judgment which had been entered against
Lorillard in Engle v. R.J. Reynolds Tobacco Company, et al., a class
action case in state court in Florida in which the jury awarded a total
of $145.0 billion in punitive damages against all the defendants. On May
21, 2003 a three judge panel of the Florida Third District Court of
Appeal vacated the Dade County Court's judgment and decertified the
class. On September 22, 2003, the Court of Appeal denied plaintiff's
attempt to reinstate the judgment. Plaintiffs have sought review of Engle
by the Florida Supreme Court.
. Substantial annual payments by Lorillard, continuing in perpetuity, and
restrictions on marketing and advertising agreed to under the terms of
the settlement agreements entered into between the major cigarette
manufacturers, including Lorillard, and each of the 50 states, the
District of Columbia, the Commonwealth of Puerto Rico and certain other
U.S. territories (together, the "State Settlement Agreements").
. The continuing contraction of the U.S. cigarette market, in which
Lorillard currently conducts its only significant business. As a result
of price increases, restrictions on advertising and promotions, increases
in regulation and excise taxes, health concerns, a decline in the social
acceptability of smoking, increased pressure from anti-tobacco groups and
other factors, U.S. cigarette shipments among major U.S. cigarette
manufacturers have decreased at a compound annual rate of approximately
2.4% over the period 1982 through 2002 and approximately 4.3% over the
period from 1998 through 2002, as measured by MSAI. In the third quarter
and first nine months of 2003, domestic U.S. cigarette industry volume
declined by 4.5% and 6.7%, respectively, as compared to the corresponding
periods of 2002, according to information provided by MSAI.
117
. Competition from deep discounters who enjoy competitive cost and pricing
advantages because they are not subject to the same payment obligations
under the State Settlement Agreements as Lorillard. Market share for the
deep discount brands increased 0.35 share points from 7.36% in the third
quarter of 2002 to 7.71% in the third quarter of 2003, as estimated by
MSAI. In addition, deep discount price brands increased their market
share for the nine months ended September 30, 2003 by 0.90 share points
to 7.84% as compared to the prior year's period. Lorillard's focus on the
premium market and its obligations under the State Settlement Agreements
make it very difficult to compete successfully in the deep discount
market.
. Increases in industry-wide promotional expenses and sales incentives
implemented in response to declining unit volume, state excise tax
increases and increased competition among the four largest cigarette
manufacturers, including Lorillard, and smaller participants who have
gained market share in recent years, principally in the deep-discount
cigarette segment. As a result of increased competition based on the
retail price of brands and the related increased market share of deep
discounters described in the immediately preceding bullet, the ability of
Lorillard and the other major manufacturers to raise prices has been
adversely affected. In light of this environment, Lorillard has not
increased its wholesale prices since March of 2002. Certain manufacturers
have reduced the list prices of many of their brands, including Lorillard
in the case of Maverick, at the wholesale level. Increases by
manufacturers in wholesale and retail price promotional allowances also
effectively reduce the prices of many key brands. On May 5, 2003,
Lorillard lowered the wholesale list price of its discount brand,
Maverick, by $55.00 per thousand cigarettes ($1.10 per pack of 20
cigarettes) in an effort to reposition the brand to be more competitive
in the deep discount cigarette segment. Certain of Lorillard's major
competitors continue to promote their products through the use of
restrictive merchandising programs that Lorillard believes impede its
ability to compete for shelf space in retail outlets and make it
difficult to effectively communicate its promotions to consumers. Profits
per pack of cigarettes for all of the major cigarette manufacturers,
including Lorillard, have been negatively impacted by these wholesale
price reductions and/or increased wholesale and retail price promotions.
. Continuing increases in state excise taxes on cigarette sales in the
third quarter of 2003, ranging from $0.10 per pack to $0.70 per pack in
nine states, as well as proposals for additional increases in federal,
state and local excise taxes. Lorillard believes that increases in
excise and similar taxes have had an adverse impact on sales of
cigarettes and that future increases, the extent of which cannot be
predicted, could result in further volume declines for the cigarette
industry, including Lorillard, and an increased sales shift toward lower
priced discount cigarettes rather than premium brands.
. Increases in actual and proposed state and local regulation of the
tobacco industry relating to the manufacture, sale, distribution,
advertising, labeling and use of tobacco products and government
restrictions on smoking, including enacted and proposed regulations in
some states with respect to mandatory disclosure of ingredients and
enacted legislation in New York State requiring that all cigarettes sold
in that state be designed to have reduced ignition propensity.
. Substantial and increasing regulation of the tobacco industry and
118
governmental restrictions on smoking, including recent proposals to enact
legislation to grant the Food and Drug Administration ("FDA") authority
to regulate tobacco products under the Federal Food, Drug and Cosmetic
Act. The FDA proposals would, among other things, increase federal
regulation of the manufacture, sale, distribution, advertising and
labeling of cigarettes and would permit state regulation of labeling and
advertising. Proposals have also been introduced to end the federal price
support and quota system for tobacco growers and to compensate the
growers with payments to be funded by a fee, tax or other charge on
tobacco products to be paid by tobacco manufacturers. Recently, efforts
have been made to link the new FDA proposals with the buy-out of the
federal tobacco price support and quota system, which is intended to
increase the likelihood of the passage of both the FDA proposals and the
buy-out.
. Increasing sales of counterfeit cigarettes in the United States, which
adversely impact sales by the manufacturer of the counterfeited brands
and potentially damage the value and reputation of those brands.
See Part II, Item 1 - Legal Proceedings and Note 12 of the Notes to
Consolidated Condensed Financial Statements included in Part I, Item 1 of this
Report for information with respect to the Engle action and other litigation
against cigarette manufacturers and the State Settlement Agreements.
Loews Hotels
Revenues increased by $4.1 and $11.2 million, or 6.6% and 5.5%, and income
from continuing operations increased by $0.5 and $0.8 million, respectively,
for the three and nine months ended September 30, 2003 as compared to the
corresponding periods of the prior year.
Revenues increased for the three and nine months ended September 30, 2003,
as compared to 2002, due primarily to an increase in revenue per available
room, higher other hotel operating revenues, and for the nine month period, an
increase in equity income from the Universal Orlando properties reflecting the
opening of the Royal Pacific Hotel. Revenue per available room increased by
$9.92 and $2.87, or 8.8% and 2.4%, to $122.79 and $124.80, respectively, due
to increased occupancy and 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.
Net income for the three and nine month periods ended September 30, 2003
includes a gain from the sale of the Metropolitan Hotel. Discontinued
operations, net includes a gain of approximately $56.7 million ($90.3 million
pretax) from the sale of this property. Income from continuing operations
increased for the three and nine month periods ended September 30, 2003 due to
the improvement in revenue per available room discussed above, partially
offset by higher operating costs, advertising and selling expenses.
Diamond Offshore
Diamond Offshore's revenues vary based upon demand, which affects the number
of days the fleet is utilized and the dayrates earned. When a rig is idle, no
dayrate is earned and revenues will decrease as a result. Revenues can also
increase or decrease as a result of the acquisition or disposal of rigs. In
order to improve utilization or realize higher dayrates, Diamond Offshore may
119
mobilize its rigs from one market to another. During periods of mobilization,
however, revenues may be adversely affected. As a response to changes in
demand, Diamond Offshore may withdraw a rig from the market by stacking it or
may reactivate a rig stacked previously, which may decrease or increase
revenues, respectively.
Operating income is primarily affected by revenue factors, but is also a
function of varying levels of operating expenses. Operating expenses generally
are not affected by changes in dayrates and may not be significantly affected
by fluctuations in utilization. For instance, if a rig is to be idle for a
short period of time, Diamond Offshore may realize few decreases in operating
expenses since the rig is typically maintained in a prepared state with a full
crew. In addition, when a rig is idle, Diamond Offshore is responsible for
certain operating expenses such as rig fuel and supply boat costs, which are
typically a cost of the operator under drilling contracts. However, if the rig
is to be idle for an extended period of time, Diamond Offshore may reduce the
size of a rig's crew and take steps to "cold stack" the rig, which lowers
expenses and partially offsets the impact on operating income.
Revenues decreased by $1.3 and $89.1 million, or 0.7% and 15.0%, and net
income decreased by $7.9 and $39.7 million for the three and nine months ended
September 30, 2003, as compared to the corresponding periods of the prior
year. Revenues for the three and nine months ended September 30, 2003
decreased due primarily to losses on sales of marketable securities, as
compared to gains in the prior year, reduced investment income, and for the
nine month period, lower contract drilling revenues of $75.7 million. The
lower revenues for the three month period were partially offset by increased
revenues related to reimbursable expenses.
Revenues from high specification floaters and other semisubmersible rigs
decreased by $0.8 and $64.0 million, or 0.4% and 10.8%, for the three and nine
months ended September 30, 2003, as compared to the corresponding periods of
the prior year. The decrease reflects a decline in dayrates of $17.7 million,
partially offset by increased utilization of $6.5 million and revenues
generated by the recent additions of the Ocean Patriot and the Ocean Rover
amounting to $10.4 million for the three months ended September 30, 2003. The
decrease in revenues for the nine months ended September 30, 2003 is due to
decreased dayrates of $69.4 million and decreased utilization of $11.3
million, partially offset by revenues generated by the Ocean Rover, Ocean
Patriot and the Ocean Vanguard of $16.7 million.
Revenues from jack-up rigs increased $4.3 million, or 2.3%, for the three
months ended September 30, 2003 due primarily to increased dayrates of $3.7
million as compared to the corresponding period of 2002. Revenues from jack-
ups decreased $5.4 million, or 0.9%, for the nine months ended September 30,
2003 due primarily to decreased utilization of $4.8 million as compared to the
corresponding period of 2002.
Investment income decreased by $3.9 and $13.7 million, or 58.8% and 57.2%,
for the three and nine months ended September 30, 2003, primarily due to lower
yields on cash and marketable securities and reduction in marketable
securities held for the three and nine months ended September 30, 2003,
compared to the corresponding periods of 2002.
Net income decreased due primarily to the losses on sales of marketable
securities, lower investment income, increased contract drilling expenses and,
for the nine months ended September 30, 2003, lower contract drilling
revenues, partially offset by a reduction in depreciation expense related to a
120
change in the estimated useful lives and salvage values of Diamond Offshore's
drilling rigs.
Texas Gas
Revenues and net income for the three and nine months ended September 30,
2003 reflect operations from May 17, 2003, the date of acquisition. See Note 9
of the Notes to Consolidated Condensed Financial Statements.
Bulova
Revenues decreased by $3.6 and $2.9 million, or 8.7% and 2.5%, for the three
and nine months ended September 30, 2003 as compared to the corresponding
periods of the prior year. Net income decreased by $0.7 million, or 30.4%, for
the three months ended September 30, 2003 and remained unchanged for the nine
months ended September 30, 2003, as compared to the corresponding periods of
the prior year.
Net sales decreased $3.8 and $2.2 million, or 9.2% and 1.9%, for the three
and nine months ended September 30, 2003, as compared to the corresponding
periods of the prior year. The decrease in sales for the three months ended
September 30, 2003 is primarily attributable to a decline in watch and clock
unit volume, and a decrease in watch unit selling prices, partially offset by
an increase in clock unit selling prices, as compared to the corresponding
period of the prior year. The decrease in sales for the nine months ended
September 30, 2003 is attributable to lower watch and clock unit sales volume,
partially offset by a higher watch and clock unit selling prices, as compared
to the corresponding period of the prior year.
Net income for the three months ended September 30, 2003 decreased primarily
due to the decline in net sales discussed above. Net income for the nine
months ended September 30, 2003 remained relatively the same due primarily to
a lower effective tax rate reflecting a settlement of prior years' franchise
taxes, partially offset by decreased net sales.
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 through Majestic Shipping Corporation
("Majestic"), corporate interest expenses and other corporate administrative
costs. Majestic, a wholly owned subsidiary, owns a 49% common stock interest
in Hellespont Shipping Corporation ("Hellespont"). Hellespont is engaged in
the business of owning and operating six ultra large crude oil tankers that
are used primarily to transport crude oil from the Persian Gulf to a limited
number of ports in the Far East, Northern Europe and the United States.
Exclusive of investment gains (losses), revenues decreased by $2.9 and $24.1
million and net loss increased by $0.7 and $7.3 million for the three and nine
months ended September 30, 2003, respectively, as compared to the
corresponding periods of the prior year.
Revenues decreased for the three and nine months ended September 30, 2003
due primarily to lower investment income of $8.3 and $29.6 million, partially
offset by improved results from shipping operations of $4.9 and $0.9 million.
Net loss increased due to reduced investment income of $5.6 and $14.3 million,
partially offset by improved results from shipping operations of $3.2 and $0.6
million for the three and nine months ended September 30, 2003, respectively.
The decline in investment income is primarily due to lower yields on invested
121
balances and a reduced investment portfolio reflecting the $527.3 million cash
outlay in May of 2003 to acquire Texas Gas.
The components of investment gains (losses) included in Corporate operations
are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
- ------------------------------------------------------------------------------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions)
Derivative instruments $ 27.7 $ (16.3) $ 10.1 $ (19.5)
Equity securities, including short positions 22.2 (53.0) 30.8 (90.3)
Short-term investments (14.8) 42.9 (21.5) 67.0
Other (19.9) 29.0 6.9 35.2
- ------------------------------------------------------------------------------------------------
15.2 2.6 26.3 (7.6)
Income tax (expense) benefit (5.3) (1.7) (9.1) 1.8
Minority interest 1.9 (6.6) 2.2 (10.3)
- ------------------------------------------------------------------------------------------------
Net gain (loss) $ 11.8 $ (5.7) $ 19.4 $ (16.1)
================================================================================================
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, 2003, net cash provided by operating
activities was $1,481.5 million as compared with $806.9 million for the same
period in 2002. The increase in cash provided by operating activities related
primarily to a decrease in paid claims and increased net premium collections
in 2003 as compared with 2002.
Cash flows from investing activities include the purchase and sale 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, 2003, net cash used by investing
activities was $1,270.2 million as compared with net cash used by investing
activities of $635.4 million for the same period in 2002. Cash flows used for
investing activities related principally to purchases of fixed maturity
securities.
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, 2003, net cash used by financing
activities was $159.6 million as compared with $55.3 million for the same
122
period in 2002. Cash flows used by financing activities were related
principally to repayment of debt.
CNA is closely 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. As of October 3, 2003, CNA has paid $546.0 million in claims and
recovered $364.0 million from reinsurers.
CNA's initial estimated gross pretax losses for the WTC event were $1,648.0
million pretax ($958.3 million after tax and minority interest). Net pretax
losses before the effect of corporate aggregate reinsurance treaties were
$727.0 million. Approximately 1.0%, 60.0% and 33.0% 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.
Debt Financing
CNA has a shelf Registration Statement on Form S-3 registering the future
sale of up to $549.0 million of debt and/or equity securities, which was
declared effective by the Securities and Exchange Commission.
See the Company's Annual Report on Form 10-K for the year ended December 31,
2002 for a detailed discussion of the Company's debt.
During the first quarter of 2003, The Continental Corporation
("Continental"), a wholly owned subsidiary, repaid its $128.0 million, 7.250%
Senior Note, due March 1, 2003.
CNA pays a facility fee to the lenders for having funds available for loans
under the credit facility maturing April 30, 2004. The fee varies based on the
long term debt ratings of CNA. At September 30, 2003 and December 31, 2002,
the facility fee was 17.5 basis points.
CNA pays interest on any outstanding debt/borrowings under the facility
based on a rate determined using the long term debt ratings of CNA. The
interest rate is equal to LIBOR plus 57.5 basis points. Further, if CNA has
outstanding loans greater than 50.0% of the amounts available under the
facility, CNA will also pay a utilization fee of 12.5 basis points on such
loans. At September 30, 2003 and December 31, 2002, the weighted-average
interest rate on the borrowings under the facility, including facility fees
and utilization fees, was 2.1% and 2.3%.
A Moody's downgrade of the CNA senior debt rating from Baa2 to Baa3 would
increase the facility fee from 17.5 basis points to 25.0 basis points. The
applicable interest rate would increase from LIBOR plus 57.5 basis points to
LIBOR plus 75.0 basis points. The utilization fee would remain unchanged on
the facility at 12.5 basis points.
CNA Surety Corporation ("CNA Surety"), a 64.0% owned and consolidated
subsidiary of CNA, pays interest on any outstanding borrowings under its
credit agreement based on an applicable margin determined by the amount of
leverage of CNA. The current interest rate on any borrowings under the
facility is LIBOR plus the applicable margin. The margin on the term loan was
62.5 basis points. The margin on the revolving loan was 90.0 basis points. In
addition, CNA Surety pays a facility fee that is currently 35.0 basis points.
If the utilization of the credit facility is greater than 50.0% of the amount
available under the facility, an additional fee of 5.0 basis points will be
incurred. At September 30, 2003, the aggregate commitment of the term loan
123
component of the credit agreement was reduced by $5.0 million to an aggregate
commitment of $20.0 million. Effective January 30, 2003, CNA Surety entered
into an interest rate swap on the term loan portion of its credit agreement,
which uses the 3-month LIBOR to determine the swap increment. As a result, the
term loan effective interest rate on September 30, 2003 was 2.8%. At September
30, 2003, the weighted-average interest rate on the $50.0 million of
outstanding borrowings under the credit agreement, including facility fees and
utilization fees was 2.7%. At December 31, 2002, the weighted-average interest
rate on the $60.0 million of outstanding borrowings under the credit
agreement, including facility fees and utilization fees was 2.0%. At September
30, 2003 and December 31, 2002, CNA Surety was in compliance with all
restrictive debt covenants, except for the fixed charge coverage ratio for the
period ended September 30, 2003. The lenders have waived compliance with this
covenant with respect to the period ending September 30, 2003 and have amended
the 2002 Credit Facility to replace the fixed charge coverage ratio for the
next three quarters with a minimum earnings before interest, income taxes,
depreciation and amortization requirement.
See Note 13 of the Notes to the Consolidated Condensed Financial Statements
for information related to CNA's commitments and contingencies. The impact of
these commitments and contingencies should be considered when evaluating CNA's
liquidity and capital resources.
Regulatory Matters
CNA has established a plan to reorganize and streamline its U.S. property
and casualty insurance legal entity structure. Once completed, the plan will
consolidate CNA's U.S. property and casualty insurance risks into CCC, as well
as realign the capital supporting these risks. Under the plan, CNA will
implement, in the fourth quarter of 2003, a 100% quota share reinsurance
agreement, effective January 1, 2003, ceding all of the CIC Group's net
insurance risks to CCC. The ownership of the CIC Group will be moved under CCC
in the fourth quarter of 2003 in order to properly align the insurance risks
with the supporting capital. Additionally, CNA will continue its efforts to
reduce both the number of U.S. property and casualty insurance entities it
maintains and the number of states in which such entities are domiciled. In
order to facilitate the execution of this plan, CNA, CCC and CIC have agreed
to cooperate with a working group of the National Association of Insurance
Commissioners.
In connection with the approval process for aspects of the reorganization
plan, CNA has agreed to undergo a state regulatory financial examination of
CIC as of December 31, 2003, including a review of insurance reserves by an
independent actuarial firm. CCC is also scheduled to undergo its routine state
regulatory financial examination as of December 31, 2003.
CNA has also agreed that any proceeds from the sale of any member of the CIC
pool, net of transaction expenses, will be retained in CIC or one of its
subsidiaries until the dividend stipulation discussed below expires.
Dividend Paying Ability
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
by the respective state insurance departments.
124
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 of Insurance (the "Department"), may be paid only from earned
surplus, which is calculated by removing unrealized gains from unassigned
surplus. As of September 30, 2003, CCC's earned surplus is in a positive
earned surplus position, thereby enabling CCC to pay approximately $72.0
million of dividend payments during the remainder of 2003 that would not be
subject to the Department's prior approval. CNA's scheduled debt service
payments for the fourth quarter of 2003 are expected to be paid with CNA's
available cash. However, as a result of the fourth quarter 2003 implementation
of the 100% quota share reinsurance agreement, which is effective January 1,
2003, whereby CCC will assume 100% of the CIC Group's net insurance risks,
including its 2003 underwriting activity, CNA expects that CCC will be in a
negative earned surplus position as of December 31, 2003. CNA expects CCC to
receive prior approval for dividends to fund CNA's debt service and principal
repayment in 2004.
As a result of the ownership change of the CIC Group under CCC in the fourth
quarter, no dividends will be paid to CNA from the CIC Group companies. In
addition, by agreement with the New Hampshire Insurance Department, the CIC
Group will not pay dividends to CCC until after January 1, 2006.
Ratings
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.
The actions that can be taken by rating agencies are changes in ratings or
modifiers. "On Review," "Credit Watch" and "Rating Watch" are modifiers used
by the ratings agencies to alert those parties relying on CNA's ratings of the
possibility of a rating change in the near term. Modifiers are utilized when
the agencies are uncertain as to the impact of a Company action or initiative,
which could prove to be material to the current rating level. Modifiers are
generally used to indicate a possible change in rating within 90 days.
On November 12, 2003, in response to CNA's earnings and capital plan
announcement the rating agencies took various rating actions on CNA. A.M. Best
affirmed the existing CNA insurance financial strength and debt ratings with a
negative outlook. S&P retained the current rating levels and the existing
Credit Watch with negative implications status across all insurance financial
strength and debt ratings. Moody's affirmed CNA's Property and Casualty
insurance financial strength ratings and lowered CAC/VFL insurance financial
strength ratings to Baa1. Moody's has also affirmed Continental's debt ratings
but has lowered CNA's debt rating to Baa3. All of the Moody's ratings have a
negative outlook. Fitch has affirmed CNA's existing insurance financial
strength and senior debt ratings and placed the Property and Casualty
companies and debt ratings on negative outlook. Fitch has also retained the
Rating Watch Negative status on the Life and Group companies.
125
The Institutional Markets business unit, which provides investment products
to pension plan sponsors and other institutional customers, is most
significantly impacted by the Moody's downgrade of CAC/VFL, however, the
Company does not expect the downgrade to have a significant impact on its
results of operations or liquidity.
The table below reflects the various group ratings issued by A.M. Best, S&P,
Moody's and Fitch as of November 12, 2003 for the Property and Casualty and
Life and Group companies. The table also includes the ratings for CNA's senior
debt and Continental senior debt.
Insurance Financial Strength Ratings Debt Ratings
- ------------------------------------------------------------------------------------------------
Property and Casualty Life & Group CNA Continental
- ------------------------------------------------------------------------------------------------
CCC CIC Senior Senior
Group Group CAC/VFL CNAGLA Debt Debt
- ------------------------------------------------------------------------------------------------
A.M. Best A A A A bbb bbb-
Fitch A- A- A+ A BBB- BBB-
Moody's A3 A3 Baa1* NR Baa2 Baa3
S&P A- A- A NR BBB- BBB-
NR = Not Rated
All modifiers for the insurance financial strength and debt ratings as
evaluated by S&P are Credit Watch with negative implications.
*Continental Assurance Corporation ("CAC") and Valley Forge Life Insurance
Company ("VFL") are rated separately by Moody's and both have a Baa1 rating.
If CNA's insurance financial strength ratings were downgraded, CNA's
business and the Company's results of operations could be materially adversely
affected. The severity of the impact on CNA's business is dependent on the
level of downgrade and, for certain products, which rating agency takes the
rating action. Among the adverse effects in the event of such downgrading
would be the inability to obtain business from certain major insurance
brokers, the inability to sell CNA's insurance products to certain markets,
and the required collateralization of certain future payment obligations or
reserves.
CNA has entered into several settlement agreements and assumed reinsurance
contracts that require collateralization of future payment obligations and
assumed reserves if CNA's ratings or other specific criteria fall below
certain thresholds. The ratings triggers are generally more than one level
below CNA's November 12, 2003 ratings.
Lorillard
Lorillard and other cigarette manufacturers continue to be confronted with
substantial litigation. Plaintiffs in most of the cases seek unspecified
amounts of compensatory damages and punitive damages, although some seek
damages ranging into the billions of dollars. Plaintiffs in some of the cases
seek treble damages, statutory damages, disgorgement of profits, equitable and
injunctive relief, and medical monitoring, among other damages.
126
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, 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. While Lorillard intends to defend vigorously all tobacco products
liability litigation, 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. Lorillard may enter
into discussions in an attempt to settle particular cases if it believes it is
appropriate to do so.
On May 21, 2003 the Florida Third District Court of Appeal vacated the
judgment entered in favor of a class of Florida smokers in the case of Engle
v. R.J. Reynolds Tobacco Co., et al. The judgment reflected an award of
punitive damages to the class of approximately $145.0 billion, including $16.3
billion against Lorillard. The court of appeals also decertified the class
ordered during pre-trial proceedings. Plaintiffs are seeking review of the
case by the Florida Supreme Court. The Company and Lorillard believe that the
panel's decision should be upheld on further appeals.
Except for the impact of the State Settlement Agreements as described in
Note 12 of the Notes to Consolidated Condensed Financial Statements included
in Item 1 of this Report, management is unable to make a meaningful estimate
of the amount or range of loss that could result from an unfavorable outcome
of pending litigation and, therefore, no provision has been made in the
consolidated condensed financial statements for any unfavorable outcome. It is
possible that the Company's results of operations, cash flows and its
financial position could be materially adversely affected by an unfavorable
outcome of certain pending litigation.
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's cash payment under the State Settlement Agreements in the first
nine months of 2003 was approximately $628.0 million. In 2003, Lorillard
anticipates its total payments under the State Settlement Agreements will
range from $750.0 to $800.0 million in accordance with the terms of those
agreements.
See Part II, Item 1 - Legal Proceedings and Note 12 of the Notes to
Consolidated Condensed Financial Statements included in Part I of this Report
for additional information regarding this settlement and other litigation
matters.
In 1977, Lorillard sold substantially all of its cigarette trademarks
outside of the United States and the international business associated with
those brands. Lorillard received notice from Brown & Williamson Tobacco
Corporation ("B&W"), a successor to the purchaser, that sought indemnity under
certain provisions of the 1977 agreement with respect to suits brought by
various foreign jurisdictions, and certain cases brought in foreign countries
by individuals concerning periods prior to June 1977 and during portions of
1978. In 2003, Lorillard entered into a settlement agreement with B&W and paid
$28.0 million to B&W for a release of all indemnity obligations and for the
agreement by B&W and its affiliates to terminate all rights to use the
Lorillard name within 18 months.
On May 16, 2003, Lorillard and several other tobacco manufacturers and
tobacco leaf buyers reached a settlement with a class of U.S. tobacco growers
and quota holders who filed suit alleging antitrust violations in the
127
purchasing of domestic tobacco leaf. The settlement calls for Lorillard to pay
the class $20.0 million and requires that Lorillard purchase at least 20
million pounds of U.S. leaf tobacco each year through 2013. Lorillard has
committed to purchase at least 35% of its annual total requirements for flue-
cured and burley tobacco domestically for the same period. Lorillard will also
be responsible for 10% of the plaintiffs' attorneys' fees, to be determined by
the court after class approval. The settlement has received preliminary
approval from the court and still must be approved by members of the class.
Lorillard's marketable securities totaled $1,978.4 and $1,640.7 million at
September 30, 2003 and December 31, 2002, respectively. At September 30, 2003,
fixed maturity securities represented 91.4% of the total investment in
marketable securities, including 27.6% invested in Treasury Bills with an
average duration of approximately 3 months, 34.3% invested in overnight
repurchase agreements and 38.1% invested in money market accounts.
The principal source of liquidity for Lorillard's business and operating
needs is internally generated funds from its operations. Lorillard's operating
activities resulted in a net cash inflow of approximately $869.7 million for
the nine months ended September 30, 2003, compared to $681.6 million for the
corresponding period of the prior year. Lorillard believes, based on current
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 any 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
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.
In July of 2003 Loews Hotels sold a New York City property, the Metropolitan
Hotel, and realized a gain of $56.7 million after taxes.
Diamond Offshore
At September 30, 2003, Diamond Offshore's cash and marketable securities
totaled $581.1 million, down from $812.5 million at December 31, 2002. Cash
generated by a net loss adjusted for non-cash items, including depreciation,
for the nine months ended September 30, 2003 decreased $181.8 million
primarily due to a decline in results of operations in 2003, as compared to
the prior year.
In March of 2003, Diamond Offshore completed the acquisition of the third-
generation semisubmersible drilling rig, Omega, renamed the Ocean Patriot for
$65.0 million. Diamond Offshore capitalized $63.5 million to rig equipment and
recorded $1.5 million to rig inventory.
Diamond Offshore expects to spend approximately $110.0 million for rig
upgrade capital expenditures during 2003 for the completion of the Ocean Rover
upgrade ($68.0 million) and three remaining jack-up upgrades ($42.0 million).
During the first nine months of 2003, Diamond Offshore spent $96.1 million,
including capitalized interest expense, for rig upgrades. These expenditures
were for the deepwater upgrade of the Ocean Rover ($67.5 million), and
upgrades to three of Diamond Offshore's jack-ups ($28.6 million). Two of these
128
upgrades were completed in the first half of 2003 and one is expected to be
completed during the fourth quarter of 2003.
The upgrade of the Ocean Rover, which began in January of 2002, was
completed early in July of 2003 on time and under budget. The project,
originally budgeted to cost $200.0 million was completed for approximately
$189.0 million. The rig commenced its contract with Murphy Sabah Oil Company,
Ltd. on July 10, 2003 for a minimum three well drilling program offshore
Malaysia.
Diamond Offshore has budgeted approximately $100.0 to $110.0 million in 2003
for capital expenditures associated with its ongoing rig equipment replacement
and enhancement programs and other corporate requirements. During the nine
months ended September 30, 2003, Diamond Offshore spent $81.3 million in
association with its ongoing rig equipment replacement and enhancement
programs and to meet other corporate requirements.
On October 16, 2003, Diamond Offshore announced that its quarterly cash
dividend effective December 1, 2003, will be $0.0625 per share of common
stock. The dividend rate for previous quarters this year was $0.125 per share
of common stock. Diamond Offshore elected to reduce the dividend rate in order
to help maintain its strong liquidity position in light of recent earnings
declines.
Cash required to meet Diamond Offshore's capital commitments is determined
by evaluating rig upgrades 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 the opinion of Diamond Offshore's management that operating cash flows
and existing cash reserves will be sufficient to meet these capital
commitments; however, periodic assessments will be made 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 issue any such securities
will be dependent on Diamond Offshore's results of operations, its current
financial condition, current market conditions and other factors beyond its
control.
Texas Gas
In May of 2003, the Company acquired Texas Gas from The Williams Companies,
Inc. The transaction value was approximately $1.05 billion, which included
$250.0 million of existing Texas Gas debt. The Company funded the
approximately $802.3 million balance of the purchase price, including
transaction costs and closing adjustments, with $528.3 million of its
available cash and $275.0 million of proceeds from an interim loan incurred at
the subsidiary level.
Upon completion of the acquisition, TGT Pipeline, LLC, a wholly owned
subsidiary of the Company and the immediate parent of Texas Gas, issued $185.0
million of 5.2% Notes due 2018 and Texas Gas issued $250.0 million of 4.6%
Notes due 2015. The net offering proceeds of approximately $431.0 million were
used to repay the $275.0 million interim loan and to retire approximately
$132.7 million principal amount of Texas Gas's existing $150.0 million of
8.625% Notes due 2004. Texas Gas intends to use the balance of the offering
proceeds, together with cash on hand, to retire the remaining 2004 notes.
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Bulova
At September 30, 2003, Bulova's cash and marketable securities totaled $7.6
million, down from $10.2 million at December 31, 2002. Bulova does not
currently expect to incur any material capital expenditures.
Bulova and the Company have a credit agreement, which provides for unsecured
loans to Bulova by the Company from time to time, in principal amounts
aggregating up to $50.0 million. In September of 2003, Bulova borrowed $8.0
million under this agreement. The interest rate for amounts outstanding under
the credit agreement is a fixed rate equal to the six-month LIBOR in effect on
the date Bulova requests the loan, plus 250 basis points (2.5%). The effective
rate for the balance outstanding at September 30, 2003 was 3.68%. The credit
agreement has been periodically extended and currently expires on December 31,
2005. Funds from the credit agreement have been utilized to fund working
capital requirements, related primarily to inventory purchases. Bulova may
require additional working capital advances under this credit agreement for
its international expansion efforts.
Majestic Shipping
As previously reported in the Company's 2002 Annual Report on Form 10-K, in
2002 and 2003, subsidiaries of Hellespont acquired four new supertankers for
approximately $370.8 million. Hellespont issued to Majestic a $57.5 million
promissory note. The principal amount that is outstanding is $51.1 million as
of September 30, 2003. The ships were financed by bank debt of up to $200.0
million, guaranteed by Hellespont. As of September 30, 2003, $197.0 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.
Corporate
The parent company's cash and investments at September 30, 2003 totaled $2.1
billion, as compared to $2.3 billion at December 31, 2002. The decline was
primarily due to a cash outlay of approximately $528.3 million to purchase
Texas Gas in May of 2003, partially offset by dividends received from its
subsidiaries.
The Company has been a major source of capital for CNA's liquidity and
capital resource needs. For information with respect to capital support
aggregating up to $1.4 billion committed by Loews in the fourth quarter of
2003, see Consolidated Financial Results - Capital Plan.
In December of 2002, the Company purchased from CNA $750.0 million of CNA
series H cumulative preferred stock (the "Preferred Issue"). CNA used $250.0
million of the proceeds from the Preferred Issue to prepay a $250.0 million
one-year bank term loan due April 29, 2003 and an additional $250.0 million
was contributed to CCC to improve its statutory surplus.
CNA completed a common stock rights offering in September of 2001,
successfully raising $1,006.0 million (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.
On April 25, 2003, the Company filed a shelf Registration Statement on Form
S-3 registering the future sale of up to $1.5 billion of debt and/or equity
130
securities, which was declared effective by the Securities and Exchange
Commission on May 6, 2003.
As of September 30, 2003, there were 185,447,050 shares of Loews common
stock outstanding and 39,910,000 shares of Carolina Group stock outstanding.
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.
INVESTMENTS
Insurance
The significant components of CNA's investment income are presented in the
following table:
Three Months Ended Nine Months Ended
September 30, September 30,
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2003 2002 2003 2002
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(In millions)
Fixed maturity securities $ 412.0 $ 461.0 $1,254.0 $1,404.0
Short term investments 14.0 17.0 46.0 44.0
Limited partnerships 61.0 (72.0) 159.0 (28.0)
Equity securities 4.0 10.0 13.0 25.0
Interest on funds withheld and other deposits (148.0) (53.0) (288.0) (168.0)
Other 20.0 22.0 63.0 62.0
- ------------------------------------------------------------------------------------------------
Gross investment income 363.0 385.0 1,247.0 1,339.0
Investment expense (11.0) (21.0) (36.0) (47.0)
- ------------------------------------------------------------------------------------------------
Investment income, net of expense $ 352.0 $ 364.0 $1,211.0 $1,292.0
================================================================================================
CNA experienced lower net investment income for the three and nine months
ended September 30, 2003 as compared with the same periods in 2002. The
decreases were due primarily to lower investment yields on fixed maturity
securities and increased interest costs on funds withheld and other deposits.
The interest costs on funds withheld and other deposits increased principally
as a result of additional cessions to the corporate aggregate reinsurance and
other treaties due to adverse reserve development recorded in the three and
nine months ended September 30, 2003. These decreases were partially offset by
increased limited partnership income, which increased as a result of improving
equity markets and favorable conditions in the fixed income markets. See the
Reinsurance section of this MD&A for further discussion of CNA's aggregate
reinsurance treaties.
The bond segment of the investment portfolio yielded 5.3% and 6.0% for the
nine months ended September 30, 2003 and 2002.
131
The components of net realized investment gains (losses) are presented in
the following table:
Three Months Ended Nine Months Ended
September 30, September 30,
- --------------------------------------------------------------------- -------------------------
2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------
(In millions)