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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2004
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 April 23, 2004
- ------------------------------ ------------------------------
Common stock, $1.00 par value 185,488,800 shares
Carolina Group stock, $0.01 par value 57,966,750 shares
==============================================================================
1
INDEX
Page
Part I. Financial Information No.
-----
Item 1. Financial Statements
Consolidated Condensed Balance Sheets
March 31, 2004 and December 31, 2003 3
Consolidated Condensed Statements of Income
Three months ended March 31, 2004 and 2003 4
Consolidated Condensed Statements of Cash Flows
Three months ended March 31, 2004 and 2003 6
Notes to Consolidated Condensed Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 63
Item 3. Quantitative and Qualitative Disclosures about Market Risk 122
Item 4. Disclosure Controls and Procedures 126
Part II. Other Information
Item 1. Legal Proceedings 127
Item 6. Exhibits and Reports on Form 8-K 128
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED BALANCE SHEETS
- ------------------------------------------------------------------------------------------------
(In millions)
March 31, December 31,
2004 2003
- ------------------------------------------------------------------------------------------------
Assets:
Investments:
Fixed maturities, amortized cost of $27,746.2 and $27,664.9 $29,015.1 $28,781.3
Equity securities, cost of $504.8 and $593.1 850.9 888.2
Limited partnership investments 1,899.6 1,335.1
Other investments 45.4 245.6
Short-term investments 10,325.6 11,264.6
- ------------------------------------------------------------------------------------------------
Total investments 42,136.6 42,514.8
Cash 133.3 180.8
Receivables-net 19,143.9 20,467.9
Property, plant and equipment-net 3,826.5 3,879.7
Deferred income taxes 599.5 530.2
Goodwill 307.5 311.4
Other assets 3,027.2 3,785.4
Deferred acquisition costs of insurance subsidiaries 1,345.2 2,532.7
Separate account business 745.0 3,678.0
Assets related to businesses held for sale 6,291.1
- ------------------------------------------------------------------------------------------------
Total assets $77,555.8 $77,880.9
================================================================================================
Liabilities and Shareholders' Equity:
Insurance reserves:
Claim and claim adjustment expense $31,183.2 $31,730.2
Future policy benefits 4,503.4 8,160.9
Unearned premiums 4,832.6 4,891.5
Policyholders' funds 1,853.0 601.4
- ------------------------------------------------------------------------------------------------
Total insurance reserves 42,372.2 45,384.0
Payable for securities purchased 2,893.7 2,147.7
Securities sold under agreements to repurchase 370.6 441.8
Long-term debt, less unamortized discount 6,105.4 5,820.2
Reinsurance balances payable 3,328.7 3,432.0
Other liabilities 3,482.4 4,251.3
Separate account business 745.0 3,678.0
Liabilities related to businesses held for sale 5,471.3
- ------------------------------------------------------------------------------------------------
Total liabilities 64,769.3 65,155.0
Minority interest 1,664.7 1,671.6
Shareholders' equity 11,121.8 11,054.3
- ------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $77,555.8 $77,880.9
================================================================================================
See accompanying Notes to Consolidated Condensed Financial Statements.
3
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
- ------------------------------------------------------------------------------------------------
(In millions)
Three Months Ended
March 31,
-------------------------
2004 2003
-------------------------
Revenues:
Insurance premiums $ 2,167.0 $ 2,380.2
Investment income, net of expense 493.6 456.6
Investment losses (416.2) (95.6)
Manufactured products (including excise
taxes of $156.1 and $156.9) 808.2 884.0
Other 438.6 320.6
- -----------------------------------------------------------------------------------------------
Total 3,491.2 3,945.8
- -----------------------------------------------------------------------------------------------
Expenses:
Insurance claims and policyholders' benefits 1,620.3 1,869.8
Amortization of deferred acquisition costs 433.2 458.2
Cost of manufactured products sold 487.5 481.2
Other operating expenses 772.9 780.5
Interest 99.1 73.7
- -----------------------------------------------------------------------------------------------
Total 3,413.0 3,663.4
- -----------------------------------------------------------------------------------------------
78.2 282.4
- -----------------------------------------------------------------------------------------------
Income tax expense 45.4 93.1
Minority interest (10.8) (1.0)
- -----------------------------------------------------------------------------------------------
Total 34.6 92.1
- -----------------------------------------------------------------------------------------------
Income from continuing operations 43.6 190.3
Discontinued operations-net (0.3)
- -----------------------------------------------------------------------------------------------
Net income $ 43.6 $ 190.0
===============================================================================================
Net income attributable to:
Loews common stock:
Income from continuing operations $ 9.2 $ 161.7
Discontinued operations-net (0.3)
- -----------------------------------------------------------------------------------------------
Loews common stock 9.2 161.4
Carolina Group stock 34.4 28.6
- ----------------------------------------------------------------------------------------------
Total $ 43.6 $ 190.0
==============================================================================================
4
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF INCOME (Continued)
- ------------------------------------------------------------------------------------------------
(In millions, except per share data)
Three Months Ended
March 31,
-------------------------
2004 2003
-------------------------
Income per share of Loews common stock:
Income from continuing operations $ 0.05 $ 0.87
Discontinued operations-net
- ------------------------------------------------------------------------------------------------
Net income $ 0.05 $ 0.87
================================================================================================
Net income per share of Carolina Group stock $ 0.59 $ 0.72
================================================================================================
Weighted average number of shares outstanding:
Loews common stock 185.47 185.45
Carolina Group stock 57.97 39.91
See accompanying Notes to Consolidated Condensed Financial Statements.
5
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
- ------------------------------------------------------------------------------------------------
(In millions)
Three Months Ended
March 31,
-------------------------
2004 2003
-------------------------
Operating Activities:
Net income $ 43.6 $ 190.0
Adjustments to reconcile net income to net cash
provided (used) by operating activities-net 348.2 143.5
Changes in operating assets and liabilities-net:
Reinsurance receivable 284.0 (235.7)
Other receivables (108.8) (182.0)
Federal income taxes 133.5 (33.7)
Prepaid reinsurance premiums 103.5 (116.7)
Deferred acquisition costs 10.3 (56.8)
Insurance reserves and claims (365.0) 527.9
Reinsurance balances payable (71.5) 28.0
Other liabilities (520.1) (339.6)
Trading securities 107.6 (170.3)
Other-net (13.6) 59.3
- -----------------------------------------------------------------------------------------------
(48.3) (186.1)
- ------------------------------------------------------------------------------------------------
Investing Activities:
Purchases of fixed maturities (16,863.3) (20,029.3)
Proceeds from sales of fixed maturities 11,534.3 15,727.3
Proceeds from maturities of fixed maturities 2,988.0 3,536.2
Securities sold under agreements to repurchase (71.2) 117.8
Purchases of equity securities (45.5) (121.1)
Proceeds from sales of equity securities 40.8 73.5
Change in short-term investments 2,237.5 1,270.6
Purchases of property, plant and equipment (59.7) (177.1)
Proceeds from sales of property, plant and equipment 1.3 0.1
Change in other investments 15.0 6.1
- ------------------------------------------------------------------------------------------------
(222.8) 404.1
- ------------------------------------------------------------------------------------------------
Financing Activities:
Dividends paid to Loews shareholders (54.2) (45.7)
Dividends paid to minority interests (3.7) (7.5)
Issuance of Loews common stock 1.2 0.2
Principal payments on long-term debt (23.3) (129.3)
Issuance of long-term debt 297.4
Withdrawals of policyholder account balances 6.0 (7.0)
Other 0.2 (0.6)
- ------------------------------------------------------------------------------------------------
223.6 (189.9)
- ------------------------------------------------------------------------------------------------
Net change in cash (47.5) 28.1
Cash, beginning of period 180.8 185.4
- ------------------------------------------------------------------------------------------------
Cash, end of period $ 133.3 $ 213.5
================================================================================================
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 and casualty insurance (CNA Financial
Corporation ("CNA"), a 91% 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.
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
March 31, 2004 and December 31, 2003 and the statements of income and changes
in cash flows for the three months ended March 31, 2004 and 2003.
Results of operations for the first three months of each of the years is not
necessarily indicative of results of operations for that entire year.
Reference is made to the Notes to Consolidated Financial Statements in the
2003 Annual Report to Shareholders on Form 10-K/A 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 2004.
Accounting Changes - In January of 2003, the Financial Accounting Standards
Board ("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. On December
24, 2003, the FASB issued a complete replacement of FIN 46 ("FIN 46R"), which
clarified certain complexities of FIN 46. FIN 46R is applicable for financial
statements issued for reporting periods that end after March 15, 2004. The
7
adoption of FIN 46R did not have a significant impact on the results of
operations or equity of the Company.
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, therefore prior year
amounts have not been conformed to the current year presentation.
The Company adopted SOP 03-01 as of January 1, 2004. The assets and
liabilities of certain guaranteed investment contracts and indexed group
annuity contracts that were previously segregated and reported as separate
accounts no longer qualify for separate account presentation. Prior to the
adoption of SOP 03-01, the asset and liability presentation of these affected
contracts were categorized as separate account assets and liabilities in the
Consolidated Condensed Balance Sheets. The results of operations from separate
account business were primarily classified as other revenue in the
Consolidated Condensed Statements of Income. In accordance with the provisions
of SOP 03-01, the classification and presentation of certain balance sheet and
income statement items have been modified within these financial statements.
Accordingly, the investment securities previously classified as separate
account assets have now been reclassified to the general account and will be
reported based on their investment classification whether available-for-sale
or trading securities. The investment portfolio for the indexed group annuity
contracts is classified as held for trading purposes and is carried at fair
value with both the net realized and unrealized gains (losses) included within
investment income, in the Consolidated Condensed Statements of Income.
CNA continues to have contracts that meet the criteria for separate account
presentation. The assets and liabilities of these contracts are legally
segregated and reported as assets and liabilities of the separate account
business. Substantially all assets of the separate account business are
carried at fair value. Separate account liabilities are carried at contract
values.
The following table provides the balance sheet presentation of assets and
liabilities for certain guaranteed investment contracts and indexed group
annuity contracts upon adoption of SOP 03-01, including the classification of
the indexed group annuity contract investments as trading securities.
8
March 31, January 1,
2004 (a) 2004
- ------------------------------------------------------------------------------------------------
(In millions)
Assets
Investments:
Fixed maturity securities, available-for-sale $ 1,245.0 $ 1,220.0
Fixed maturity securities, trading 393.0 304.0
Equity securities 4.0 4.0
Limited partnerships 463.0 419.0
Short term investments, available-for-sale 47.0 55.0
Short term investments, trading 389.0 414.0
- ------------------------------------------------------------------------------------------------
Total investments 2,541.0 2,416.0
Accrued investment income 12.0 13.0
Receivables for securities sold 83.0 97.0
Other assets 1.0
- ------------------------------------------------------------------------------------------------
Total assets $ 2,636.0 $ 2,527.0
================================================================================================
Liabilities
Insurance reserves:
Claim and claim adjustment expense $ 1.0 $ 1.0
Future policy benefits 605.0 617.0
Policyholders' funds 1,345.0 1,324.0
Collateral on loaned securities and derivatives 2.0 17.0
Payables for securities purchased 101.0 43.0
Other liabilities 62.0 47.0
- ------------------------------------------------------------------------------------------------
Total liabilities $ 2,116.0 $ 2,049.0
================================================================================================
(a) Includes $73.0 of Investments and $72.0 of Future Policy Benefits reserves transferred to
Assets and Liabilities Related to Businesses Held for Sale. See Note 16.
In December of 2003, the FASB issued a revised version of SFAS No. 132,
"Employers Disclosures about Pensions and Other Postretirement Benefits." The
revised version of SFAS No. 132 makes several significant changes to the
required disclosures for pension and other postretirement benefit plan assets,
obligations, and net cost in financial statements. SFAS No. 132 made no
changes to the methodologies underlying the measurement of obligations or
calculation of expense. In addition, SFAS No. 132 requires disclosure of
certain plan information on a quarterly basis in interim financial statements.
This quarterly report includes the disclosure of plan information required for
interim financial statements (see Note 11).
In January of 2004, the FASB issued FASB Staff Position ("FSP") 106-1,
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003," which allowed companies to
elect a one-time deferral of the recognition of the effects of the Medicare
Prescription Drug Act in accounting for their plans under SFAS No. 106 and in
providing disclosures related to the plan required by SFAS No. 132(R). The
FASB allowed the one-time deferral due to the accounting issues raised by the
Medicare Prescription Drug Act - in particular, the accounting for the federal
subsidy that is not explicitly addressed in SFAS No. 106 - and due to the fact
that uncertainties exist as to the direct effects of the Medicare Prescription
Drug Act and its ancillary effects on plan participants. For companies
electing the one-time deferral, such deferral remains in effect until
authoritative guidance on the accounting for the federal subsidy is issued, or
9
until certain other events, such as a plan amendment, settlement or
curtailment, occur. The Company is currently evaluating the effects of the
Medicare Prescription Drug Act on its other postretirement benefit plan and
its participants, and has elected the one-time deferral. The Company's
accumulated postretirement benefit obligation and net postretirement benefit
cost for 2004 does not reflect the effects of the Medicare Prescription Drug
Act.
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 equal 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 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 income and the
related basic and diluted income per Loews common and Carolina Group shares
would have been as follows:
Three Months Ended
March 31,
-------------------------
2004 2003
-------------------------
(In millions,
except per share data)
Net income:
Loews common stock:
Net income as reported $ 9.2 $ 161.4
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method, net (1.3) (1.3)
- ------------------------------------------------------------------------------------------------
Pro forma net income $ 7.9 $ 160.1
================================================================================================
Carolina Group stock:
Net income as reported $ 34.4 $ 28.6
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method, net
- ------------------------------------------------------------------------------------------------
Pro forma net income $ 34.4 $ 28.6
================================================================================================
Net income per share:
Loews common stock:
As reported $ 0.05 $ 0.87
Pro forma 0.04 0.86
Carolina Group stock:
As reported 0.59 0.72
Pro forma 0.59 0.72
================================================================================================
10
Comprehensive Income - Comprehensive income includes all changes to
shareholders' equity, except those resulting from investments by shareholders
and distributions to shareholders. For the three months ended March 31, 2004
and 2003, comprehensive income totaled $120.9 and $385.6 million,
respectively. Comprehensive income includes net income, unrealized
appreciation (depreciation) of investments and foreign currency translation
gains or losses.
2. Investments
Three Months Ended
March 31,
-------------------------
2004 2003
-------------------------
(In millions)
Investment income consisted of:
Fixed maturity securities $ 408.6 $ 429.4
Short-term investments 15.1 28.5
Limited partnerships 86.1 25.0
Equity securities 5.1 5.3
Interest expense on funds withheld and other deposits (49.8) (46.7)
Other 37.8 34.7
- ------------------------------------------------------------------------------------------------
Total investment income 502.9 476.2
Investment expenses (9.3) (19.6)
- ------------------------------------------------------------------------------------------------
Investment income, net of expense $ 493.6 $ 456.6
================================================================================================
Investment gains (losses) are as follows:
Trading securities:
Derivative instruments $ (1.9) $ 6.7
Equity securities, including short positions 32.3 (37.3)
- ------------------------------------------------------------------------------------------------
30.4 (30.6)
Other than trading:
Fixed maturities 138.5 (35.9)
Equity securities 11.1
Short?term investments 0.1 5.3
Other (a) (596.3) (34.4)
- ------------------------------------------------------------------------------------------------
Investment losses (416.2) (95.6)
Income tax benefit 110.1 34.1
Minority interest 29.1 4.9
- ------------------------------------------------------------------------------------------------
Investment losses-net $ (277.0) $ (56.6)
================================================================================================
(a) Includes an impairment loss of $565.9 ($368.3 after tax and minority
interest) related to CNA's planned sale of its individual life insurance
business.
Realized investment losses included $255.0 million of pretax impairment
losses for the three months ended March 31, 2003. These impairment losses were
primarily for securities in certain market sectors, including the airline,
healthcare and energy industries. There were no impairment losses for other
than temporary declines in fair value for fixed maturity and equity securities
for the three months ended March 31, 2004.
11
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 income attributable to each class of common stock by
the weighted average number of common shares of each class of common stock
outstanding for the period. Diluted earnings per share reflects the potential
dilution that could occur if securities or other contracts to issue common
stock were exercised or converted into common stock. For the three months
ended March 31, 2004 and 2003, income per common share assuming dilution is
the same as basic income per share because the impact of securities that could
potentially dilute basic income per common share was insignificant or
antidilutive for the periods presented.
Options to purchase 0.31 and 0.81 million shares of Loews common stock were
outstanding at March 31, 2004 and 2003, 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 0.17 and 0.34
million shares of Carolina Group stock were outstanding at March 31, 2004 and
2003, 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 income to each class of common stock was as follows:
Three Months Ended
March 31,
-------------------------
2004 2003
-------------------------
(In millions)
Loews common stock:
Consolidated net income $ 43.6 $ 190.0
Less income attributable to Carolina Group stock (34.4) (28.6)
- ------------------------------------------------------------------------------------------------
Income attributable to Loews common stock $ 9.2 $ 161.4
================================================================================================
Carolina Group stock:
Income available to Carolina Group stock $ 103.0 $ 124.4
Weighted average economic interest of the Carolina Group stock 33.43% 23.01%
- ------------------------------------------------------------------------------------------------
Income attributable to Carolina Group stock $ 34.4 $ 28.6
================================================================================================
4. Loews and Carolina Group Consolidating Condensed Financial Information
The Company has a two class common stock structure which includes Loews
common stock and Carolina Group stock. Carolina Group 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 ($2.0 billion outstanding at March 31,
2004), 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
12
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.
As of March 31, 2004, the outstanding Carolina Group stock represents a
33.43% 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 33.43% 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
March 31, 2004 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Assets:
Investments $ 1,128.7 $ 100.0 $ 1,228.7 $ 40,907.9 $ 42,136.6
Cash 3.2 0.2 3.4 129.9 133.3
Receivables-net 20.9 20.9 19,149.8 $ (26.8) (a) 19,143.9
Property, plant and
equipment-net 229.3 229.3 3,597.2 3,826.5
Deferred income taxes 441.9 441.9 157.6 599.5
Goodwill 307.5 307.5
Other assets 411.8 411.8 2,615.4 3,027.2
Investment in combined
attributed net assets
of the Carolina Group 1,528.8 (1,998.3) (a)
469.5 (b)
Deferred acquisition
costs of insurance
subsidiaries 1,345.2 1,345.2
Separate account
business 745.0 745.0
Assets related to
businesses held for
sale 6,291.1 6,291.1
- ------------------------------------------------------------------------------------------------
Total assets $ 2,235.8 $ 100.2 $ 2,336.0 $ 76,775.4 $ (1,555.6) $ 77,555.8
================================================================================================
Liabilities and
Shareholders' Equity:
Insurance reserves $ 42,372.2 $ 42,372.2
Payable for securities
purchased 2,893.7 2,893.7
Securities sold under
agreements to
repurchase 370.6 370.6
Long-term debt, less
unamortized discounts $ 1,998.3 $ 1,998.3 6,105.4 $ (1,998.3) (a) 6,105.4
Reinsurance balances
payable 3,328.7 3,328.7
Other liabilities $ 1,026.5 16.4 1,042.9 2,466.3 (26.8) (a) 3,482.4
Separate account
business 745.0 745.0
Liabilities related
to businesses held
for sale 5,471.3 5,471.3
- ------------------------------------------------------------------------------------------------
Total liabilities 1,026.5 2,014.7 3,041.2 63,753.2 (2,025.1) 64,769.3
Minority interest 1,664.7 1,664.7
Shareholders' equity 1,209.3 (1,914.5) (705.2) 11,357.5 469.5 (b) 11,121.8
- ------------------------------------------------------------------------------------------------
Total liabilities
and shareholders'
equity $ 2,235.8 $ 100.2 $ 2,336.0 $ 76,775.4 $ (1,555.6) $ 77,555.8
================================================================================================
(a) To eliminate the intergroup notional debt and interest payable/receivable.
(b) To eliminate the Loews Group's 66.57% equity interest in the combined attributed net assets
of the Carolina Group.
14
Loews and Carolina Group
Consolidating Condensed Balance Sheet Information
Carolina Group Adjustments
---------------------------------- Loews and
December 31, 2003 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Assets:
Investments $ 1,530.2 $ 100.0 $ 1,630.2 $ 40,884.6 $ 42,514.8
Cash 1.5 0.4 1.9 178.9 180.8
Receivables-net 23.9 23.9 20,471.6 $ (27.6) (a) 20,467.9
Property, plant and
equipment-net 221.0 221.0 3,658.7 3,879.7
Deferred income taxes 441.9 441.9 88.3 530.2
Goodwill 311.4 311.4
Other assets 406.4 406.4 3,379.0 3,785.4
Investment in combined
attributed net assets
of the Carolina Group 1,546.7 (2,032.1) (a)
485.4 (b)
Deferred acquisition
costs of insurance
subsidiaries 2,532.7 2,532.7
Separate account
business 3,678.0 3,678.0
- ------------------------------------------------------------------------------------------------
Total assets $ 2,624.9 $ 100.4 $ 2,725.3 $ 76,729.9 $ (1,574.3) $ 77,880.9
================================================================================================
Liabilities and
Shareholders' Equity:
Insurance reserves $ 45,384.0 $ 45,384.0
Payable for securities
purchased 2,147.7 2,147.7
Securities sold under
agreements to
repurchase 441.8 441.8
Long-term debt, less
unamortized discounts $ 2,032.1 $ 2,032.1 5,820.2 $ (2,032.1) (a) 5,820.2
Reinsurance balances
payable 3,432.0 3,432.0
Other liabilities $ 1,405.0 17.4 1,422.4 2,856.5 (27.6) (a) 4,251.3
Separate account
business 3,678.0 3,678.0
- ------------------------------------------------------------------------------------------------
Total liabilities 1,405.0 2,049.5 3,454.5 63,760.2 (2,059.7) 65,155.0
Minority interest 1,671.6 1,671.6
Shareholders' equity 1,219.9 (1,949.1) (729.2) 11,298.1 485.4 (b) 11,054.3
- ------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $ 2,624.9 $ 100.4 $ 2,725.3 $ 76,729.9 $ (1,574.3) $ 77,880.9
================================================================================================
(a) To eliminate the intergroup notional debt and interest payable/receivable.
(b) To eliminate the Loews Group's 66.57% equity interest in the combined attributed net
assets of the Carolina Group.
15
Loews and Carolina Group
Consolidating Condensed Statement of Income Information
Carolina Group Adjustments
Three Months Ended ---------------------------------- Loews and
March 31, 2004 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $ 2,167.0 $ 2,167.0
Investment income,
net $ 8.0 $ 0.4 $ 8.4 525.5 $ (40.3) (a) 493.6
Investment gains
(losses) (416.2) (416.2)
Manufactured products 767.9 767.9 40.3 808.2
Other (0.2) (0.2) 438.8 438.6
- -----------------------------------------------------------------------------------------------
Total 775.7 0.4 776.1 2,755.4 (40.3) 3,491.2
- ------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders'
benefits 1,620.3 1,620.3
Amortization of
deferred acquisition
costs 433.2 433.2
Cost of manufactured
products sold 467.3 467.3 20.2 487.5
Other operating
expenses (b) 99.6 0.1 99.7 673.2 772.9
Interest 40.3 40.3 99.1 (40.3)(a) 99.1
- ------------------------------------------------------------------------------------------------
Total 566.9 40.4 607.3 2,846.0 (40.3) 3,413.0
- ------------------------------------------------------------------------------------------------
208.8 (40.0) 168.8 (90.6) 78.2
- ------------------------------------------------------------------------------------------------
Income tax (benefit)
expense 81.4 (15.6) 65.8 (20.4) 45.4
Minority interest (10.8) (10.8)
- ------------------------------------------------------------------------------------------------
Total 81.4 (15.6) 65.8 (31.2) 34.6
- ------------------------------------------------------------------------------------------------
Income from operations 127.4 (24.4) 103.0 (59.4) 43.6
Equity in earnings
of the Carolina Group 68.6 (68.6)(c)
- ------------------------------------------------------------------------------------------------
Net income $ 127.4 $ (24.4) $ 103.0 $ 9.2 $ (68.6) $ 43.6
================================================================================================
(a) To eliminate interest on the intergroup notional debt.
(b) Includes $0.1 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.
16
Loews and Carolina Group
Consolidating Condensed Statement of Income Information
Carolina Group Adjustments
Three Months Ended ---------------------------------- Loews and
March 31, 2003 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $ 2,380.2 $ 2,380.2
Investment income,
net $ 7.9 $ 0.6 $ 8.5 496.3 $ (48.2) (a) 456.6
Investment gains
(losses) 0.3 0.3 (95.9) (95.6)
Manufactured
products 844.2 844.2 39.8 884.0
Other (0.2) (0.2) 320.8 320.6
- ------------------------------------------------------------------------------------------------
Total 852.2 0.6 852.8 3,141.2 (48.2) 3,945.8
- ------------------------------------------------------------------------------------------------
Expenses:
Insurance claims
and policyholders'
benefits 1,869.8 1,869.8
Amortization of
deferred
acquisition costs 458.2 458.2
Cost of
manufactured
products sold 459.7 459.7 21.5 481.2
Other operating
expenses (b) 141.2 0.1 141.3 639.2 780.5
Interest 48.2 48.2 73.7 (48.2) (a) 73.7
- ------------------------------------------------------------------------------------------------
Total 600.9 48.3 649.2 3,062.4 (48.2) 3,663.4
- ------------------------------------------------------------------------------------------------
251.3 (47.7) 203.6 78.8 282.4
- ------------------------------------------------------------------------------------------------
Income tax (benefit)
expense 97.8 (18.6) 79.2 13.9 93.1
Minority interest (1.0) (1.0)
- ------------------------------------------------------------------------------------------------
Total 97.8 (18.6) 79.2 12.9 92.1
- ------------------------------------------------------------------------------------------------
Income from
operations 153.5 (29.1) 124.4 65.9 190.3
Equity in earnings
of the Carolina Group 95.8 (95.8) (c)
- ------------------------------------------------------------------------------------------------
Income from continuing
opeations 153.5 (29.1) 124.4 161.7 (95.8) 190.3
Discontinued
operations-net (0.3) (0.3)
- ------------------------------------------------------------------------------------------------
Net income $ 153.5 $ (29.1) $ 124.4 $ 161.4 $ (95.8) $ 190.0
================================================================================================
(a) To eliminate interest on the intergroup notional debt.
(b) Includes $0.1 of expenses allocated by the Carolina Group to the Loews Group for computer
related charges and $0.1 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.
17
Loews and Carolina Group
Consolidating Condensed Statement of Cash Flows Information
Carolina Group Adjustments
Three Months Ended ---------------------------------- Loews and
March 31, 2004 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Net cash (used)
provided by
operating
activities $ (252.4) $ (25.4) $ (277.8) $ 282.0 $ (52.5) $ (48.3)
- ------------------------------------------------------------------------------------------------
Investing activities:
Purchases of property
and equipment (18.2) (18.2) (41.5) (59.7)
Proceeds from sales
of property and
equipment 0.4 0.4 0.9 1.3
Change in short-term
investments 409.9 409.9 1,827.6 2,237.5
Other investing
activities (2,368.1) (33.8) (2,401.9)
- ------------------------------------------------------------------------------------------------
392.1 392.1 (581.1) (33.8) (222.8)
- ------------------------------------------------------------------------------------------------
Financing activities:
Dividends paid to
shareholders (138.0) 59.1 (78.9) (27.8) 52.5 (54.2)
Reduction of
intergroup notional
debt (33.8) (33.8) 33.8
Other financing
activities 277.8 277.8
- ------------------------------------------------------------------------------------------------
(138.0) 25.3 (112.7) 250.0 86.3 223.6
- ------------------------------------------------------------------------------------------------
Net change in cash 1.7 (0.1) 1.6 (49.1) (47.5)
Cash, beginning of
period 1.5 0.3 1.8 179.0 180.8
- ------------------------------------------------------------------------------------------------
Cash, end of period $ 3.2 $ 0.2 $ 3.4 $ 129.9 $ 133.3
================================================================================================
18
Loews and Carolina Group
Consolidating Condensed Statement of Cash Flows Information
Carolina Group Adjustments
Three Months Ended ---------------------------------- Loews and
March 31, 2003 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Net cash used by
operating
activities $ (56.5) $ (30.1) $ (86.6) $ (40.1) $ (59.4) $ (186.1)
- ------------------------------------------------------------------------------------------------
Investing activities:
Purchases of property
and equipment (7.2) (7.2) (169.9) (177.1)
Change in short-term
investments 234.0 0.3 234.3 1,036.3 1,270.6
Other investing
activities (625.5) (63.9) (689.4)
- ------------------------------------------------------------------------------------------------
226.8 0.3 227.1 240.9 (63.9) 404.1
- ------------------------------------------------------------------------------------------------
Financing activities:
Dividends paid to
shareholders (171.0) 93.8 (77.2) (27.9) 59.4 (45.7)
Reduction of
intergroup notional
debt (63.9) (63.9) 63.9
Other financing
activities (144.2) (144.2)
- ------------------------------------------------------------------------------------------------
(171.0) 29.9 (141.1) (172.1) 123.3 (189.9)
- ------------------------------------------------------------------------------------------------
Net change in cash (0.7) 0.1 (0.6) 28.7 28.1
Cash, beginning of
period 2.0 0.2 2.2 183.2 185.4
- ------------------------------------------------------------------------------------------------
Cash, end of period $ 1.3 $ 0.3 $ 1.6 $ 211.9 $ 213.5
================================================================================================
19
5. Reinsurance
CNA assumes and cedes reinsurance with other insurers, reinsurers and
members of various reinsurance pools and associations. CNA utilizes
reinsurance arrangements to limit its maximum loss, provide greater
diversification of risk, minimize exposures on larger risks and to exit
certain lines of business. 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.
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 investment income, was $50.0 and
$47.0 million for the three months ended March 31, 2004 and 2003. The amount
subject to interest crediting rates on such contracts was $2,732.0 and
$2,789.0 million at March 31, 2004 and December 31, 2003. 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 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.
Amounts receivable from reinsurers were $14,829.0 and $16,253.8 million at
March 31, 2004 and December 31, 2003. Of these amounts, $642.0 and $813.0
million were billed to reinsurers as of March 31, 2004 and December 31, 2003,
as reinsurance contracts generally require payment of claims by the ceding
company before the amount can be billed to the reinsurer. The remaining
receivable relates to the estimated case and IBNR reserves and future
policyholder benefits ceded under reinsurance contracts.
CNA has established an allowance for doubtful accounts to provide for
estimated uncollectible reinsurance receivables. The allowance for doubtful
accounts was $590.4 and $572.6 million at March 31, 2004 and December 31,
2003.
CNA attempts to mitigate its credit risk related to reinsurance by entering
into reinsurance arrangements only with reinsurers that have credit ratings
above certain levels and by obtaining substantial amounts of collateral. The
primary methods of obtaining collateral are through reinsurance trusts,
letters of credit and funds withheld balances.
20
The effects of reinsurance on earned premiums are shown in the following
table.
Assumed/
Direct Assumed Ceded Net Net%
------------------------------------------------------
Three Months Ended March 31, 2004
------------------------------------------------------
Property and casualty $2,643.0 $ 78.0 $ 863.0 $ 1,858.0 4.2%
Accident and health 342.0 16.0 155.0 203.0 7.9%
Life 240.0 134.0 106.0
------------------------------------------------------
Total earned premiums $3,225.0 $ 94.0 $1,152.0 $ 2,167.0 4.3%
======================================================
Three Months Ended March 31, 2003
------------------------------------------------------
Property and casualty $ 2,638.0 $ 161.0 $ 981.0 $ 1,818.0 8.9%
Accident and health 388.0 37.0 24.0 401.0 9.2
Life 258.0 5.0 102.0 161.0 3.1
------------------------------------------------------
Total earned premiums $ 3,284.0 $ 203.0 $1,107.0 $ 2,380.0 8.5%
======================================================
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. The aggregate limits under both sections of the Aggregate
Cover were fully utilized in 2003. Included in the pretax results of
operations for the three months ended March 31, 2004 and 2003 are $20.0 and
$13.0 million of interest charges from the aggregate cover.
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
21
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. During 2003, the
aggregate limits under the CCC Cover were fully utilized. Included in the
pretax results of operations for the three months ended March 31, 2004 and
2003 is $11.0 and $8.0 million of interest charges from the CCC Cover.
6. Receivables
March 31, December 31,
2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Reinsurance $14,829.0 $16,253.8
Other insurance 3,121.7 3,070.4
Security sales 1,132.8 890.7
Accrued investment income 318.8 343.3
Federal income taxes 391.6 517.4
Other 337.9 348.4
- -----------------------------------------------------------------------------------------------
Total 20,131.8 21,424.0
Less: Allowance for doubtful accounts on reinsurance receivables 590.4 572.6
Allowance for other doubtful accounts and cash discounts 397.5 383.5
- -----------------------------------------------------------------------------------------------
Receivables-net $19,143.9 $20,467.9
===============================================================================================
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. All of these
factors can affect the estimation of claim and claim adjustment expense
reserves.
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
the incidence of a loss and the payment or settlement of the claim, the more
variable the ultimate settlement amount can be. Accordingly, short-tail
claims, such as property damage claims, tend to be more reasonably estimable
than long-tail claims, such as general liability and professional liability
claims. Adjustments to prior year reserve estimates, if necessary, are
reflected in the results of operations in the period that the need for such
adjustments is determined.
22
Catastrophes are an inherent risk of the property and casualty insurance
business and have contributed to material period-to-period fluctuations in
CNA's results of operations and/or equity. The level of catastrophe losses
experienced in any period cannot be predicted and can be material to the
results of operations and/or equity of the Company.
Asbestos, Environmental Pollution and Mass Tort ("AMPT") 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; enactment of national
federal legislation to address asbestos claims; a further increase in asbestos
and environmental pollution claims which cannot now be anticipated; increase
in number of 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 payments that may
exhaust underlying umbrella and excess coverages at accelerated rates; and
future developments pertaining to CNA's ability to recover reinsurance for
asbestos and environmental pollution claims.
CNA has regularly performed ground up reviews of all open APMT claims to
evaluate the adequacy of CNA's APMT reserves. 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 predicted future
exposures, including such factors as claims volume, trial conditions, prior
settlement history, settlement demands and defense costs; the impact of
asbestos defendant bankruptcies on the policyholder; 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.
23
With respect to other court cases and how they might affect CNA's reserves
and reasonable possible losses, the following should be noted. State and
federal courts issue numerous decisions each year, which potentially impact
losses and reserves in both a favorable and unfavorable manner. Examples of
favorable developments include decisions to allocate defense and indemnity
payments in a manner so as to limit carriers' obligations to damages taking
place during the effective dates of their policies; decisions holding that
injuries occurring after asbestos operations are completed are subject to the
completed operations aggregate limits of the policies; and decisions ruling
that carriers' loss control inspections of their insured's premises do not
give rise to a duty to warn third parties to the dangers of asbestos. Examples
of unfavorable developments include decisions limiting the application of the
"absolute pollution" exclusion; and decisions holding carriers liable for
defense and indemnity of asbestos and pollution claims on a joint and several
basis.
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.
Due to the inherent uncertainties in estimating claim and claim adjustment
expense reserves for APMT 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, insurer financial strength and debt ratings and the Company's
results of operations and equity. 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.
March 31, 2004 December 31, 2003
- ------------------------------------------------------------------------------------------------
Environmental Environmental
Pollution and Pollution and
Asbestos Mass Tort Asbestos Mass Tort
- ------------------------------------------------------------------------------------------------
(In millions)
Gross reserves $ 3,262.0 $ 801.0 $ 3,347.0 $ 839.0
Ceded reserves (1,550.0) (260.0) (1,580.0) (262.0)
- ------------------------------------------------------------------------------------------------
Net reserves $ 1,712.0 $ 541.0 $ 1,767.0 $ 577.0
================================================================================================
24
Asbestos
CNA's property and casualty insurance subsidiaries have exposure to asbestos-
related claims. Estimation of asbestos-related claim and claim adjustment
expense reserves involve limitations such as inconsistency of court decisions,
specific policy provisions, allocation of liability among insurers and
insureds, and additional factors such as missing policies and proof of
coverage. Furthermore, estimation of asbestos-related claims is difficult due
to, among other reasons, the proliferation of bankruptcy proceedings and
attendant uncertainties, the targeting of a broader range of businesses and
entities as defendants, the uncertainty as to which other insureds may be
targeted in the future and the uncertainties inherent in predicting the number
of future claims.
As of March 31, 2004 and December 31, 2003, CNA carried approximately
$1,712.0 and $1,767.0 million of claim and claim adjustment expense reserves,
net of reinsurance recoverables for reported and unreported asbestos-related
claims. There was $9.0 million of unfavorable asbestos-related net claim and
claim adjustment expense reserve development for the three months ended March
31, 2004 and no asbestos-related net claim and claim adjustment expense
development for the same period in 2003. CNA paid asbestos-related claims, net
of reinsurance recoveries, of $64.0 and $39.0 million for the three months
ended March 31, 2004 and 2003.
Some asbestos-related defendants have asserted that their policies issued by
CNA 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 and/or equity.
Certain asbestos litigation in which CNA is currently engaged is 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 is
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 an injunction to protect
CNA from any future claims.
25
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 74,000 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.
26
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 Kanawha
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 policy
holders. 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 the carriers failed 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. The Montana direct action
is currently stayed as to CNA because of W.R. Grace's pending bankruptcy.
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 results of
operations and/or 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; the 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.
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
27
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 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 1,400 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 modify Superfund have been made by various parties.
However, no modifications were enacted by Congress during 2003 or in the first
quarter of 2004, 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 and/or equity.
As of March 31, 2004 and December 31, 2003, CNA carried approximately $541.0
and $577.0 million of claim and claim adjustment expense reserves, net of
reinsurance recoverables, for reported and unreported environmental pollution
and mass tort claims. There was no environmental pollution and mass tort net
claim and claim adjustment expense reserve development for the three months
ended March 31, 2004 and 2003. CNA paid environmental pollution-related claims
and mass tort-related claims, net of reinsurance recoveries, of $36.0 and
$25.0 million for the three months ended March 31, 2004 and 2003.
CNA has made resolution of large environmental pollution exposures a
management priority. CNA has resolved a number of its large environmental
accounts by negotiating 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 scope of the release provisions contained in those
settlement agreements should, in many cases, prevent future exposure from
settled policyholders. It remains uncertain, however, whether a court
28
interpreting the language of the settlement agreements will adhere to the
intent of the parties and uphold the broad scope of language of the
agreements.
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. Moreover, judicial interpretations regarding
application of various tort defenses, including application of various
theories of joint and several liability, impede CNA's ability to estimate its
ultimate liability for such claims.
Net Prior Year Development
Favorable net prior year development of $1.0 million, including $17.0
million of unfavorable claim and allocated claim adjustment expense reserve
development and $18.0 million of favorable premium development, was recorded
for the three months ended March 31, 2004. Unfavorable net prior year
development of $27.0 million, including $93.0 million of unfavorable claim and
allocated claim adjustment expense reserve development and $66.0 million of
favorable premium development, was recorded for the same period in 2003. The
gross carried claim and claim adjustment expense reserves for CNA were
$31,183.2 and $31,730.2 million at March 31, 2004 and December 31, 2003. The
net carried claim and claim adjustment expense reserves for CNA were $17,190.0
and $17,514.0 million at March 31, 2004 and December 31, 2003.
Unfavorable net prior year development of approximately $47.0 million was
recorded for the three months ended March 31, 2003, related to certain
programs written in Excess & Surplus ("E&S"). One E&S program, covering
facilities that provide services to developmentally disabled individuals,
accounted for approximately $10.0 million of the unfavorable net prior year
development. The unfavorable net prior year development was due to an increase
in the size of known claims and increases in policyholder defense costs. These
increases became apparent as the result of an actuarial review completed
during the first quarter of 2003, with most of the unfavorable net prior year
development from accident years 1999 and 2000. Another E&S program, which
accounts for approximately $25.0 million of E&S unfavorable net prior year
development, covers tow truck and ambulance operators in the 2000 and 2001
accident years. CNA 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 $12.0
million of unfavorable net prior year development was recorded during 2003
related to a specific large loss.
Partially offsetting the unfavorable net prior year development in E&S was
favorable net prior year development recorded in property lines during 2003.
The favorable net prior year development was principally from accident years
2001 and 2002 and was the result of the low number of large losses in recent
years.
29
8. Shareholders' Equity
March 31, December 31,
2004 2003
- -----------------------------------------------------------------------------------------------
(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 - 185,486,300 and 185,447,050 shares $ 185.5 $ 185.4
Carolina Group stock, $0.01 par value:
Authorized - 600,000,000 shares
Issued - 58,306,750 and 58,305,000 shares 0.6 0.6
Additional paid-in capital 1,514.4 1,513.7
Earnings retained in the business 8,591.5 8,602.1
Accumulated other comprehensive income 837.5 760.2
- -----------------------------------------------------------------------------------------------
11,129.5 11,062.0
Less treasury stock, at cost (340,000 shares of Carolina Group stock) 7.7 7.7
- -----------------------------------------------------------------------------------------------
Total shareholders' equity $11,121.8 $11,054.3
===============================================================================================
9. Significant Transactions
Texas Gas Transmission, LLC
As previously discussed in the Company's 2003 Annual Report on Form 10-K/A,
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 following unaudited pro forma financial information is presented as if
Texas Gas had been acquired as of January 1, 2003. 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.
30
Three Months Ended
March 31, 2003
- ------------------------------------------------------------------------------
(In millions, except per share data)
Total revenues $ 4,031.6
Income from continuing operations 219.4
Net income 219.1
Income per share of Loews common stock:
Income from continuing operations 1.03
Net income 1.03
==============================================================================
The pro forma information does not necessarily reflect the actual results
that would have occurred had the companies been combined during the period
presented, nor is it necessarily indicative of future results of operations.
Personal Insurance Transaction
As part of the sale of CNA's personal insurance business to The Allstate
Corporation on October 1, 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's remaining obligation with respect to
indemnity and allocated claim adjustment expense reserves, valued as of
October 1, 2003, was settled in March of 2004 and the sharing agreement was
terminated. This settlement did not have a material impact on the Company's
results of operations for the three months ended March 31, 2004.
10. Statutory Accounting Practices
CNA's insurance subsidiaries maintain their accounts in conformity with
accounting practices prescribed or permitted by state insurance regulatory
authorities which vary in certain respects from GAAP. In converting from
statutory to GAAP, typical adjustments include deferral of policy acquisition
costs and the inclusion of net realized holding gains or losses in
shareholders' equity relating to fixed maturity securities. The National
Association of Insurance Commissioners ("NAIC") developed a codified version
of statutory accounting principles, designed to foster more consistency among
the states for accounting guidelines and reporting.
Combined statutory capital and surplus and net income (loss), determined in
accordance with accounting practices prescribed or permitted by insurance
regulatory authorities for the property and casualty and the life and group
insurance subsidiaries, were as follows.
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.
31
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 March 31, 2004, CCC is in a negative earned surplus position.
Until CCC is in a positive earned surplus position, all dividends require
prior approval of the Department. In January of 2004, the Department approved
extraordinary dividend capacity in the amount of approximately $312.0 million
to be used to fund CNA's 2004 debt service and principal repayment
requirements.
Statutory Net Income (Loss) (a)
Statutory Capital and Surplus -------------------------------
------------------------------ Three Months Ended March 31,
March 31, December 31, --------------------------------
Unaudited 2004 2003 2004 2003
- ------------------------------------------------------------ --------------------------------
(In millions)
Property and
casualty companies $ 6,606.0 $ 6,170.0 $ 176.0 $ 59.0
Life insurance
companies 719.0 707.0 303.0 (91.0)
- ------------------------------------------------------------------------------------------------
(a) Statutory net income (loss) includes the life insurance subsidiaries in 2004, and the life
and group insurance subsidiaries in 2003.
11. Benefit Plans
Pension Plans - The Company has several non-contributory defined benefit
plans for eligible employees. The benefits for certain plans which cover
salaried employees and certain union employees are based on formulas which
include, among others, years of service and average pay. The benefits for one
plan which covers union workers under various union contracts and certain
salaried employees are based on years of service multiplied by a stated
amount. Benefits for another plan are determined annually based on a specified
percentage of annual earnings (based on the participant's age) and a specified
interest rate (which is established annually for all participants) applied to
accrued balances.
The Company's funding policy is to make contributions in accordance with
applicable governmental regulatory requirements. The assets of the plans are
invested primarily in interest-bearing obligations.
Other Postretirement Benefit Plans - The Company has several postretirement
benefit plans covering eligible employees and retirees. Participants generally
become eligible after reaching age 55 with required years of service. Actual
requirements for coverage vary by plan. Benefits for retirees who were covered
by bargaining units vary by each unit and contract. Benefits for certain
retirees are in the form of a Company health care account.
Benefits for retirees reaching age 65 are generally integrated with
Medicare. Other retirees, based on plan provisions, must use Medicare as their
primary coverage, with the Company reimbursing a portion of the unpaid amount;
or are reimbursed for the Medicare Part B premium or have no Company coverage.
The benefits provided by the Company are basically health and, for certain
retirees, life insurance type benefits.
32
The Company does not fund any of these benefit plans and accrues
postretirement benefits during the active service of those employees who would
become eligible for such benefits when they retire.
Net periodic benefit cost components:
Pension Benefits Other Postretirement Benefits
---------------------------------------------------
Three Months Ended March 31 2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Service cost $ 15.0 $ 13.2 $ 3.7 $ 3.2
Interest cost 60.2 51.6 11.0 9.5
Expected return on plan assets (64.4) (54.2) (1.3) (0.8)
Amortization of unrecognized
net loss (gain) 0.7 0.4 (0.2) (0.9)
Amortization of unrecognized prior
service cost 1.9 2.3 (5.4) (4.5)
Actuarial loss 6.7 1.6 1.6 1.0
- ------------------------------------------------------------------------------------------------
Net periodic benefit cost $ 20.1 $ 14.9 $ 9.4 $ 7.5
================================================================================================
12. Business Segments
The Company's reportable segments are primarily 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.
As a result of CNA's decision to focus on property and casualty operations
and to exit certain businesses, the Company revised its reportable segment
structure to reflect changes in CNA's core operations and how it makes
business decisions. CNA now manages its property and casualty operations in
two operating segments which represent CNA's core operations: Standard Lines
and Specialty Lines. The non-core operations are now managed in Life and Group
Non-Core Segment and Other Insurance Segment. Standard Lines includes standard
property and casualty coverages sold to small and middle market commercial
businesses primarily through an independent agency distribution system, and
excess and surplus lines, as well as insurance and risk management products
sold to large corporations in the U.S. and globally. Specialty Lines provides
professional, financial and specialty property and casualty products and
services. Life and Group Non-Core primarily includes the results of the life
and group lines of business sold or placed in run-off. This segment includes
the results of the individual life business which is to be sold. Other
Insurance primarily includes the results of certain property and casualty
lines of business placed in run-off, including CNA Re. This segment also
includes the results related to the centralized adjusting and settlement of
APMT claims as well as the results of CNA's participation in voluntary
insurance pools, which are primarily in run-off, and various other non-
insurance operations. Prior period segment disclosures have been conformed to
the current year presentation.
33
The changes made to the Company's reportable segments were as follows: 1)
Standard Lines and Specialty Lines (formerly included in the Property and
Casualty segment) are now reported as separate individual segments; 2) CNA
Global (formerly included in Specialty Lines) which consists of marine and
global standard lines is now included in Standard Lines; 3) CNA Guaranty and
Credit (formerly included in Specialty Lines) is currently in run-off and is
now included in the Other Insurance segment; 4) CNA Re (formerly included in
the Propety and Casualty segment) is currently in run-off and is also now
included in the Other Insurance segment; 5) Group Operations and Life
Operations (formerly separate reportable segments) have now been combined into
one reportable segment where the run-off of the retained group and life
products will be managed; 6) certain run-off life and group operations
formerly included in the Other Insurance segment are now included in the Life
and Group Non-Core segment.
In addition, the operations of Bulova were formerly reported in its own
operating segment and are now included in the Corporate and other segment.
Lorillard is engaged in the production and sale of cigarettes with its
principal products 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 20 hotels, 18 of which are in the United
States and two are in Canada.
Diamond Offshore's business primarily consists of operating 45 offshore
drilling rigs that are chartered on a contract basis for fixed terms by
companies engaged in exploration and production of hydrocarbons. Offshore rigs
are mobile units that can be relocated based on market demand.
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 Corporate and other segment consists primarily of investment income,
including investment gains (losses) from non-insurance subsidiaries, as well
as the operations of Bulova Corporation which distributes and sells watches
and clocks, equity earnings from shipping operations, corporate interest
expenses and other corporate administrative costs.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies. 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.
34
The following tables set forth the Company's consolidated revenues and
income by business segment:
Three Months Ended
March 31,
- ------------------------------------------------------------------------------------------------
2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues (a):
CNA Financial:
Standard Lines $ 1,492.7 $ 1,426.2
Specialty Lines 636.7 497.7
Life and Group Non-core 7.9 725.7
Other Insurance 130.3 195.9
- ------------------------------------------------------------------------------------------------
Total CNA Financial 2,267.6 2,845.5
Lorillard 775.7 851.9
Loews Hotels 80.7 73.0
Diamond Offshore 185.9 152.0
Texas Gas 86.0
Corporate and other 95.3 23.4
- ------------------------------------------------------------------------------------------------
Total $ 3,491.2 $ 3,945.8
================================================================================================
Pretax income (loss)(a):
CNA Financial:
Standard Line $ 206.6 $ 57.0
Specialty Lines 133.4 76.8
Life and Group Non-core (534.3) (61.6)
Other Insurance 28.4 35.8
- ------------------------------------------------------------------------------------------------
Total CNA Financial (165.9) 108.0
Lorillard 208.8 251.0
Loews Hotels 11.3 8.5
Diamond Offshore (16.1) (28.8)
Texas Gas 43.1
Corporate and other (3.0) (56.3)
- ------------------------------------------------------------------------------------------------
Total $ 78.2 $ 282.4
================================================================================================
Net income (loss)(a):
CNA Financial:
Standard Lines $ 138.3 $ 41.9
Specialty Lines 80.5 44.7
Life and Group Non-core (346.4) (34.9)
Other Insurance 19.6 27.8
- ------------------------------------------------------------------------------------------------
Total CNA Financial (108.0) 79.5
Lorillard 127.4 153.3
Loews Hotels 6.9 5.4
Diamond Offshore (6.9) (12.1)
Texas Gas 26.0
Corporate and other (1.8) (35.8)
- ------------------------------------------------------------------------------------------------
Income from continuing operations 43.6 190.3
Discontinued operations-net (0.3)
- -----------------------------------------------------------------------------------------------
Total $ 43.6 $ 190.0
===============================================================================================
(a) Investment gains (losses) included in Revenues, Pretax income (loss) and
Net income (loss) are as follows:
35
Three Months Ended
March 31,
- ------------------------------------------------------------------------------------------------
2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues and pretax income (loss):
CNA Financial:
Standard Lines $ 56.9 $ 7.0
Specialty Lines 20.3 2.9
Life and Group Non-core (558.4) (104.4)
Other Insurance 26.2 18.4
- ------------------------------------------------------------------------------------------------
Total CNA Financial (455.0) (76.1)
Corporate and other 38.8 (19.5)
- ------------------------------------------------------------------------------------------------
Total $(416.2) $ (95.6)
================================================================================================
Net income (loss):
CNA Financial:
Standard Lines $ 34.2 $ 2.2
Specialty Lines 11.9 1.2
Life and Group Non-core (363.9) (61.1)
Other Insurance 15.6 13.8
- ------------------------------------------------------------------------------------------------
Total CNA Financial (302.2) (43.9)
Corporate and other 25.2 (12.7)
- ------------------------------------------------------------------------------------------------
Total $(277.0) $ (56.6)
================================================================================================
13. 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.
Some of these premiums were received from John Hancock Financial Services,
Inc. ("John Hancock"). CNA is aware that a number of reinsurers with workers
36
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 CNA, 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
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 are purported class actions on behalf of present and former 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. CNA has denied the material allegations of the amended
complaint and intends to vigorously contest the claims. Based on facts and
circumstances presently known in the opinion of management, an unfavorable
outcome would not materially adversely affect the equity of CNA, although
results of operations may be adversely affected.
Voluntary Market Premium Litigation
CNA, along with dozens of other insurance companies, is a defendant in
twelve cases, including eleven purported class actions, brought by large
policyholders which generally allege that the 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. In one federal court case, 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
37
decision by the District Court for the Southern District of Texas certifying a
multi-state class. CNA intends to vigorously contest these claims. Based on
facts and circumstances presently known in the opinion of management an
unfavorable outcome will not materially affect the equity of CNA, although
results of operations may be adversely affected.
See Note 7 for information with respect to claims and litigation involving
CNA related to environmental pollution, asbestos and mass torts.
Non-Insurance
TOBACCO RELATED
Tobacco Related Product Liability Litigation
Approximately 4,250 product liability cases are pending against cigarette
manufacturers in the United States. Lorillard is a defendant in approximately
3,825 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 1,450 cases are pending, including
approximately 1,075 cases against Lorillard. The 1,450 cases include
approximately 1,000 cases pending in a single West Virginia court that have
been consolidated for trial. Lorillard is a defendant in nearly 925 of the
approximately 1,000 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 2,725 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. Twelve 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.
"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. Lorillard is a
defendant in 12 of the 14 pending Reimbursement cases. Lorillard and the
Company also are named as defendants in a case pending in Israel.
"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 six pending Contribution cases.
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Excluding the flight attendant and the consolidated West Virginia suits,
approximately 500 product liability cases are pending against U.S. cigarette
manufacturers. Lorillard is a defendant in approximately 175 of the 500 cases.
The Company, which is not a defendant in any of the flight attendant or the
consolidated West Virginia matters, is a defendant in six 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.
CONVENTIONAL PRODUCT LIABILITY CASES ?- Approximately 1,450 cases are pending
in the United States, including approximately 1,075 cases against Lorillard.
The 1,450 cases include approximately 1,000 cases pending in a single West
Virginia court that have been consolidated for trial. Lorillard is a defendant
in nearly 925 of the approximately 1,000 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.
One of the states in which cases are pending against Lorillard is
Mississippi. During 2003, the Mississippi Supreme Court ruled that the
Mississippi Product Liability Act "precludes all tobacco cases that are based
on products liability." Based on this ruling, Lorillard is seeking, or intends
to seek, dismissal of each of the approximately 40 cases pending against it in
Mississippi.
Since January 1, 2002, verdicts have been returned in 20 matters. Lorillard
was not a defendant in any of these cases. Defense verdicts were returned in
12 of the cases. In a thirteenth case, the court determined that the jury's
verdict in favor of the plaintiffs was not supported by the evidence and it
entered judgment in the defendant's favor. This ruling was affirmed on appeal.
As of April 23, 2004, appeals were pending in twelve cases in which verdicts
had been returned in favor of the plaintiffs. In one additional case, all
post-verdict issues had not been resolved by April 23, 2004, and the case
remains before the trial court. In another matter, as discussed in the
paragraph above, a jury's verdict in favor of the plaintiffs was overruled by
the trial court as it was not supported by the evidence, and the court of
appeals has affirmed the judgment that was entered in favor of the defendant
following trial. Neither the Company nor Lorillard were defendants in any of
these cases. These 14 cases, and the verdict amounts, are below:
Frankson v. Brown & Williamson Tobacco Corporation, et al. (Supreme Court,
New York County, New York). During December of 2003, plaintiff was awarded
$350,000 in actual damages. The jury also determined that the decedent was 50%
contributorily negligent, which is expected to reduce the award to $175,000,
although plaintiff has filed a motion requesting that the award be increased
above the amount awarded by the jury. The jury also found in its December of
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2003 verdict that defendants' conduct permitted an award of punitive damages.
During January of 2004, plaintiff was awarded $20.0 million in punitive
damages. As of April 23, 2004, the court had not ruled on the parties post-
trial motions and a final judgment had not been entered.
Thompson v. Brown & Williamson Tobacco Corporation, et al. (Circuit Court,
Jackson County, Missouri). During November of 2003, the jury awarded actual
damages and damages for loss of consortium to the plaintiffs and did not award
punitive damages. The final judgment entered by the court reflects the jury's
findings that the smoker was 50% contributorily negligent and, as a result,
awarded the plaintiffs $1.1 million in damages. Defendants have appealed.
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. 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 and subsequently denied plaintiffs' motion for rehearing.
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
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 pursued simultaneous
appeals to the Florida Supreme Court and the U.S. Supreme Court. During
January of 2004, the U.S. Supreme Court denied R.J. Reynolds' petition for
writ of certiorari. During April of 2004, the Florida Supreme Court denied
R.J. Reynolds' other petition.
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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. During April of 2004, the California Court of Appeal reversed
the judgment and remanded the case for a new trial. Plaintiffs have sought
rehearing of this decision.
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. The California Supreme Court has agreed to review the case.
Defense verdicts have been returned in the following twelve matters since
January 1, 2002. Neither Lorillard nor the Company are defendants in any of
these cases. As of April 23, 2004, either appeals were pending or all post-
verdict activity had not been concluded in four of these cases.
Longden v. Philip Morris USA, Inc. (Hillsborough Superior Court, Northern
District, New Hampshire). During November of 2003, the jury returned a verdict
in favor of the defendant. As of April 23, 2004, the court had not ruled on
plaintiff's motion to set aside the verdict and for new trial.
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 appealed.
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. The jury did not reach a
verdict as to one of the claims that was submitted to it. Trial of that claim
has been scheduled for January of 2005. A judgment reflecting the July of 2003
verdict will not be entered until the remaining claim is resolved.
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Carter v. Philip Morris USA (Court of Common Pleas, Philadelphia County,
Pennsylvania). A defense verdict was returned during January of 2003.
Plaintiff has appealed.
In eight cases in which defendants prevailed at trial after January 1, 2002,
plaintiffs either chose not to appeal or have withdrawn their appeals and the
cases are concluded. These eight matters and the dates of the verdicts are
Hall v. R.J. Reynolds Tobacco Company, et al. (Circuit Court, Hillsborough
County, Florida, December of 2003); Welch v. Brown & Williamson Tobacco
Corporation, et al. (Circuit Court, Jackson County, Missouri, June of 2003);
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);
Lucier v. Philip Morris USA, et al. (Superior Court, Sacramento County,
California, 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); and Hyde v. Philip Morris Incorporated (U.S. District Court, Rhode
Island, March of 2002). Lorillard was not a defendant in any of these eight
matters.
In addition to the cases listed above, one case was pending on appeal
against Lorillard from a verdict that was returned in favor of the defendants
before 2002:
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. During March of 2004, the U.S.
Court of Appeals for the Sixth Circuit rejected plaintiff's appeal and
affirmed the verdict. As of April 23, 2004, the time for plaintiff to seek
further review of the verdict had not expired.
As of April 23, 2004, trial was proceeding in one Conventional Product
Liability case in the United States. Neither Lorillard nor the Company are
defendants in this matter. Some cases against U.S. cigarette manufacturers and
manufacturers of smokeless tobacco products are scheduled for trial during
2004 and beyond. As of April 23, 2004, Lorillard is a defendant in three cases
scheduled for trial during 2004. A trial involving the approximately 1,000
consolidated cases pending against Lorillard and the other major tobacco
companies in the Circuit Court of Ohio County, West Virginia, is scheduled for
March 21, 2005. As of April 23, 2004, the Company is not a defendant in any of
the cases scheduled for trial during 2004. The trial dates are subject to
change.
FLIGHT ATTENDANT CASES - As of April 23, 2004, approximately 2,725 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 April 23, 2004, 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
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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.
Lorillard has been a defendant in each of the six flight attendant cases in
which verdicts have been returned. In one of the six trials, 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
trials. In one of them, the court granted plaintiff's motion for new trial and
defendants have appealed. Both of the cases tried during 2003 ended in defense
verdicts. Plaintiffs did not appeal either of the cases tried during 2003.
As of April 23, 2004, one flight attendant case was scheduled for trial
during 2004. Trial dates are subject to change.
CLASS ACTION CASES - Lorillard is a defendant in 12 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 34 cases, 13 of which were in state court
and 21 of which were in federal court. These 34 cases were filed in 17 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. Motions
for class certification have also been ruled upon in some of the "lights"
cases or in other class actions to which Lorillard was not a party. In some of
these cases, courts have denied class certification to the plaintiffs, while
classes have been certified in other matters.
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). 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. During 2000, a
jury awarded approximately $16.3 billion in 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
April 23, 2004, 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
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appellate options available to them as they could seek review of the case by
the U.S. Supreme Court. The Company and Lorillard believe that the appeals
court's decision should be upheld upon further appeals.
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
terminate and the class would be free to challenge the Florida legislation. As
of March 31, 2004, Lorillard, Inc. had a balance sheet net worth of
approximately $1.2 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.
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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.
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 and were exposed to
defendants' marketing and advertising activities in California. 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
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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. The trial is proceeding in phases. In its phase one
verdict, which was returned in July of 2003, 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 found in favor of the class as to certain claims, including whether
defendants failed to disclose the addictiveness of nicotine, whether
defendants marketed to children, and whether smoking cessation methods and
aids exist that would assist smokers in quitting. The second phase began in
March of 2004 and was continuing as of April 23, 2004. In this phase of the
trial the jury will determine the scope, administration and cost of a
statewide smoking cessation program and award an amount sufficient to fund
such a program. Plaintiffs are seeking a $1.2 billion court-supervised fund to
pay for a 25-year program. The Defendants dispute plaintiffs' proposed scope
and cost. If the second phase verdict results in an award of damages to the
certified class, Lorillard intends to pursue an appeal.
As discussed 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 - Although the cases settled by the State Settlement
Agreements, as described below, are concluded, certain matters are pending
against cigarette manufacturers. The pending cases include Reimbursement cases
on file in U.S. courts, a Reimbursement case on file in Israel, and cases
challenging the State Settlement Agreements. Lorillard is a defendant in 14
pending Reimbursement cases in the U.S. and has been named as a party to the
case in Israel. The Company is a defendant in two of the pending U.S. cases
and also has been named as a party to the case in Israel. Additional cases are
pending against other cigarette manufacturers. 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,
46
American Indian tribes, hospitals or hospital districts, private companies and
private citizens. Plaintiffs in some of these cases seek certification as
class actions.
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 court
filing, the government stated that it is seeking an aggregate of $280.0
billion in disgorgement of profits from the defendants, including Lorillard,
as well as injunctive relief. Trial of this matter is scheduled to begin
during September of 2004.
Reimbursement Cases filed by Foreign Governments in U.S. Courts - As of
April 23, 2004, 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, 2002, none of the Reimbursement cases have 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 the amount 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 jury's findings in favor of the defendants precluded any
award of punitive damages. 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.
During September of 2003, the Second Circuit reversed the portion of the
judgment addressing plaintiff's Subrogation claim but it certified questions
to the New York Court of Appeals in order to assist it in ruling on issues of
New York law concerning plaintiff's Direct claim. The New York Court of
Appeals has accepted the certified questions. In its September of 2003 order,
the Second Circuit deferred ruling on the appeal of the attorney's fees award
until the certified questions are resolved.
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
separately moved to set aside the order that permitted service outside the
47
jurisdiction. As of April 23, 2004, 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 $201.1 and $197.5 million ($122.7 and
$120.7 million after taxes), for the three months ended March 31, 2004 and
2003, 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: $8.4
billion through 2007 and $9.4 billion thereafter. 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
up to $125.0 million in each year beginning 2004 through 2008. 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.
From time to time, lawsuits have been brought against Lorillard and other
participating manufacturers to the MSA, or against one or more of the states,
challenging the validity of that agreement on certain grounds, including as a
violation of the antitrust laws. While Lorillard is not a party to any such
pending matter, Lorillard understands that such cases are proceeding against
other defendants.
In addition, in connection with the Master Settlement Agreement, the
Original Participating Manufacturers entered into 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
allocated among the Original Participating Manufacturers generally according
to their relative domestic market share. Of the total $5.2 billion, a total of
48
$2.0 billion has been paid since 1999 through March 31, 2004, $178.3 million
of which has been paid by Lorillard. Lorillard estimates its remaining
payments under the agreement will total approximately $800 - $850 million. All
payments will be adjusted for inflation, changes in the unit volume of
domestic cigarette shipments, and the effect of 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.
CONTRIBUTION CLAIMS - Plaintiffs seek recovery of funds paid by them to
individuals whose asbestos disease or illness was alleged to have been caused
in whole or in part by smoking-related illnesses. Six such cases are pending
against Lorillard. The Company is not a defendant in any of these cases.
FILTER CASES - In addition to the above, 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 60 such
matters are pending against Lorillard. The Company is a defendant in one of
these matters. Since January 1, 2002 and through April 23, 2004, Lorillard has
paid, or has reached agreement to pay, a total of approximately $12.5 million
in payments of judgments and settlements to finally resolve approximately 30
previously pending claims. In Sachs v. Lorillard Tobacco Co., the only filter
case tried to a verdict since January 1, 2002, the jury found in favor of
Lorillard. Trial dates are scheduled in some of the pending cases. As of April
23, 2004, trial of the case in which the Company is a defendant was scheduled
to begin during August of 2004. Trial dates are subject to change.
Other Tobacco - Related
TOBACCO - RELATED ANTITRUST CASES -
Indirect Purchaser Suits - Approximately 30 suits were filed in various state
courts alleging violations of state antitrust laws which permit indirect
purchasers, such as retailers and consumers, to sue under price fixing or
consumer fraud statutes. Approximately 18 states permit such suits. Lorillard
is a defendant in all but one of these indirect purchaser cases. Three
indirect purchaser suits in New York, Florida and Michigan, were dismissed in
their entirety and plaintiffs have withdrawn their appeals. Since November 30,
2003, the state court indirect purchaser price-fixing actions in the following
states have been voluntarily dismissed: Nevada, Minnesota, District of
Columbia, South Dakota, Michigan, Maine, West Virginia, North Dakota and
Arizona. Motions to approve stipulated orders of dismissal in all of the
remaining actions, except for New Mexico and Kansas, are pending. A decision
granting class 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. 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.
49
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, settled the
litigation and the settlement for Lorillard and all but one other defendant
was approved by the court on October 1, 2003. Pursuant to the settlement
agreement, Lorillard has paid $27.5 million. 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.
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. Lorillard was
named as a defendant in a fourth case, which was filed during 2004. These four
cases are pending in the U.S. District Court for the Northern District of
Illinois as a result of a multi-district litigation proceeding. 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. During 2004, the court granted
defendants' motions to dismiss the three cases filed during 2002. As of April
23, 2004, plaintiffs in two of these three suits have amended their
complaints. Plaintiffs in the third case have appealed the dismissal order.
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. Plaintiffs have prevailed in several cases, as noted above. It
is possible that one or more of the pending actions could be decided
unfavorably as to Lorillard or the other defendants. 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
50
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 or settlement 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 and/or equity.
14. Commitments and 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 in
question 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 March
31, 2004.
CNA has provided parent company guarantees, which expire in 2015, related to
lease obligations of certain subsidiaries. Certain of those subsidiaries have
been sold; however, the lease obligation guarantees remain in effect. CNA
would be required to remit prompt payment on leases in question if the primary
obligor fails to observe and perform its covenants under the lease agreements.
The maximum potential amount of future payments that CNA could be required to
pay under these guarantees is approximately $8.0 million at March 31, 2004.
CCC and CAC are parties to a corporate guarantee whereby CCC agrees to cause
CAC to have sufficient cash for the timely payment of claims under certain
insurance policies or contracts issued by CAC so long as CAC is owned directly
or indirectly by CNA.
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 March 31, 2004 that CNA
could be required to pay under this guarantee is approximately $323.0 million.
51
If CNA were required to assume the entire lease obligation, CNA would have the
right to pursue reimbursement from the other shareholders and would have the
right to all sublease revenues.
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 March 31, 2004.
In the 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 March 31, 2004, the aggregate amount of quantifiable
indemnification agreements in effect for sales of business entities and assets
was $580.0 million.
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 March 31, 2004,
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. CNA has recorded
approximately $21.0 and $16.0 million of other liabilities related to these
indemnification agreements as of March 31, 2004 and December 31, 2003.
Other
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 March 31, 2004 and December 31, 2003, there were
approximately $58.0 million of outstanding letters of credit.
The Company is obligated to make future payments totaling $397.1 million for
non-cancelable operating leases expiring from 2004 through 2014 primarily for
office space and data processing, office and transportation equipment.
Estimated future minimum payments under these contracts are as follows: $47.1
million in 2004; $60.7 million in 2005; $52.0 million in 2006; $43.6 million
in 2007; and $193.7 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 $18.0 million.
Estimated future minimum payments under these contracts are as follows: $13.0
million in 2004 and $5.0 million in 2005.
As of March 31, 2004 and December 31, 2003, CNA had committed approximately
$137.0 and $154.0 million for future capital calls from various third-party
limited partnership investments in exchange for an ownership interest in the
related partnership.
52
The Company 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
March 31, 2004, the Company had commitments to purchase $278.8 million and
commitments to sell $36.2 million of various bank loan participations.
In the normal course of investing activities, CCC had committed
approximately $51.0 million as of March 31, 2004 to future capital calls from
certain of its unconsolidated affiliates in exchange for an ownership interest
in such affiliates.
CNA Surety
CNA has entered into a credit agreement with a large national contractor
that undertakes projects for the construction of government and private
facilities to provide an $86.4 million credit facility. CNA Surety, a 64%
owned and consolidated subsidiary of CNA, 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. The credit facility and all loans under
it will mature in March of 2006. Advances under the credit facility bear
interest 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 affiliates.
Loews and CNA have entered into a participation agreement, pursuant to which
Loews has purchased a participation interest in one-third of the loans and
commitments under the credit facility, on a dollar-for-dollar basis, up to a
maximum of $25.0 million. Although Loews does not have rights against the
contractor directly under the participation agreement, it shares recoveries
and certain fees under the facility proportionally with CNA.
In March of 2003, CNA purchased the contractor's outstanding bank debt for
$16.4 million. The contractor purchased the bank debt and retired it, with
$11.4 million of the purchase price 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 is also required to reimburse
the banks for any draws upon outstanding letters of credit issued by the banks
for the contractor's benefit. Of these letters of credit, a replacement due to
expire in August of 2004 remains in the amount of $3.4 million. Any CNA
reimbursements for draws upon the banks' letters of credit will become
obligations of the contractor to CNA as draws upon the credit facility. As of
March 31, 2004, the aggregate amount of outstanding principal and accrued
interest under the credit facility was $90.0 million.
As of March 31, 2004, the credit facility was amended to provide for
calculating the amount available for borrowing without regard to approximately
$1.1 million representing accrued interest on a bridge loan provided by CNA
that became a borrowing under the facility; the elimination of a reduction in
CNA's commitment upon receipt by the contractor of certain claim proceeds; and
an increase in the monthly compensation limits for the contractor's
principals. In connection with the amendment, the principals and an affiliate
contributed $5.0 million in the aggregate to the contractor's capital by
forgiving certain of the contractor's indebtedness.
The contractor has initiated a restructuring plan that is intended to reduce
costs and improve cash flow, and a chief restructuring officer has been
53
appointed to manage execution of the plan. 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 to CNA Surety arising from bonds
issued to the contractor or assumed are excluded from CNA Surety's $40.0
million excess of $20.0 million per principal reinsurance program with
unaffiliated reinsurers in place in 2002. 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 100.0% of losses above that
retention level. Through facultative reinsurance contracts with CCC, CNA
Surety's exposure on bonds written from October 1, 2002 through October 31,
2003 has been limited to $20.0 million per bond. For bonds written subsequent
to November 1, 2003, CNA Surety's exposure is limited to $14.5 million per
bond subject to an aggregate limit of $150.0 million under all facultative
insurance coverage and two excess of loss treaties between CNA Surety and CCC.
Both excess of loss contracts are effective January 1, 2004. The first excess
of loss contract, $40.0 million excess of $60.0 million, provides CNA Surety
coverage exclusively for the national contractor, while the second excess of
loss contract, $50.0 million excess of $100.0 million, provides CNA Surety
with coverage for the national contractor as well as other CNA Surety risks.
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 may be successful and provide
sufficient cash flow for its operations, 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 the Company's results of operations. If such failures occur,
CNA estimates the surety loss, net of indemnification and subrogation
recoveries, but before the effects of minority interest could be up to $200.0
million. In addition, such failures could cause the full amount due under the
credit facility to be uncollectible.
CCC provided an excess of loss reinsurance contract to the insurance
subsidiaries of CNA Surety 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
24.0% 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 March 31, 2004 and December 31, 2003.
Effective October 1, 2002, CCC provided an excess of loss protection for new
and renewal bonds for CNA Surety for each 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.
Effective January 1, 2004, this contract was commuted and CCC paid CNA Surety
$11.0 million in return premium in the first quarter of 2004 based on
experience under the contract. Effective October 1, 2003, 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.
54
15. Consolidating Financial Information
The following schedules present the Company's consolidating balance sheet
information at March 31, 2004 and December 31, 2003, and consolidating
statements of operations information for the three months ended March 31, 2004
and 2003. 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, corporate long-term
debt and Bulova Corporation, a 97% owned subsidiary. 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.
55
Loews Corporation
Consolidating Balance Sheet Information
CNA Loews Diamond Texas Corporate
March 31, 2004 Financial Lorillard Hotels Offshore Gas and Other Eliminations Total
- ---------------------------------------------------------------------------------------------------------------------------------
(In millions)
Assets:
Investments $ 37,042.7 $ 1,128.7 $ 88.8 $ 735.6 $ 28.0 $ 3,112.8 $42,136.6
Cash 80.9 3.2 3.0 8.2 9.0 29.0 133.3
Receivables-net 18,902.2 20.9 27.4 149.4 54.1 116.3 $ (126.4) 19,143.9
Property, plant and equipment 211.6 229.3 363.8 2,274.9 698.0 48.9 3,826.5
Deferred income taxes 693.0 441.9 73.1 33.5 (642.0) 599.5
Goodwill 118.2 2.6 17.4 169.3 307.5
Investments in capital stocks
of subsidiaries 11,726.0 (11,726.0)
Other assets 2,083.7 411.8 103.6 72.8 181.0 392.6 (218.3) 3,027.2
Deferred acquisition costs
of insurance subsidiaries 1,345.2 1,345.2
Separate account business 745.0 745.0
Assets related to businesses held
for sale 6,291.1 6,291.1
- ---------------------------------------------------------------------------------------------------------------------------------
Total assets $ 67,513.6 $ 2,235.8 $ 589.2 $ 3,258.3 $ 1,212.5 $15,459.1 $(12,712.7) $77,555.8
=================================================================================================================================
Liabilities and Shareholders' Equity:
Insurance reserves $ 42,372.2 $42,372.2
Payable for securities purchased 1,785.8 $ 0.9 $ 124.9 $ 982.1 2,893.7
Securities sold under agreements
to repurchase 370.6 370.6
Long-term debt, less unamortized
discounts 1,898.2 146.0 927.1 $ 530.9 2,603.2 6,105.4
Reinsurance balances payable 3,328.7 3,328.7
Deferred income taxes 28.1 367.8 246.1 $ (642.0)
Other liabilities 2,100.7 $ 1,026.5 215.7 127.7 142.2 135.7 (266.1) 3,482.4
Separate account business 745.0 745.0
Liabilities related to businesses held
for sale 5,471.3 5,471.3
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities 58,072.5 1,026.5 390.7 1,547.5 673.1 3,967.1 (908.1) 64,769.3
Minority interest 898.5 760.9 5.3 1,664.7
Shareholders' equity 8,542.6 1,209.3 198.5 949.9 539.4 11,486.7 (11,804.6) 11,121.8
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $67,513.6 $ 2,235.8 $ 589.2 $ 3,258.3 $ 1,212.5 $15,459.1 $(12,712.7) $77,555.8
=================================================================================================================================
56
Loews Corporation
Consolidating Balance Sheet Information
CNA Loews Diamond Texas Corporate
December 31, 2003 Financial Lorillard Hotels Offshore Gas and Other Eliminations Total
- ---------------------------------------------------------------------------------------------------------------------------------
(In millions)
Assets:
Investments $ 38,121.5 $ 1,530.2 $ 81.4 $ 591.2 $ 15.2 $ 2,175.3 $ 42,514.8
Cash 139.0 1.5 2.0 19.1 3.9 15.3 180.8
Receivables-net 20,143.2 23.9 20.1 154.1 57.4 168.2 $ (99.0) 20,467.9
Property, plant and equipment 239.6 221.0 369.6 2,297.7 703.5 48.3 3,879.7
Deferred income taxes 646.5 441.9 88.1 21.5 (667.8) 530.2
Goodwill 118.7 2.6 20.8 169.3 311.4
Investments in capital stocks
of subsidiaries 11,402.5 (11,402.5)
Other assets 2,832.7 406.4 96.2 75.7 200.6 360.9 (187.1) 3,785.4
Deferred acquisition costs
of insurance subsidiaries 2,532.7 2,532.7
Separate account business 3,678.0 3,678.0
- ---------------------------------------------------------------------------------------------------------------------------------
Total assets $ 68,451.9 $ 2,624.9 $ 571.9 $3,158.6 $1,238.0 $14,192.0 $(12,356.4) $ 77,880.9
=================================================================================================================================
Liabilities and Shareholders' Equity:
Insurance reserves $ 45,384.0 $ 45,384.0
Payable for securities purchased 2,022.1 $ 1.1 $ 124.5 2,147.7
Securities sold under
agreements to repurchase 441.8 441.8
Long-term debt, less
unamortized discounts 1,903.6 146.5 $ 922.9 $ 548.1 2,299.1 5,820.2
Reinsurance balances payable 3,432.0 3,432.0
Deferred income taxes 75.9 370.1 221.8 $ (667.8)
Other liabilities 2,438.7 $ 1,405.0 172.0 134.5 166.5 142.5 (207.9) 4,251.3
Separate account business 3,678.0 3,678.0
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities 59,300.2 1,405.0 395.5 1,427.5 714.6 2,787.9 (875.7) 65,155.0
Minority interest 896.9 769.5 5.2 1,671.6
Shareholders' equity 8,254.8 1,219.9 176.4 961.6 523.4 11,398.9 (11,480.7) 11,054.3
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $ 68,451.9 $ 2,624.9 $ 571.9 $3,158.6 $1,238.0 $14,192.0 $(12,356.4) $ 77,880.9
=================================================================================================================================
57
Loews Corporation
Consolidating Statement of Operations Information
CNA Loews Diamond Texas Corporate
Three Months Ended March 31, 2004 Financial Lorillard Hotels Offshore Gas and Other Eliminations Total
- ---------------------------------------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $ 2,167.9 $ (0.9) $ 2,167.0
Investment income, net 473.1 $ 8.0 $ 0.5 $ 1.6 $ 12.1 (1.7) 493.6
Intercompany interest and dividends 152.4 (152.4)
Investment gains (losses) (455.0) 38.8 (416.2)
Manufactured products 767.9 40.3 808.2
Other 81.6 (0.2) 80.2 184.3 $ 86.0 6.7 438.6
- ---------------------------------------------------------------------------------------------------------------------------------
Total 2,267.6 775.7 80.7 185.9 86.0 250.3 (155.0) 3,491.2
- ---------------------------------------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 1,620.3 1,620.3
Amortization of deferred
acquisition costs 433.2 433.2
Cost of manufactured products sold 467.3 20.2 487.5
Other operating expenses 345.0 99.6 67.8 195.6 33.4 32.4 (0.9) 772.9
Interest 35.0 1.6 6.4 9.5 48.3 (1.7) 99.1
- ---------------------------------------------------------------------------------------------------------------------------------
Total 2,433.5 566.9 69.4 202.0 42.9 100.9 (2.6) 3,413.0
- ---------------------------------------------------------------------------------------------------------------------------------
(165.9) 208.8 11.3 (16.1) 43.1 149.4 (152.4) 78.2
- ---------------------------------------------------------------------------------------------------------------------------------
Income tax expense (benefit) (52.0) 81.4 4.4 (4.2) 17.1 (1.3) 45.4
Minority interest (5.9) (5.0) 0.1 (10.8)
- ---------------------------------------------------------------------------------------------------------------------------------
Total (57.9) 81.4 4.4 (9.2) 17.1 (1.2) 34.6
- ---------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ (108.0) $ 127.4 $ 6.9 $ (6.9) $ 26.0 $ 150.6 $ (152.4) $ 43.6
=================================================================================================================================
58
Loews Corporation
Consolidating Statement of Operations Information
CNA Loews Diamond Corporate
Three Months Ended March 31, 2003 Financial Lorillard Hotels Offshore and Other Eliminations Total
- ---------------------------------------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $ 2,381.1 $ (0.9) $ 2,380.2
Investment income, net 432.2 $ 7.9 $ 0.5 $ 4.2 $ 11.8 456.6
Intercompany interest and
dividends 8.8 (8.8)
Investment gains (losses) (76.1) 0.3 (0.1) (19.7) (95.6)
Manufactured products 844.2 39.8 884.0
Other 108.3 (0.2) 72.5 147.8 (7.8) 320.6
- ---------------------------------------------------------------------------------------------------------------------------------
Total 2,845.5 852.2 73.0 151.9 32.9 (9.7) 3,945.8
- ---------------------------------------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 1,869.8 1,869.8
Amortization of deferred
acquisition costs 458.2 458.2
Cost of manufactured
products sold 459.7 21.5 481.2
Other operating expenses 375.2 141.2 62.2 175.2 27.6 (0.9) 780.5
Interest 34.3 2.3 5.6 31.5 73.7
- ---------------------------------------------------------------------------------------------------------------------------------
Total 2,737.5 600.9 64.5 180.8 80.6 (0.9) 3,663.4
- ---------------------------------------------------------------------------------------------------------------------------------
108.0 251.3 8.5 (28.9) (47.7) (8.8) 282.4
- ---------------------------------------------------------------------------------------------------------------------------------
Income tax expense (benefit) 19.6 97.8 3.1 (6.8) (20.6) 93.1
Minority interest 8.9 (10.0) 0.1 (1.0)
- ---------------------------------------------------------------------------------------------------------------------------------
Total 28.5 97.8 3.1 (16.8) (20.5) 92.1
- ---------------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations 79.5 153.5 5.4 (12.1) (27.2) (8.8) 190.3
Discontinued operations-net (0.3) (0.3)
- ---------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 79.5 $ 153.5 $ 5.1 $ (12.1) $ (27.2) $ (8.8) $ 190.0
=================================================================================================================================
59
16. Assets and Liabilities Related to Businesses Held for Sale
In February of 2004, CNA entered into a definitive agreement to sell its
individual life insurance business to Swiss Re for approximately $700.0
million. The business sold includes term, universal and permanent life
insurance policies and individual annuity products. CNA's individual long term
care and structured settlement businesses are excluded from the sale.
Additionally, CNA's Nashville, Tennessee insurance servicing and
administration building will be acquired by Swiss Re as part of the sale. The
transaction which is subject to certain customary closing conditions, is
expected to be completed on April 30, 2004.
As a result of the pending sale, CNA has classified the assets and
liabilities of the individual life insurance business including the Nashville,
Tennessee, insurance servicing and administration building, as held for sale
at March 31, 2004. As required by SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," the book values of these assets and
liabilities are now reflected as Assets and Liabilities Related to Businesses
Held for Sale on the Consolidated Condensed Balance Sheet at March 31, 2004.
Upon classification of this asset group as held for sale, CNA performed an
assessment to determine whether there was any impairment. Based on the terms
of the sale agreement, the Company recorded an impairment charge of $565.9
million pretax to write-down the assets related to businesses held for sale to
their individual estimated fair values less costs to sell. This impairment
charge is recorded as Investment Losses on the Consolidated Condensed
Statements of Income for the three months ended March 31, 2004.
Additionally, in connection with CNA's decision to focus on its property and
casualty business, CNA has initiated a plan to sell CNA Trust, its limited
operations bank located in Costa Mesa, California, which provides full trustee
and pension third-party administrative services to the under 500 employer
market. Accordingly, the assets and liabilities related to CNA Trust have been
classified as "Assets Related to Businesses Held for Sale" and "Liabilities
Related to Businesses Held for Sale" on the Consolidated Condensed Balance
Sheet at March 31, 2004. The estimated fair value of the business less costs
to sell exceeds the carrying value of CNA Trust, and therefore no impairment
charge was recorded.
60
The following table provides the components of the assets and liabilities
related to businesses held for sale.
Individual CNA
March 31, 2004 Life Trust Total
- ------------------------------------------------------------------------------------------------
(In millions)
Investments
Fixed maturity securities, available-for-sale $ 3,509.0 $ 192.0 $ 3,701.0
Equity securities 13.0 13.0
Mortgage loans and other 172.0 172.0
Short-term investments, available-for-sale 221.0 13.0 234.0
- ------------------------------------------------------------------------------------------------
Total investments 3,915.0 205.0 4,120.0
- ------------------------------------------------------------------------------------------------
Cash 2.0 7.0 9.0
Reinsurance receivables 1,176.0 1,176.0
Accrued investment income 47.0 4.0 51.0
Deferred acquisition costs 502.0 502.0
Property & equipment 20.0 2.0 22.0
Separate account assets 411.0 411.0
- ------------------------------------------------------------------------------------------------
Total assets related to businesses held for sale $ 6,073.0 $ 218.0 $ 6,291.0
================================================================================================
Insurance reserves $ 4,600.0 $ 4,600.0
Reinsurance balances payable 32.0 32.0
Deferred income taxes 72.0 $ 3.0 75.0
Other liabilities 171.0 182.0 353.0
Separate account liabilities 411.0 411.0
- ------------------------------------------------------------------------------------------------
Total liabilities related to businesses held
for sale $ 5,286.0 $ 185.0 $ 5,471.0
================================================================================================
The assets and liabilities of the individual life business were $6.6 and
$5.4 billion at December 31, 2003. The revenues of the individual life
business were $158.0 and $160.0 million for the three months ended March 31,
2004 and 2003. The net income for this business was $8.2 million for the three
months ended March 31, 2004 and the net loss was $15.3 million for the three
months ended March 31, 2003.
The assets and liabilities of CNA Trust were $216.0 and $184.0 million at
December 31, 2003. The revenues of CNA Trust were $6.0 and $7.0 million for
the three months ended March 31, 2004 and 2003. Net income for this business
was $0.3 million for each of the three months ended March 31, 2004 and 2003.
17. Subsequent Events
On April 12, 2004, the Company redeemed its $300.0 million principal amount
7.625% notes due June 1, 2023 at a redemption price of 103.8125%. Proceeds
from the sale of $300.0 million principal amount of 5 1/4% senior notes due
March 15, 2016 were used to fund this redemption.
Hellespont Shipping Corporation ("Hellespont"), in which the Company holds a
49% common stock interest, has entered into agreements to sell each of its
four ultra-large crude oil tankers to Euronav Luxembourg SA. The sales, which
are subject to customary closing conditions, are scheduled to be consummated
61
in four separate closings during the second and third quarter of 2004.
Hellespont, an equity method investee, expects to record a gain on sale for
each of its four ultra-large crude oil tankers.
62
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
- ------------------------------------------------------------------------------
Management's discussion and analysis of financial condition and results of
operations is comprised of the following sections:
Page No.
--------
Overview 63
Consolidated Financial Results 64
CNA Recent Developments 65
Classes of Common Stock 66
Parent Company Structure 67
Critical Accounting Estimates 67
Results of Operations by Business Segment 70
CNA Financial 71
Reserves - Estimates and Uncertainties 71
Reinsurance 73
Terrorism Insurance 75
Restructuring 76
Non-GAAP Financial Measures 76
Standard Lines 79
Specialty Lines 80
Life and Group Non-core 81
Other Insurance 81
APMT Reserves 82
Lorillard 93
Results of Operations 93
Selected Market Share Data 95
Business Environment 96
Loews Hotels 98
Diamond Offshore 99
Texas Gas 100
Corporate and other 100
Liquidity and Capital Resources 101
CNA Financial 101
Lorillard 104
Loews Hotels 106
Diamond Offshore 106
Texas Gas 106
Majestic Shipping 107
Corporate and other 107
Investments 108
Accounting Standards 119
Forward-Looking Statements Disclaimer 120
OVERVIEW
Loews Corporation is a holding company. Its subsidiaries are engaged in the
following lines of business: property and casualty (CNA Financial Corporation
("CNA"), a 91% owned subsidiary); the production and sale of cigarettes
(Lorillard, Inc. ("Lorillard"), a wholly owned subsidiary); the operation of
63
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. The following discussion should be read in
conjunction with the Consolidated Condensed Financial Statements in Item 1 and
the Company's Annual Report on Form 10-K/A for the year ended December 31,
2003.
Consolidated Financial Results
The Company reported consolidated net income (including both the Loews Group
and Carolina Group) for the 2004 first quarter of $43.6 million, compared to
$190.0 million in the 2003 first quarter. Income before net investment losses
attributable to Loews common stock amounted to $286.2 million in the first
quarter of 2004 compared to $218.3 million in the comparable 2003 quarter. Net
income attributable to Loews common stock includes net investment losses of
$277.0 million (after tax and minority interest) due primarily to an
impairment loss of $368.3 million (after tax and minority interest) for CNA's
planned sale of its individual life insurance business, compared to net
investment losses of $56.6 million (after tax and minority interest) in the
comparable period of the prior year.
Net income and earnings per share information attributable to Loews common
stock and Carolina Group stock is summarized in the table below.
Three Months Ended March 31,
2004 2003
- ------------------------------------------------------------------------------------------------
(In millions, except per share data)
Net income attributable to Loews common stock:
Income before net investment losses $ 286.2 $218.3
Net investment losses (a) (277.0) (56.6)
- ------------------------------------------------------------------------------------------------
Income from continuing operations 9.2 161.7
Discontinued operations-net (0.3)
- ------------------------------------------------------------------------------------------------
Net income attributable to Loews common stock 9.2 161.4
Net income attributable to Carolina Group stock 34.4 28.6
- ------------------------------------------------------------------------------------------------
Consolidated net income $ 43.6 $190.0
================================================================================================
Net income per share:
Loews common stock $ 0.05 $ 0.87
Carolina Group stock 0.59 0.72
================================================================================================
(a) Includes an impairment loss of $368.3 (after tax and minority interest) in 2004 related to
CNA's planned sale of its individual life insurance business.
64
Net income attributable to Loews common stock for the first quarter of 2004
amounted to $9.2 million or $0.05 per share, compared to $161.4 million or
$0.87 per share in the comparable period of the prior year.
Net income attributable to Carolina Group stock for the first quarter of
2004 was $34.4 million or $0.59 per Carolina Group share, compared to $28.6
million, or $0.72 per Carolina Group share in the first quarter of 2003. The
Company is issuing a separate press release reporting the results of the
Carolina Group for the quarter ended March 31, 2004 and 2003.
Consolidated revenues in the first quarter of 2004 amounted to $3.5 billion
compared to $3.9 billion in the comparable 2003 quarter. The decline in
revenues reflects CNA's sale of its Group Benefits business and the impact of
the planned sale of the individual life insurance business.
CNA Recent Developments
During 2003, CNA completed a strategic review of its operations and decided
to concentrate its efforts on the property and casualty business. As a result
of this review, and several significant charges in 2003, a capital plan was
developed to replenish the statutory capital of the property and casualty
subsidiaries. A summary of the capital plan, related actions, and other
significant 2003 business decisions is discussed below:
On December 31, 2003, CNA completed the sale of the majority of its Group
Benefits business. The business sold included group life and accident, short
and long term disability and certain other products. CNA's group long term
care and specialty medical businesses were excluded from the sale.
Consideration from the sale was approximately $530.0 million, resulting in an
after-tax and minority interest realized investment loss on the sale of $116.4
million during 2003.
In February of 2004, CNA entered into a definitive agreement to sell its
individual life insurance business for approximately $700.0 million. The
business sold includes term, universal and permanent life insurance policies,
individual annuity products and an office building used in the business. CNA's
individual long term care and structured settlement businesses are excluded
from the sale. The transaction is expected to be completed on April 30, 2004,
subject to certain customary closing conditions. As a result of the pending
sale, CNA classified the assets and liabilities of its individual life
insurance business, as Assets Related to Businesses Held for Sale and
Liabilities Related to Businesses Held for Sale in the Consolidated Condensed
Financial Statements. See Note 16 of the Notes to Consolidated Condensed
Financial Statements in Item 1.
During 2003, CNA sold the renewal rights for most of the treaty business of
CNA Re and withdrew from the assumed reinsurance business. CNA will manage the
run-off of its retained liabilities.
The Group Benefits business, individual life and annuity insurance business
and CNA Re absorbed approximately $150.0 million of the total shared corporate
overhead expenses that are allocated to all of CNA's businesses. CNA expects
that the 2004 consolidated net results will include an approximate $31.9
million after-tax and minority interest loss for these three businesses,
primarily due to these corporate overhead expenses. This amount has been
revised from the $50.0 million guidance that was previously given primarily
because of favorable investment results. The 2003 expense initiative discussed
below did not contemplate the sale or exit of these businesses, and therefore
the savings from this initiative will be partially offset by these expenses.
65
CNA is evaluating its corporate expense structure and anticipates taking
actions in 2004 that will reduce these expenses.
The primary components of the 2003 expense initiative were 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. As of December 31, 2003, CNA has achieved the
targeted workforce reduction. Actions related to reducing commissions and
other acquisition expenses began in 2003 and will continue through 2004.
The capital plan consisted of the November of 2003 sale of $750.0 million of
a new series of CNA convertible preferred stock to Loews. The preferred stock
converted into 32,327,015 shares of CNA common stock on April 20, 2004.
Additionally, the capital plan included a commitment from Loews for additional
capital support of up to $500.0 million by February 27, 2004 through the
purchase of surplus notes of Continental Casualty Company ("CCC"), CNA's
principal insurance subsidiary, in the event certain additions to CCC's
statutory capital were not achieved through asset sales. Loews also committed
up to an additional $150.0 million, to support the statutory capital of CCC in
the event of additional shortfalls in relation to business and asset sales. In
accordance with such commitments, in February of 2004 Loews purchased a $45.6
million surplus note from CCC, in relation to the sale of CNA's Group Benefits
business, and also purchased a $300.0 million additional surplus note of CCC
in relation to the planned sale of CNA's individual life business, discussed
above. CNA has estimated that the sale of the individual life business will
result in an addition to statutory capital of approximately $500.0 million.
Following the consummation of the individual life sale, CNA plans to seek
approval from the insurance regulatory authority for the repayment of the
surplus note purchased in relation to such sale. The Company believes that CNA
will not require any additional capital support pursuant to the capital plan.
Classes of Common Stock
The issuance of Carolina Group stock has resulted in a two class common
stock structure for Loews Corporation. Carolina Group stock, commonly called a
tracking stock, is intended to reflect the economic performance of a defined
group of assets and liabilities of the Company referred to as the Carolina
Group. The principal assets and liabilities attributed to the Carolina Group
are (a) the Company's 100% stock ownership interest in Lorillard, Inc.; (b)
notional, intergroup debt owed by the Carolina Group to the Loews Group ($2.0
billion outstanding at March 31, 2004), bearing interest at the annual rate of
8.0% and, subject to optional prepayment, due December 31, 2021; and (c) any
and all liabilities, costs and expenses arising out of or related to tobacco
or tobacco-related businesses.
As of March 31, 2004, the outstanding Carolina Group stock represents a
33.43% 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 33.43% economic interest represented by the outstanding Carolina
Group stock, and includes as an asset the notional, intergroup debt of the
Carolina Group.
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
66
assets, liabilities, revenues, 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.
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, the availability of sufficient
funds in such subsidiaries, applicable state laws, including in the case of
the insurance subsidiaries of CNA, laws and rules governing the payment of
dividends by regulated insurance companies. Claims of creditors of the
Company's subsidiaries will generally have priority as to the assets of such
subsidiaries over the claims of the Company and its creditors and stockholders
(see Liquidity and Capital Resources - CNA, below).
At March 31, 2004, the book value per share of Loews common stock was
$61.23, compared to $60.92 at December 31, 2003.
CRITICAL ACCOUNTING ESTIMATES
The preparation of the consolidated 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 financial statements and the related
notes. Actual results could differ from those estimates.
The consolidated 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 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 policies discussed below are considered by management to be
critical to an understanding of the Company's Consolidated Condensed Financial
Statements as their application places the most significant demands on
67
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 and/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 insurance 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. Changes in estimates of claim and allocated claim
adjustment expense reserves and premium accruals for prior accident years are
defined as development within this MD&A. These changes can be favorable or
unfavorable. The inherent risks associated with the reserving process are
discussed in Reserves - Estimates and Uncertainties section below.
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 receivables in the Consolidated Condensed Balance
Sheets. 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 Results of Operations - Reinsurance below.
Tobacco and Other 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
68
case by the Florida Supreme Court. The Company and Lorillard believe that the
appeals court's decision should be upheld upon further appeals.
Except for the impact of the State Settlement Agreements as described in
Note 13 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.
CNA is also involved in various legal proceedings that have arisen during
the ordinary course of business. CNA evaluates the facts and circumstances of
each situation and when CNA determines it necessary, a liability is estimated
and recorded.
Valuation of Investments and Impairment of Securities
Invested assets are exposed to various risks, such as interest rate, market
and credit risks. Due to the level of risk associated with certain invested
assets and the level of uncertainty related to changes in the value of these
assets, it is possible that changes in risks in the near term could have an
adverse material impact on the Company's results of operations or equity.
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 results of operations
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 Company's results of operations and/or
equity may be materially adversely affected if actual experience varies
significantly from these assumptions.
Loans to National Contractor
CNA has made loans through a credit facility provided to a national
contractor to whom CNA Surety provides significant amounts of surety bond
69
insurance coverage. As of March 31, 2004, the Company has credit exposure of
$90.0 million under the credit facility. The credit facility was established
to help the contractor meet its liquidity needs. The contractor has initiated
restructuring efforts to reduce costs and improve cash flow and is attempting
to develop additional sources of funds. Based on the contractor's
restructuring efforts to date, CNA estimates that amounts due under the credit
facility are collectible. Therefore, no valuation allowance has been
established. Further information on this credit agreement is provided in Note
14 of the Notes to Consolidated Condensed Financial Statements included under
Item 1, and the Liquidity and Capital Resources section below.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
As a result of the strategic review and other actions described above in
"CNA Recent Developments," CNA has changed how it manages its core operations
and makes business decisions. Accordingly, the Company and CNA have revised
the reportable business segment structure to reflect these changes.
CNA now manages its property and casualty operations in two operating
segments which represent CNA's core operations: Standard Lines and Specialty
Lines. The non-core operations are now managed in the Life and Group Non-Core
and Other Insurance segments. Standard Lines includes standard property and
casualty coverages sold to small and middle market commercial businesses
primarily through an independent agency distribution system, and excess and
surplus lines, as well as insurance and risk management products sold to large
corporations in the U.S. and globally. Specialty Lines provides professional,
financial and specialty property and casualty products and services. Life and
Group Non-core primarily includes the results of the life and group lines of
business sold or placed in run-off. This segment includes the results of the
individual life business which is to be sold. Other Insurance includes the
results of certain property and casualty lines of business placed in run-off,
including CNA Re (formerly a stand-alone property and casualty segment). This
segment also includes the results related to the centralized adjusting and
settlement of Asbestos, Environment Pollution and Mass Tort ("APMT") claims as
well as the results of CNA's participation in voluntary insurance pools, which
are primarily in run-off, and various other non-insurance operations. Prior
period segment disclosures have been conformed to the current year
presentation.
The changes made to the Company's reportable segments were as follows: 1)
Standard Lines and Specialty Lines (formerly included in the Property and
Casualty segment) are now reported as separate individual segments; 2) CNA
Global (formerly included in Specialty Lines) which consists of marine and
global standard lines is now included in Standard Lines; 3) CNA Guaranty and
Credit (formerly included in Specialty Lines) is currently in run-off and is
now included in the Other Insurance segment; 4) CNA Re (formerly included in
the Property and Casualty segment) is currently in run-off and is also now
included in the Other Insurance segment; 5) Group Operations and Life
Operations (formerly separate reportable segments) have now been combined into
one reportable segment where the run-off of the retained group and life
products will be managed; 6) certain run-off life and group operations
formerly included in the Other Insurance segment are now included in the Life
and Group Non-core segment. Throughout this Management's Discussion and
Analysis ("MD&A"), the 2003 results of operations include discussion and
results for all of CNA's businesses, including those sold or exited as
described above.
In addition, the operations of Bulova were formerly reported in its own
operating segment and are now included in the Corporate and other segment.
70
CNA Financial
Insurance operations are conducted by subsidiaries of CNA Financial
Corporation ("CNA"). CNA is a 91% owned subsidiary of the Company.
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
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 as 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;
71
. the effects of 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;
. class action litigation relating to claims handling and other practices;
. increases in the number of construction defect claims, including claims
for a broad range of additional insured endorsements on policies; and
. increases in the number of claims alleging abuse by members of the
clergy.
The 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 the Operating Results section of this
MD&A 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
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;
. inconsistent court decisions and developing legal theories;
. increasingly aggressive tactics of plaintiffs' lawyers;
. the risks and lack of predictability inherent in major litigation;
. changes in the volume of asbestos and environmental pollution and mass
tort claims which cannot now be anticipated;
. continued increase in mass tort claims relating to silica and silica-
containing products;
. the impact of the exhaustion of primary limits and the resulting increase
in claims on any umbrella or excess policies CNA has issued;
. the number and outcome of direct actions against CNA; and
. CNA's ability to recover reinsurance for asbestos and environmental
pollution and mass tort 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
72
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
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 APMT Reserves section
of this 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 the Company's results of operations
and/or equity, and CNA's 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. 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. 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.
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 $50.0
and $47.0 million for the three months ended March 31, 2004 and 2003. The
amount subject to interest crediting rates on such contracts was $2,732.0 and
$2,789.0 million at March 31, 2004 and December 31, 2003. 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.
73
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.
Amounts receivable from reinsurers were $14,829.0 and $16,254.0 million at
March 31, 2004 and December 31, 2003. Of these amounts, $642.0 and $813.0
million were billed to reinsurers as of March 31, 2004 and December 31, 2003,
as reinsurance contracts generally require payment of claims by the ceding
company before the amount can be billed to the reinsurer. The remaining
receivable relates to the estimated case and incurred but not reported
("IBNR") reserves and future policyholder benefits ceded under reinsurance
contracts.
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 an adverse material impact on CNA's results of
operations.
CNA has established an allowance for doubtful accounts to provide for
estimated uncollectible reinsurance receivables. The allowance for doubtful
accounts was $590.4 and $572.6 million at March 31, 2004 and December 31,
2003. 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 attempts to mitigate its credit risk related to reinsurance by entering
into reinsurance arrangements only with reinsurers that have credit ratings
above certain levels and by obtaining substantial amounts of collateral. The
primary methods of obtaining collateral are through reinsurance trusts,
letters of credit and funds withheld balances.
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. The aggregate limits under both sections of the Aggregate
Cover have been fully utilized through 2003. Included in the pretax results of
operations for the three months ended March 31, 2004 and 2003 was $20.0 and
$13.0 million of interest charges from the Aggregate Cover.
74
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. If the aggregate
loss ratio would exceed these certain thresholds, then additional interest
charges on funds withheld would be approximately $29.0 million in 2004. During
2003, the aggregate limits under the CCC Cover were fully utilized. Included
in the pretax results of operations for the three months ended March 31, 2004
and 2003 was $11.0 and $8.0 million of interest charges from the CCC Cover.
Terrorism Insurance
CNA and the insurance industry incurred substantial losses related to the
2001 World Trade Center 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") 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. 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.
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.
The Act requires 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, CNA'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.
75
Reinsurers' obligations for terrorism-related losses under reinsurance
agreements are not covered by the Act. CNA's assumed reinsurance arrangements,
beginning with the January 1, 2002 renewal period, either exclude terrorism
coverage or significantly limit the level of coverage.
Restructuring
As discussed in the Company's 2003 Form 10-K/A, CNA continues to manage the
liabilities from two separate restructuring plans. The first plan related to
CNA's Information Technology operations (the "IT Plan"). The second plan
related to restructuring the property and casualty segments and the former
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 months ended March 31, 2004 and 2003. During the first
three months of 2004, $1.0 million in payments were charged against the
liability. As of March 31, 2004, the accrued liability relating to employee
termination and related benefit costs was $3.0 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 months ended March 31, 2004 and 2003. During the first
three months of 2004, $4.0 million in payments for lease termination costs
were charged against the liability. As of March 31, 2004, the accrued
liability, relating primarily to lease termination costs, was $16.0 million.
Of the remaining accrual, approximately $5.0 million is expected to be paid in
2004.
Non-GAAP Financial Measures
This MD&A discusses certain GAAP and non-GAAP financial measures to provide
information used by 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 are made
related to the sale or impairment of investments that will 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 interests 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. Management uses underwriting
results and operating ratios 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
76
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
(loss), which is the most directly comparable GAAP measure to underwriting
results and 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 (loss) 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 (loss).
Throughout CNA's MD&A, certain business segment results are discussed using
underwriting results, which as described above is a non-GAAP measure. The
following reconciliation provides the differences between Underwriting Income
(Loss) and Net Income.
77
Standard Specialty Other
Three Months Ended March 31, 2004 Lines Lines Insurance
- ------------------------------------------------------------------------------------------------
(In millions)
Underwriting income (loss) $ 3.0 $ 53.0 $ (30.0)
Net investment income 138.0 62.0 67.0
Other revenues 40.0 25.0 (17.0)
Other expenses (31.0) (27.0) (18.4)
- ------------------------------------------------------------------------------------------------
Income before income tax expense,
minority interest and net realized
investment gains 150.0 113.0 1.6
Income tax (expense) benefit (34.0) (34.0) 0.9
Minority interest (11.9) (10.4) 1.5
- ------------------------------------------------------------------------------------------------
Income before net realized investment
gains 104.1 68.6 4.0
Realized investment gains, net
of participating policyholders' and
minority interest 53.6 19.1 24.8
Income tax expense on realized
investment gains (19.4) (7.2) (9.2)
- ------------------------------------------------------------------------------------------------
Net income $ 138.3 $ 80.5 $ 19.6
================================================================================================
Three Months Ended March 31, 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Underwriting (loss) income $ (87.0) $ 21.0 $ (14.0)
Net investment income 129.0 49.0 51.0
Other revenues 71.0 17.0 (21.0)
Other expenses (63.0) (13.0) 0.9
- ------------------------------------------------------------------------------------------------
Income before income tax expense, minority interest
and net realized investment gains 50.0 74.0 16.9
Income tax expense (5.0) (24.0) (3.1)
Minority interest (5.3) (6.5) 0.2
- ------------------------------------------------------------------------------------------------
Income before net realized investment gains 39.7 43.5 14.0
Realized investment gains, net of participating
policyholders' and minority interest 6.7 2.7 16.9
Income tax expense on realized investment gains (4.5) (1.5) (3.1)
- ------------------------------------------------------------------------------------------------
Net income $ 41.9 $ 44.7 $ 27.8
================================================================================================
78
Operating Results
Standard Lines
The following table summarizes the results of operations for Standard Lines:
Three Months Ended
March 31,
- ------------------------------------------------------------------------------------------------
2004 2003
- ------------------------------------------------------------------------------------------------
(In millions of dollars)
Net written premiums $ 1,265.0 $ 1,273.0
Net earned premiums 1,258.0 1,219.0
Underwriting income (loss) 3.0 (87.0)
Income before net realized investment gains 104.1 39.7
Net realized investment gains 34.2 2.2
Net income 138.3 41.9
Ratios
Loss and loss adjustment expense 65.5% 73.3%
Expense 33.5 32.7
Dividend 0.7 1.2
- ------------------------------------------------------------------------------------------------
Combined 99.7% 107.2%
================================================================================================
Net income increased $96.4 million for the three months ended March 31, 2004
as compared with the same period in 2003. This improvement was driven by
improved underwriting results, and increased net realized investment results.
See the Investments section of this MD&A for further discussion on net
investment income and net realized investment gains.
Net written premiums for Standard Lines decreased $8.0 million for the three
months ended March 31, 2004 as compared with the same period in 2003. Net
earned premiums increased $39.0 million for the three months ended March 31,
2004 as compared with the same period in 2003. This improvement in earned
premium was primarily driven by increased rate and retention across most
property and casualty lines of business, partially offset by decreased net
earned premium from an E&S program covering facilities which provide services
to developmentally disabled individuals.
Standard Lines averaged rate increases of 6.0 - 7.0% and 20.0% for the three
months ended March 31, 2004 and 2003 for the contracts that renewed during the
period. Retention rates of 74.0% and 71.0% were achieved for those contracts
that were up for renewal. Competitive market pressures are expected to
contribute to the moderation in rate increases as the property and casualty
market pricing continues to soften.
Underwriting results improved by $90.0 million and the combined ratio
decreased 7.5 points for the three months ended March 31, 2004 as compared
with the same period in 2003. The loss ratio decreased 7.8 points due to
improvement in the current net accident year loss ratio and decreased
unfavorable net prior year development of $45.0 million. Favorable net prior
year development of $18.0 million was recorded for the three months ended
March 31, 2004, including $2.0 million of favorable claim and allocated claim
adjustment expense reserve development and $16.0 million of favorable premium
development.
79
Unfavorable net prior year development of $27.0 million, including $68.0
million of unfavorable claim and allocated claim adjustment expense reserve
development and $41.0 million of favorable premium development, was recorded
for the same period in 2003. The gross carried claim and claim adjustment
expense reserves for Standard Lines were $14,134.0 and $14,282.0 million at
March 31, 2004 and December 31, 2003. The net carried claim and claim
adjustment expense reserves were $8,903.0 and $8,967.0 million at March 31,
2004 and December 31, 2003.
The expense ratio increased 0.8 points primarily due to an increase in the
bad debt provision for insurance receivables of $15.0 million. The increase in
the bad debt provision for insurance receivables was primarily the result of
continued deterioration of Professional Employer Organization ("PEO") accounts
as well as certain accounts that were turned over to third parties for
collection during 2003. During 2002, Standard Lines ceased writing coverages
for PEO businesses, with the last contracts expiring on June 30, 2003, but
Standard Lines continues to have credit risk related to its PEO related
receivables. Partially offsetting this increase was lower underwriting
expenses.
Specialty Lines
The following table summarizes the results of operations for Specialty
Lines:
Three Months Ended
March 31,
- ------------------------------------------------------------------------------------------------
2004 2003
- ------------------------------------------------------------------------------------------------
(In millions of dollars)
Net written premiums $ 581.0 $ 476.0
Net earned premiums 529.0 428.0
Underwriting loss 53.0 21.0
Income before net realized investment gains 68.6 43.5
Net realized investment gains 11.9 1.2
Net income 80.5 44.7
Ratios
Loss and loss adjustment expense 63.1% 66.3%
Expense 26.4 28.6
Dividend 0.4 0.1
- ------------------------------------------------------------------------------------------------
Combined 89.9% 95.0%
================================================================================================
Net income increased $35.8 million for the three months ended March 31, 2004
as compared with the same period in 2003. This improvement was driven
primarily by improved underwriting results, increased net investment income,
and increased net realized investment results. See the Investments section of
this MD&A for further discussion on net investment income and net realized
gains.
Net written premiums for Specialty Lines increased $105.0 million and net
earned premiums increased $101.0 million for the three months ended March 31,
2004 as compared with the same period in 2003. These increases were driven by
80
production of new business and continuing significant rate increases in the
professional liability lines of business.
Specialty Lines averaged rate increases of 13.0% and 38.0% for the three
months ended March 31, 2004 and 2003 for the contracts that renewed during the
period. Retention rates of 83.0% and 79.0% were achieved for those contracts
that were up for renewal. CNA expects that rate increases will moderate as
competition for premiums increases in these lines of business.
Underwriting results improved by $32.0 million and the combined ratio
decreased 5.1 points for the three months ended March 31, 2004 as compared
with the same period in 2003. The loss ratio decreased 3.2 points due
principally to improvement in the current net accident year loss ratio.
Unfavorable net prior year development was not significant for the three
months ended March 31, 2004. Favorable net prior year development of $12.0
million, including $2.0 million of favorable claim and allocated claim
adjustment expense development and $10.0 million of favorable premium
development was recorded for the same period in 2003. The gross carried claim
and claim adjustment expense reserves for Specialty Lines were $4,287.0 and
$4,200.0 million at March 31, 2004 and December 31, 2003. The net carried
claim and claim adjustment expense reserves were $2,976.0 and $2,919.0 million
at March 31, 2004 and December 31, 2003.
The expense ratio decreased 2.2 points due primarily to the significant
increase in the net earned premium base and lower expenses as a result of the
2003 expense initiative.
Life and Group Non-Core
Net earned premiums for Life and Group Non-Core decreased $260.0 million in
the first quarter of 2004 as compared with the same period in 2003. The
decrease in net earned premiums was due primarily to the absence of premiums
from the Group Benefits and Group Reinsurance businesses. The Group Benefits
business was sold on December 31, 2003. Partially offsetting these declines
were higher earned premiums in the health and life and annuity products.
Net results decreased $311.5 million in the first quarter of 2004 as
compared with the same period in 2003. The decrease in net results related
primarily to increased net realized investment losses, including an estimated
impairment loss of $565.9 million pretax ($368.3 million after-tax and
minority interest) related to the pending sale of the individual life
insurance business. Net results also decreased due to the absence of favorable
results from the Group Benefits business and first quarter of 2004 unfavorable
results in the occupational accident product, partially offset by favorable
results in the institutional markets, life settlement and life and annuity
products.
Other Insurance
Revenues decreased $65.6 million for the three months ended March 31, 2004
as compared with the same period in 2003. The decrease in revenues was due
primarily to reduced net earned premiums in CNA Re due to the exit of the
assumed reinsurance market in 2003. CNA Re recorded $103.0 and $187.0 million
of revenue and $19.2 and $30.6 million of income (after-tax and minority
interest) for the three months ended March 31, 2004 and 2003.
Net income decreased $8.2 million for the three months ended March 31, 2004
as compared with the same period in 2003. The decrease in net income was due
primarily to the decline in revenues as well as a $14.6 million after-tax and
81
minority interest ($25.0 million pretax) increase in the bad debt provision
for reinsurance receivables. Partially offsetting these declines was an
increase in net investment income of $16.0 million.
Unfavorable net prior year development of $19.0 million was recorded for the
three months ended March 31, 2004, including $20.0 million of unfavorable net
prior year claim and allocated claim adjustment expense reserve development
and $1.0 million of favorable premium development. Unfavorable net prior year
claim and allocated claim adjustment expense reserve development of $15.0
million was recorded for the three months ended March 31, 2003, including
$30.0 million of unfavorable net prior year claim and allocated claim
adjustment expense reserve development and $15.0 million of favorable premium
development. The gross carried claim and claim adjustment expense reserves for
Other Insurance were $9,302.0 and $9,672.0 million at March 31, 2004 and
December 31, 2003. The net carried claim and claim adjustment expense reserves
were $3,504.0 and $3,737.0 million at March 31, 2004 and December 31, 2003.
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; enactment of national
federal legislation to address asbestos claims; a further increase in asbestos
and environmental pollution claims which cannot now be anticipated; increase
in number of 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 coverages at accelerated rates; and future
developments pertaining to CNA's ability to recover reinsurance for asbestos
and environmental pollution claims.
CNA regularly performs ground up reviews of all open APMT claims to evaluate
the adequacy of CNA's APMT reserves. In performing its comprehensive ground up
analysis, CNA considers input from its professionals with direct
82
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 predicted future
exposures, including such factors as claims volume, trial conditions, prior
settlement history, settlement demands and defense costs; the impact of
asbestos defendant bankruptcies on the policyholder; 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.
With respect to other court cases and how they might affect CNA's reserves
and reasonable possible losses, the following should be noted. State and
federal courts issue numerous decisions each year, which potentially impact
losses and reserves in both a favorable and unfavorable manner. Examples of
favorable developments include decisions to allocate defense and indemnity
payments in a manner so as to limit carriers' obligations to damages taking
place during the effective dates of their policies; decisions holding that
injuries occurring after asbestos operations are completed are subject to the
completed operations aggregate limits of the policies; and decisions ruling
that carriers' loss control inspections of their insured's premises do not
give rise to a duty to warn third parties to the dangers of asbestos.
Examples of unfavorable developments include decisions limiting the
application of the "absolute pollution" exclusion and decisions holding
carriers liable for defense and indemnity of asbestos and pollution claims on
a joint and several basis.
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.
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, and 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.
83
The following table provides data related to CNA's asbestos, environmental
pollution and mass tort claim and claim adjustment expense reserves.
March 31, 2004 December 31, 2003
- ------------------------------------------------------------------------------------------------
Environmental Environmental
Pollution and Pollution and
Asbestos Mass Tort Asbestos Mass Tort
- ------------------------------------------------------------------------------------------------
(In millions)
Gross reserves $ 3,262.0 $ 801.0 $ 3,347.0 $ 839.0
Ceded reserves (1,550.0) (260.0) (1,580.0) (262.0)
- ------------------------------------------------------------------------------------------------
Net reserves $ 1,712.0 $ 541.0 $ 1,767.0 $ 577.0
================================================================================================
Asbestos
CNA's property and casualty insurance subsidiaries have exposure to
asbestos-related claims. Estimation of asbestos-related claim and claim
adjustment expense reserves involves limitations 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. The majority of asbestos
bodily injury claims are filed by persons exhibiting few, if any, disease
symptoms. Recent studies have concluded that the percentage of unimpaired
claimants to total claimants ranges between 66.0% and up to 90.0%. 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.
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
84
devise claims payment procedures for bankruptcy trusts that would allow
asbestos claims to be paid under lax standards for injury, exposure, and
causation. This also presents the potential for exhausting policy limits in an
accelerated fashion.
As a result of bankruptcies and insolvencies, 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. New asbestos bodily injury claims increased
substantially in 2003, but the rate of increase has moderated in the first
quarter of 2004.
As of March 31, 2004 and December 31, 2003, CNA carried approximately
$1,712.0 and $1,767.0 million of claim and claim adjustment expense reserves,
net of reinsurance recoverables, for reported and unreported asbestos-related
claims. There was $9.0 million of unfavorable asbestos-related net claim and
claim adjustment expense reserve development for the three months ended March
31, 2004 and no asbestos-related net claim and claim adjustment expense
reserve development for the same period in 2003. CNA paid asbestos-related
claims, net of reinsurance recoveries, of $64.0 and $39.0 million for the
three months ended March 31, 2004 and 2003.
CNA has resolved a number of its large asbestos accounts by negotiating
settlement agreements. Structured settlement agreements provide for payments
over multiple years as set forth in each individual agreement. At March 31,
2004, CNA had ten structured settlement agreements with a reserve of $175.0
million, net of reinsurance. As to the ten structured settlement agreements
existing at March 31, 2004, payment obligations under those settlement
agreements are projected to terminate in 2016. At December 31, 2003, CNA had
structured settlement agreements with nine of its policyholders for which it
has future payment obligations with a reserve, net of reinsurance, of $188.0
million related to remaining payment obligations under these agreements.
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 March 31, 2004, with respect
to these five remaining unpaid Wellington obligations, CNA has evaluated its
exposure and the expected reinsurance recoveries under these agreements and
had a recorded reserve of $17.0 million, net of reinsurance. At December 31,
2003, CNA had fulfilled its Wellington Agreement obligations as to all but
five accounts and had recorded a reserve of $23.0 million, net of reinsurance,
related to its remaining Wellington obligations.
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. Coverage in place agreements are
evaluated based on claims filings trends and severities. As of March 31, 2004,
CNA had negotiated thirty-four coverage in place agreements. CNA has evaluated
these commitments and the expected reinsurance recoveries under these
agreements and has recorded a reserve of $109.0 million, net of reinsurance,
85
related to coverage in place agreements as of March 31, 2004. As of December
31, 2003, CNA had negotiated thirty-two such agreements and had established a
reserve of $109.0 million, net of reinsurance.
CNA categorizes active asbestos accounts as large or small accounts. CNA
defines a large account as an active account with more than $100,000 of
cumulative paid losses. CNA has made closing large accounts a significant
management priority. At March 31, 2004, CNA had 163 large accounts and had
established a reserve of $418.0 million, net of reinsurance. At December 31,
2003, CNA had 160 large accounts with a collective reserve of $405.0 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. 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 March 31, 2004, CNA had 1,081 small accounts,
approximately 83.5% of its total active asbestos accounts, with reserves of
$158.0 million, net of reinsurance. At December 31, 2003, CNA had 1,065 small
accounts and established a reserve of $147.0 million, net of reinsurance.
Small accounts are typically representative of policyholders with limited
connection to asbestos. As entities which 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
nevertheless must be defended by CNA under its policies. As claims filings
continue to increase, costs incurred in defending small accounts are expected
to increase.
CNA also evaluates its asbestos liabilities arising from its assumed
reinsurance business and its participation in various pools. At March 31,
2004, CNA's reserve was $156.0 million, net of reinsurance, related to these
liabilities. At December 31, 2003, CNA had recorded a $157.0 million reserve
related to these asbestos liabilities arising from CNA's assumed reinsurance
obligations and CNA's participation in pools, including Excess & Casualty
Reinsurance Association ("ECRA").
At March 31, 2004, the unassigned IBNR reserve was $625.0 million, net of
reinsurance. At December 31, 2003, CNA's IBNR reserve for asbestos was $684.0
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 table below depicts CNA's overall pending asbestos accounts and
associated reserves at March 31, 2004 and December 31, 2003.
86
2004 Percent
Paid Asbestos of
Number of Losses Reserves Asbestos
March 31, 2004 Policyholders (Net) (Net) Reserves
- ------------------------------------------------------------------------------------------------
Policyholders with settlement agreements
Structured Settlements 10 $ 41.0 $ 175.0 10.2%
Wellington 5 6.0 17.0 1.0
Coverage in place 34 10.0 109.0 6.4
Fibreboard 1 54.0 3.2
- ------------------------------------------------------------------------------------------------
Total with settlement agreements 50 57.0 355.0 20.8
- ------------------------------------------------------------------------------------------------
Other policyholders with active accounts
Large asbestos Accounts 163 4.0 418.0 24.4
Small asbestos Accounts 1,081 3.0 158.0 9.2
- ------------------------------------------------------------------------------------------------
Total other policyholders 1,244 7.0 576.0 33.6
- ------------------------------------------------------------------------------------------------
Assumed reinsurance and pools 156.0 9.1
Unassigned IBNR 625.0 36.5
- ------------------------------------------------------------------------------------------------
Total 1,294 $ 64.0 $1,712.0 100.0%
================================================================================================
2003 Percent
Paid Asbestos of
Number of Losses Reserves Asbestos
December 31, 2003 Policyholders (Net) (Net) Reserves
- ------------------------------------------------------------------------------------------------
Policyholders with settlement agreements
Structured Settlements 9 $ 20.0 $ 188.0 10.6%
Wellington 5 2.0 23.0 1.3
Coverage in place 32 40.0 109.0 6.2
Fibreboard 1 1.0 54.0 3.1
- ------------------------------------------------------------------------------------------------
Total with settlement agreements 47 63.0 374.0 21.2
- ------------------------------------------------------------------------------------------------
Other policyholders with active accounts
Large asbestos Accounts 160 35.0 405.0 22.9
Small asbestos Accounts 1,065 16.0 147.0 8.3
- ------------------------------------------------------------------------------------------------
Total other policyholders 1,225 51.0 552.0 31.2
- ------------------------------------------------------------------------------------------------
Assumed reinsurance and pools 7.0 157.0 8.9
Unassigned IBNR 684.0 38.7
- ------------------------------------------------------------------------------------------------
Total 1,272 $121.0 $1,767.0 100.0%
================================================================================================
Some asbestos-related defendants have asserted that their policies issued by
CNA 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
87
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 and/or equity.
Certain asbestos litigation in which CNA is currently engaged is 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 is
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 an 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
88
faces approximately 74,000 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, 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 Kanawha
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 the carriers failed 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. The Montana direct action
is currently stayed because of W.R. Grace's pending bankruptcy.
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 results of
operations and/or 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
89
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.
CNA is also monitoring possible legislative reforms, including the possible
creation of a national privately financed trust, which if established 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
legislation will be enacted or, if it is, what will be the terms and
conditions of its establishment or its impact on CNA.
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
90
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 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 1,400 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 modify Superfund have been made by various parties.
However, no modifications were enacted by Congress during 2003 or in the first
quarter of 2004, 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 March 31, 2004 and December 31, 2003, CNA carried approximately $541.0
and $577.0 million of claim and claim adjustment expense reserves, net of
reinsurance recoverables, for reported and unreported environmental pollution
and mass tort claims. There was no net prior year environmental pollution and
mass tort claim and claim adjustment expense reserve development for the three
months ended March 31, 2004 and 2003. CNA paid environmental pollution-related
claims and mass tort-related claims, net of reinsurance recoveries, of $36.0
and $25.0 million for the three months ended March 31, 2004 and 2003.
CNA has made resolution of large environmental pollution exposures a
management priority. CNA has resolved a number of its large environmental
accounts by negotiating 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 scope of the 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 adhere to the
91
intent of the parties and uphold the broad scope of language of the
agreements.
CNA classifies its environmental pollution accounts into several categories,
which include structured settlements, coverage in place agreements and active
accounts. Structured settlement agreements provide for payments over multiple
years as set forth in each individual agreement. At March 31, 2004, CNA had
one structured settlement and has fully funded its obligations under the
agreement leaving a nominal reserve. At December 31, 2003, CNA had a
structured settlement agreement with one of its policyholders for which it has
future payment obligations with a recorded reserve of $12.0 million, net of
reinsurance.
CNA has also used coverage in place agreements to resolve 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 March 31, 2004, CNA had six
coverage in place agreements and had established a reserve of $6.0 million,
net of reinsurance. At December 31, 2003, CNA had negotiated six 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. At December 31, 2003, CNA has a
recorded reserve of $8.0 million, net of reinsurance, 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. At March 31, 2004, CNA has 147 large accounts with a
collective reserve of $84.0 million, net of reinsurance. 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 had 144
large accounts with a collective reserve of $86.0 million, net of reinsurance,
at December 31, 2003. At March 31, 2004, CNA has 450 small accounts with a
collective reserve of $50.0 million, net of reinsurance. CNA had 432 small
accounts with a collective reserve of $53.0 million, net of reinsurance, at
December 31, 2003.
CNA also evaluates its environmental pollution exposures arising from its
assumed reinsurance and its participation in various pools, including ECRA.
CNA has a reserve of $38.0 million related to these liabilities, at March 31,
2004 and December 31, 2003.
At March 31, 2004, CNA's unassigned IBNR reserve was $192.0 million, net of
reinsurance. At December 31, 2003, CNA's unassigned IBNR reserve for
environmental pollution was $197.0 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 charts below depict CNA's overall pending environmental pollution
accounts and associated reserves at March 31, 2004 and December 31, 2003.
92
Total Environmental Percent of
Paid Pollution Enviornmental
Number of 2004 Reserves Pollution Net
March 31, 2004 Policyholders (Net) (Net) Reserve
- ------------------------------------------------------------------------------------------------
(In millions of dollars)
Policyholders with settlement agreements
Structured Settlements 1 $ 12.0
Coverage in place 6 2.0 $ 6.0 1.6%
- ------------------------------------------------------------------------------------------------
Total with settlement agreements 7 14.0 6.0 1.6
- ------------------------------------------------------------------------------------------------
Other policyholders with active accounts
Large pollution accounts 147 6.0 84.0 22.7
Small pollution accounts 450 4.0 50.0 13.5
- ------------------------------------------------------------------------------------------------
Total other policyholders 597 10.0 134.0 36.2
Assumed reinsurance and pools 38.0 51.9
Unassigned IBNR 192.0 10.3
- ------------------------------------------------------------------------------------------------
Total 604 $ 24.0 $ 370.0 100.0%
================================================================================================
Total Environmental Percent of
Paid Pollution Enviornmental
Number of 2003 Reserves Pollution Net
December 31, 2003 Policyholders (Net) (Net) Reserve
- ------------------------------------------------------------------------------------------------
(In millions of dollars)
Policyholders with settlement agreements
Structured Settlements 1 $ 17.0 $ 12.0 3.1%
Coverage in place 6 3.0 8.0 2.0
- ------------------------------------------------------------------------------------------------
Total with settlement agreements 7 20.0 20.0 5.1
- ------------------------------------------------------------------------------------------------
Other policyholders with active accounts
Large pollution accounts 144 21.0 86.0 21.8
Small pollution accounts 432 14.0 53.0 13.5
- ------------------------------------------------------------------------------------------------
Total other policyholders 576 35.0 139.0 35.3
Assumed reinsurance and pools 2.0 38.0 50.0
Unassigned IBNR 197.0 9.6
- ------------------------------------------------------------------------------------------------
Total 583 $ 57.0 $ 394.0 100.0%
================================================================================================
Lorillard
Lorillard, Inc. and subsidiaries ("Lorillard"). Lorillard, Inc. is a wholly
owned subsidiary of the Company.
Revenues decreased by $76.2 million, or 8.9% and net income decreased by
$25.9 million, or 16.9% for the three months ended March 31, 2004, as compared
to the corresponding period of the prior year.
93
The decrease in revenues and net income for the three months ended March 31,
2004, as compared to the corresponding period of the prior year, is primarily
due to lower net sales of $76.3 million due to lower effective unit prices
reflecting higher sales promotion expenses (accounted for as a reduction to
net sales) and decreased unit sales volume of approximately 1.4% (representing
a decrease of $2.4 million, assuming prices were unchanged from the
corresponding period of the prior year). Lorillard increased promotional
expenses for the three months ended March 31, 2004, as compared to the
corresponding period of the prior year, due to price pressure in response to
continuing high levels of competitive premium brand promotional spending and
the effects of increased state excise taxes since July of 2002. The decline in
net sales revenue in the 2004 period was partially offset by increased
revenues of $7.0 million as a result of a reduction of approximately one
percentage point, effective February 9, 2004, in Lorillard's cash discount
rate offered to direct buying accounts.
The decrease in net income for the three months ended March 31, 2004, as
compared to the corresponding period of the prior year, also reflects higher
tobacco settlement costs related to 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 U.S. territories (together, the "State Settlement Agreements"). The
$3.6 million pretax increase in tobacco settlement costs for the three months
ended March 31, 2004, as compared to the corresponding period of the prior
year, is due to another year of inflation on base payments ($5.5 million) and
other adjustments ($1.0 million), partially offset by lower charges for lower
unit sales volume ($2.9 million) under the State Settlement Agreements. In
addition, results in 2003 included a charge of $28.0 million ($17.1 million
after taxes) to resolve indemnification claims and trademark matters in
connection with the 1977 sale by Lorillard of its international business.
Lorillard's total (U.S. domestic, Puerto Rico and certain U.S. Territories)
gross unit sales volume decreased 1.4% for the three months ended March 31,
2004, as compared to the corresponding period of the prior year. Domestic
wholesale volume decreased 1.7% for the three months ended March 31, 2004, as
compared to the corresponding period of the prior year. Total Newport unit
sales volume decreased by 0.9% for the three months ended March 31, 2004, and
domestic U.S. Newport volume decreased 1.2% for the three months ended March
31, 2004, as compared to the corresponding period of the prior year. In
addition to pricing pressure due to the increases in state excise taxes since
July of 2002, the competitive impact of deep discount brands, and on-going
competitive promotions, Lorillard's volume for the three months ended March
31, 2004 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 1.9% of
Lorillard's net unit sales for the three months ended March 31, 2004, as
compared to 1.0% in 2003.
Lorillard recorded pretax charges of $201.1 and $197.5 million ($122.7 and
$120.7 million after taxes) for the three months ended March 31, 2004 and
2003, 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 share of domestic cigarette shipments in
the year preceding that in which the payment is due. Accordingly, Lorillard
94
records its portions of ongoing settlement payments as part of cost of
manufactured products sold as the related sales occur.
Other operating expenses include the costs of litigating and administering
product liability claims, as well as other legal expenses. Lorillard's outside
legal fees and other external product liability defense costs were $23.0 and
$19.1 million, for the three months ended March 31, 2004 and 2003,
respectively. Numerous factors affect product liability defense costs. The
principal factors are the number and types of cases filed, the number of cases
tried, the results of trials and appeals, the development of the law, the
application of new or different theories of liability by plaintiffs and their
counsel, and litigation strategy and tactics. See Note 13 of the Notes to
Consolidated Condensed Financial Statements included in Item 1 of this Report
for detailed information regarding tobacco litigation. The factors that have
influenced past product liability defense costs are expected to continue to
influence future costs. It is possible that adverse developments in the
factors discussed above, as well as other circumstances beyond the control of
Lorillard, could have a material adverse effect on the Company's financial
condition, results of operations or cash flows.
Selected Market Share Data
The following table provides market share and other data for Lorillard and
Newport with respect to the U.S. cigarette industry and the premium and
menthol segments of the market.
Three Months Ended March 31 2004 2003
- ------------------------------------------------------------------------------------------------
Lorillard's share of the domestic market (1) 9.56% 9.39%
Lorillard's premium segment as a percentage
of its total domestic volume (1) 95.4 96.0
Newport share of the domestic market (1) 8.67 8.47
Newport share of the premium segment (1) 11.6 11.6
Total menthol segment market share for the
industry (2) 27.08 26.64
Newport's share of the menthol segment (2) 30.9 29.7
Newport as a percentage of Lorillard's (3):
Total volume 90.9 90.4
Net sales 92.9 91.4
Sources:
(1) Management Science Associates, Inc.
(2) Lorillard proprietary data
(3) Lorillard Shipment Reports
Note: Unless otherwise specified, market share data in this MD&A 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. Deep discount price brands are produced by manufacturers which are
subject to lower payment obligations under the State Settlement Agreements.
This cost advantage enables them to price their brands as much as 65% less
95
than the list price of premium brand offerings from the major cigarette
manufacturers.
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.
Overall, domestic industry unit sales volume decreased 3.5% for the three
months ended March 31, 2004, as compared to 2003. Lorillard domestic wholesale
unit sales volume decreased 1.7% for the three months ended March 31, 2004 as
compared to 2003. Industry sales for premium brands were 74.6% of the total
domestic markets for the three months ended March 31, 2004, as compared to
72.9% in 2003.
Business Environment
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. Pending litigation includes a
jury award in Florida of $16.3 billion in punitive damages against
Lorillard in Engle v. R.J. Reynolds Tobacco Company, et al., a judgment
which was vacated by the Florida Third District Court of Appeal in
September of 2003. Plaintiffs have appealed the appellate court's decision
to the Florida Supreme Court. The U.S. Department of Justice has also
brought an action against Lorillard and other tobacco companies. The
government seeks, pursuant to the federal Racketeer Influenced and Corrupt
Organization Act, disgorgement of profits from the industry of
$280.0 billion that the government contends were earned as a consequence
of a racketeering "enterprise," as well as various injunctive relief.
Trial of this matter is scheduled to begin during September of 2004.
See Item 3 - Legal Proceedings and Note 13 of the Notes to Consolidated
Condensed Financial Statements included in Part I of this Report.
. Substantial annual payments by Lorillard, continuing in perpetuity, and
significant restrictions on marketing and advertising agreed to under the
terms of the State Settlement Agreements. 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 payment obligations of the State Settlement
Agreements.
. On October 27, 2003, R.J. Reynolds Tobacco Company ("RJR"), the second
largest cigarette manufacturer in the United States, and British American
96
Tobacco announced that they have agreed to combine the U.S. tobacco
business of RJR with British American Tobacco's U.S. tobacco business
("B&W"), the third largest cigarette manufacturer in the United States.
The closing of this combination is subject to various conditions,
including regulatory approvals. If completed, the consolidation of these
two competitors would result in further concentration of the U.S. tobacco
industry, with the top two companies, Philip Morris USA and the newly
created Reynolds American, having a combined market share of approximately
80%. In addition, this transaction would combine in one company the third
and fourth leading menthol brands, Kool and Salem, which have a combined
share of the menthol segment of approximately 21%. This concentration of
U.S. market share could make it more difficult for Lorillard and others to
compete for shelf space in retail outlets and could impact price
competition among menthol brands, either of which could have a material
adverse effect on the results of operations and financial condition of the
Company.
. 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
2.1% over the period 1984 through the first quarter of 2004 and
approximately 2.9% over the period from 2000 through the first
quarter of 2004, as measured by MSAI. In the first quarter of 2004,
domestic U.S. cigarette industry volume declined by 3.5% as compared
to 2003, according to information provided by MSAI.
. 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 decreased 0.28 share points from 8.07% in the
first quarter of 2003 to 7.79% in the first quarter of 2004, as
estimated by MSAI. The share of market of deep discounts as estimated by
MSAI, has increased from 4.79% in 2000 to 7.79% for the first quarter of
2004. 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 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. Increases by manufacturers in wholesale and
retail price promotional allowances also effectively reduce the prices of
many key brands. 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.
97
. Substantial federal, state and local excise taxes which are reflected in
the retail price of cigarettes. These taxes have increased substantially.
In 1999, federal excise taxes were $0.24 per pack and state excise taxes
ranged from $0.025 to $1.00 per pack. In 2004, federal excise taxes are
$0.39 per pack and state excise taxes ranged from $0.025 to $3.00 per
pack. A state excise tax increase of 35 cents per pack occurred in one
state during the first quarter of 2004. Proposals have been made and/or
are pending to increase federal and further increase 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.
. Substantial and increasing regulation of the tobacco industry and
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.
Lorillard believes that the FDA proposals would, among other things,
provide Philip Morris with a competitive advantage. 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.
Loews Hotels
Loews Hotels Holding Corporation and subsidiaries ("Loews Hotels"). Loews
Hotels Holding Corporation is a wholly owned subsidiary of the Company.
Revenues increased by $7.7 million, or 10.5%, and income from continuing
operations increased by $1.5 million in the three months ended March 31, 2004,
as compared to the corresponding period of the prior year.
Revenues increased for the three months ended March 31, 2004, as compared to
the corresponding period of the prior year, due primarily to an increase in
revenue per available room, higher other hotel operating revenues, and an
increase in equity income from the Universal Orlando properties. Revenue per
available room increased by $6.19 or 4.9%, to $131.63, 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.
98
Income from continuing operations increased for the three months ended March
31, 2004 due to the increase in revenues discussed above, partially offset by
higher operating costs.
Diamond Offshore
Diamond Offshore Drilling, Inc. and subsidiaries ("Diamond Offshore").
Diamond Offshore Drilling, Inc. is a 54% owned subsidiary of the Company.
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,
generally no dayrate is earned and revenues will decrease. Revenues can also
increase or decrease as a result of the acquisition or disposal of rigs,
required surveys and shipyard upgrades. In order to improve utilization or
realize higher dayrates, Diamond Offshore may mobilize its rigs from one
market to another. During periods of unpaid mobilization, however, revenues
may be adversely affected. In response to changes in demand, Diamond Offshore
may withdraw a rig from the market by cold stacking it or may reactivate a rig
stacked previously, which may decrease or increase revenues, respectively.
Revenues from dayrate drilling contracts are recognized currently. Diamond
Offshore may receive lump-sum payments in connection with specific contracts.
Such payments are recognized as revenues over the term of the related drilling
contract. Mobilization revenues in excess of costs incurred to mobilize an
offshore rig from one market to another, are recognized over the primary term
of the related drilling contract.
Revenues from offshore turnkey drilling contracts are accrued to the extent
of costs until the specified turnkey depth and other contract requirements are
met. Income is recognized on the completed contract method. Provisions for
future losses on turnkey contracts are recognized when it becomes apparent
that expenses to be incurred on a specific contract will exceed the revenue
from that contract. Diamond Offshore has elected not to pursue contracts for
integrated services, which includes turnkey contracts, except in very limited
circumstances.
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 or "ready
stacked" 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. Five of Diamond Offshore's rigs were cold stacked at March
31, 2004.
Operating income is also negatively impacted when Diamond Offshore performs
certain regulatory inspections that are due every five years ("5-year survey")
for all of Diamond Offshore rigs. Operating revenue decreases because these
surveys are performed during scheduled down-time in a shipyard. Operating
expenses increase as a result of these surveys due to the cost to mobilize the
rigs to a shipyard, inspection costs incurred and repair and maintenance
costs. Repair and maintenance costs may be required resulting from the survey
or may have been previously planned to take place during this mandatory down-
99
time. The number of rigs undergoing a 5-year survey will vary from year to
year.
Revenues increased by $33.9 million, or 22.3%, for the three months ended
March 31, 2004, as compared to the corresponding period of the prior year. Net
loss for the three months ended March 31, 2004 was $6.9 million, compared to
$12.1 million in the corresponding period of the prior year. Revenues for the
three months ended March 31, 2004 increased due primarily to higher contract
drilling revenues of $37.4 million, partially offset by reduced investment
income, as compared to the prior period.
Revenues from high specification floaters and other semisubmersible rigs
increased by $20.5 million for the three months ended March 31, 2004, as
compared to the corresponding period of the prior year. The increase reflects,
increased utilization of $11.3 million and increased revenues generated by the
Ocean Rover, which was undergoing an upgrade to high specification
capabilities in the same quarter of last year, amounting to $10.6 million,
partially offset by a decline in dayrates of $1.4 million.
Revenues from jack-up rigs increased $17.3 million, or 11.4%, for the three
months ended March 31, 2004 due primarily to increased utilization of $9.0
million and increased dayrates of $8.3 million, as compared to the
corresponding period of the prior year.
Investment income decreased by $2.6 million, or 1.7%, primarily due to lower
yields on cash and marketable securities and a reduction in invested cash
balances for the three months ended March 31, 2004, as compared to the
corresponding period of the prior year.
Net loss decreased for the three months ended March 31, 2004 due primarily
to the increased utilization and dayrates earned by semisubmersible rigs and
jack-ups, partially offset by reduced investment income and increased contract
drilling expenses.
Texas Gas
Texas Gas was acquired on May 17, 2003, therefore results of operations for
the three months ended March 31, 2003 did not include the operations of Texas
Gas.
Corporate and Other
Corporate operations consist primarily of investment income, including
investment gains (losses) from non-insurance subsidiaries, the operations of
Bulova Corporation ("Bulova"), a 97% owned subsidiary, equity earnings from
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
four 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, revenues increased by $13.6 million and net
loss increased by $3.9 million for the three months ended March 31, 2004, as
compared to the corresponding period of the prior year.
Revenues increased for the three months ended March 31, 2004 due primarily
to higher results from shipping operations of $14.7 million, partially offset
100
by decreased investment income of $1.6 million and decreased Bulova net sales
of $0.8 million. Bulova net sales declined due to lower watch unit sales
volume of 12.3%, partially offset by higher unit watch prices of 5.5%. Net
loss increased due to reduced investment income of $1.7 million and lower
results from Bulova of $1.3 million, partially offset by increased results
from shipping operations of $9.5 million for the three months ended March 31,
2004. The decrease in investment income is primarily due to lower yields on
invested balances and a reduced investment portfolio. See Liquidity and
Capital Resources - Majestic Shipping for developments related to Hellespont.
The components of investment gains (losses) included in Corporate operations
are as follows:
Three Months Ended
March 31,
- ------------------------------------------------------------------------------------------------
2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Derivative instruments $ (1.9) $ 6.7
Equity securities, including short positions 32.3 (37.3)
Short-term investments 1.2
Other 8.4 9.9
- ------------------------------------------------------------------------------------------------
38.8 (19.5)
Income tax (expense) benefit (13.6) 6.8
- ------------------------------------------------------------------------------------------------
Net gain (loss) $ 25.2 $ (12.7)
================================================================================================
LIQUIDITY AND CAPITAL RESOURCES
CNA Financial
Cash Flow
The principal operating cash flow sources of CNA's insurance subsidiaries
are premiums and investment income. The primary operating cash flow uses are
payments for claims, policy benefits and operating expenses.
For the three months ended March 31, 2004, net cash provided by operating
activities was $37.0 million as compared with $45.0 million for the same
period in 2003. The decrease in cash provided by operating activities related
primarily to an increase in paid claims in 2004 as compared with 2003.
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 three months ended March 31, 2004, net cash used by investing
activities was $441.0 million as compared with net cash provided by investing
activities of $132.0 million for the same period in 2003. Cash flows used for
investing activities related principally to purchases of fixed maturity
securities.
101
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 three months ended March 31, 2004, net cash provided by financing
activities was $346.0 million as compared with $137.0 million net cash used
for the same period in 2003. Cash flows provided by financing activities were
related principally to proceeds from the issuance of the CCC Group and Life
surplus notes.
CNA has an existing shelf registration statement under which it may issue an
aggregate of $549.0 million of debt or equity securities, declared effective
by the Securities and Exchange Commission ("SEC").
Debt and Other Commitments
The Company's 2003 Form 10-K/A provides a detailed discussion of CNA's debt.
CNA paid the $250.0 million three-year bank credit facility on April 20, 2004.
During February of 2004, Loews purchased $45.6 million of surplus notes from
CCC, in relation to the sale of CNA's group benefits business, and also
purchased $300.0 million of additional surplus notes of CCC in relation to the
planned sale of CNA's individual life business. These notes have 20-year terms
and bear interest at LIBOR plus 350 basis points, reset annually. The notes
are mandatorily prepayable upon the occurrence of certain events including the
sale of the Individual Life Business. CNA plans to seek approval from the
insurance regulatory authority for the repayment of the surplus notes
purchased in relation to such sale.
See Note 14 of the Notes to Consolidated Condensed Financial Statements for
information related to CNA Surety's related party transactions with CNA and
information related to commitments and contingencies. The impact of these
transactions 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. One phase of this multi-year
plan was completed during 2003. This phase served to consolidate CNA's U.S.
property and casualty insurance risks into CCC, as well as realign the capital
supporting these risks. As part of this phase, CNA implemented in the fourth
quarter of 2003 a 100.0% quota share reinsurance agreement, effective January
1, 2003, ceding all of the net insurance risks of The Continental Insurance
Company ("CIC") and its 14 affiliated insurance companies ("CIC Group") to
CCC. Additionally, the ownership of the CIC Group was transferred to CCC in
the fourth quarter of 2003 in order to properly align the insurance risks with
the supporting capital. In subsequent phases of this plan, 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 participate in a working group consisting of several states of
the National Association of Insurance Commissioners.
In connection with the approval process for aspects of the reorganization
plan, CNA 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 was also scheduled to undergo its routine
state regulatory financial examination as of December 31, 2003. These state
regulatory financial examinations are currently underway.
102
Pursuant to its participation in the working group referenced above, CNA has
agreed to certain time frames and informational provisions in relation to the
reorganization plan. 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.
Dividends from Subsidiaries
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.
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 March 31, 2004, CCC is in a negative earned surplus position.
Until CCC is in a positive earned surplus position, all dividends require
prior approval of the Department. In January of 2004, the Department approved
extraordinary dividend capacity in the amount of approximately $312.0 million
to be used to fund the CNA's 2004 debt service and principal repayment
requirements.
By agreement with the New Hampshire Insurance Department, the CIC Group may
not pay dividends to CCC until after January 1, 2006.
Ratings
Ratings are an 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.
"Outlooks" accompanied with ratings are additional modifiers used by the
rating agencies to alert those parties relying on CNA's ratings of the
possibility of a rating change in the longer term. The time frame referenced
in an outlook is not necessarily limited to ninety days as defined in the
Credit-Watch category.
103
The table below reflects the various group ratings issued by A.M. Best, S&P,
Moody's and Fitch as of April 6, 2004 for the Property and Casualty and Life
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(a) Life & Group CNA Continental
----------------------------------------------- ------------------------
CCC CIC Senior Senior
Group Group CAC(b) VFL(c) Debt Debt
- ------------------------------------------------------------------------------------------------
A.M. Best A A A- A bbb bbb-
Fitch A- A- A- A+ BBB- BBB-
Moody's A3 A3 Baa1 Baa1 Baa3 Baa3
S&P A- A- BBB+ A BBB- BBB-
(a) All outlooks for the Property & Casualty companies' financial strength and holding company
debt ratings are negative.
(b) A.M. Best and Moody's have a stable outlook while Fitch and S&P have negative outlooks on
the CAC rating.
(c) VFL's rating modifiers are Under Review with Developing Implications by A. M. Best, Rating
Watch Positive by Fitch, On Review for Upgrade by Moody's and Credit Watch Negative by S&P.
S&P lowered CAC's rating from A to BBB+ with a negative outlook and changed
the rating modifier on VFL from CreditWatch Developing to CreditWatch
Negative. These rating actions follow CNA's February 5, 2004 announcement
regarding the sale of the individual life and annuity business.
If CNA's insurance financial strength ratings were downgraded below current
levels, 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
downgrades would be the inability to obtain a material volume of business from
certain major insurance brokers, the inability to sell a material volume of
CNA's insurance products to certain markets, and the required
collateralization of certain future payment obligations or reserves.
In addition, the Company believes that a lowering of the debt ratings of
Loews by certain of these agencies could result in an adverse impact on CNA's
ratings, independent of any change in circumstances at CNA. Each of the major
rating agencies which rates Loews currently maintains a negative outlook, but
none currently has Loews on negative Credit Watch.
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 current ratings.
Lorillard
Lorillard and other cigarette manufacturers continue to be confronted with
substantial litigation. Plaintiffs in most of the cases seek unspecified
104
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.
Except for the impact of the State Settlement Agreements as described in
Note 13 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
quarter of 2004 was approximately $622.5 million.
See Item 3 - Legal Proceedings and Note 13 of the Notes to Consolidated
Condensed Financial Statements included in Item 1 of this Report for
additional information regarding this settlement and other litigation matters.
Lorillard's marketable securities totaled $1,128.7 and $1,530.2 million at
March 31, 2004 and December 31, 2003, respectively. At March 31, 2004, fixed
maturity securities represented 85.7% of the total investment in marketable
securities, including 57.8% invested in Treasury Bills with an average
duration of approximately 3 months, 25.8% invested in overnight repurchase
agreements and 16.4% 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 outflow of approximately $252.4 million for
the three months ended March 31, 2004, compared to $56.5 million for 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.
105
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.
Diamond Offshore
Cash provided by operating activities was $38.5 million for the three months
ended March 31, 2004, compared to $29.1 million in the comparable period of
2003. The increase is primarily due to an improvement in results of operations
in 2004.
Diamond Offshore has budgeted approximately $15.0 million during 2004 to
upgrade one of its high specification semisubmersible units, the Ocean
America, with capabilities making it more suitable for developmental drilling.
The upgrade began near the end of the first quarter of 2004 and is expected to
be completed during the latter part of the second quarter of 2004. As of March
31, 2004, Diamond Offshore spent $3.6 million on this project.
Diamond Offshore expects to spend approximately $66.0 million in 2004 for
capital expenditures associated with its continuing rig enhancement program
(other than rig upgrades) and other corporate requirements. During the three
months ended March 31, 2004, Diamond Offshore spent $19.0 million on its
continuing rig enhancement program and to meet other corporate capital
expenditure requirements.
Diamond Offshore expects to finance its capital expenditures through the use
of existing cash balances or internally generated funds.
Cash required to meet Diamond Offshore's capital commitments is determined
by evaluating 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.
In April of 2004, Moody's lowered its ratings of Diamond Offshore's long-
term debt to Baa2 from Baa1 primarily due to financial performance that was
below Moody's expectations. Moody's also changed its ratings outlook to stable
from negative. Although Diamond Offshore's long-term debt ratings continue at
investment grade levels, lower ratings could result in higher interest rates
on future debt issuances.
Texas Gas
Texas Gas funds its operations and capital requirements with cash flows from
operating activities. Funds from operations for the three months ended March
31, 2004 amounted to $49.0 million. Texas Gas's cash and cash equivalents
totaled $37.0 and $19.2 million at March 31, 2004 and December 31, 2003,
respectively.
106
In March of 2004, Texas Gas retired the remaining $17.3 million principal
amount of its 8.625% Notes upon final maturity. Texas Gas used its existing
cash balances to fund this maturity.
Majestic Shipping
As previously reported in the Company's 2003 Annual Report on Form 10-K/A,
Hellespont acquired four new ultra-large crude carrying ships which were
financed in part by bank debt of $200.0 million, guaranteed by Hellespont. As
of March 31, 2004, $184.2 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. In addition, as of March 31, 2004, $22.2 million principal amount
remains outstanding on a $57.5 million promissory note issued to Majestic by
Hellespont.
In April of 2004, Hellespont Shipping Corporation entered into agreements to
sell each of its four ultra-large crude oil tankers to Euronav Luxembourg SA.
The sales, which are subject to customary closing conditions, are scheduled to
be consummated in four separate closings during the second and third quarters
of 2004.
Corporate and Other
The parent company's cash and net investments totaled approximately $2.1
billion at March 31, 2004 and December 31, 2003. Cash and net investments
include proceeds from the issuance, in March of 2004, of $300.0 million
principal amount of senior notes at 5 1/4% due March 15, 2016. Proceeds from
this issuance were used to redeem the Company's $300.0 million 7.625% notes
due June 1, 2023 at a redemption price of 103.8125% of the principal amount in
April of 2004.
The Company has been a major source of capital for CNA's liquidity and
capital resource needs.
As discussed above in Overview - CNA Recent Developments, in order to assist
CNA in replenishing statutory capital adversely impacted by the prior year
development recorded in 2003, in November of 2003 Loews purchased $750.0
million of a new series of CNA preferred stock, which has since converted into
approximately 32.3 million shares of CNA common stock. In February of 2004,
the Company purchased $345.6 million of surplus notes from CCC, of which $45.6
million was purchased in connection with CNA's sale of its group benefits
business and $300.0 million was purchased in relation to the planned sale of
CNA's individual life business. CNA has estimated that the sale of the
individual life business will result in an addition to statutory capital of
approximately $500.0 million. Following consummation of the individual life
sale, CNA plans to seek approval from the insurance regulatory authority for
the repayment of the surplus notes purchased in relation to such sale, though
no assurance can be given that such approval will be granted.
The Company believes that its commitment to support the statutory capital of
CCC has been satisfied and does not anticipate any future funding requirements
under the capital plan.
The Company has an effective Registration Statement on Form S-3 registering
the future sale of its debt and/or equity securities. As of April 23, 2004,
107
approximately $800.0 million of securities were available for issuance under
this shelf registration statement.
As of March 31, 2004, there were 185,486,300 shares of Loews common stock
outstanding and 57,966,750 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. These include the expansion of
existing businesses, full or partial acquisitions and dispositions, and
opportunities for efficiencies and economies of scale.
INVESTMENTS
Insurance
CNA adopted Statement of Position 03-01, "Accounting and Reporting by
Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and
for Separate Accounts" ("SOP 03-01") as of January 1, 2004. The assets and
liabilities of certain guaranteed investment contracts and indexed group
annuity contracts that were previously segregated and reported as separate
accounts no longer qualify for separate account presentation. Prior to the
adoption of SOP 03-01, the asset and liability presentation of these affected
contracts were categorized as separate account assets and liabilities within
the Consolidated Condensed Balance Sheets. The results of operations from
separate account business was primarily classified as other revenue in the
Consolidated Condensed Statements of Income. In accordance with the provisions
of SOP 03-01, the classification and presentation of certain balance sheet and
income statement items have been modified. Accordingly, certain investment
securities previously classified as separate account assets have now been
reclassified on the balance sheet to the general account and are reported as
available-for-sale or trading securities. The investment portfolio for the
indexed group annuity contracts is classified as held for trading purposes,
which is carried at fair value with both the net realized and unrealized gains
(losses) included within net investment income in the Consolidated Condensed
Statements of Income. Consistent with the requirements of SOP 03-01, prior
year amounts have not been conformed to the current year presentation.
108
The significant components of CNA's investment income are presented in the
following table:
Three Months Ended
March 31,
- ------------------------------------------------------------------------------------------------
2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity securities $ 407.3 $ 420.1
Short term investments 15.7 20.2
Limited partnerships 74.7 23.3
Equity securities 4.4 4.5
Interest on funds withheld and other deposits (49.8) (46.7)
Other 29.6 25.3
- ------------------------------------------------------------------------------------------------
Gross investment income 481.9 446.7
Investment expense (8.8) (14.5)
- ------------------------------------------------------------------------------------------------
Investment income, net of expense $ 473.1 $ 432.2
================================================================================================
CNA experienced higher net investment income for the three months ended
March 31, 2004 as compared with the same period in 2003. This increase was due
primarily to increased limited partnership income and additional income from
the indexed group annuity contracts as a result of the adoption of SOP 03-01.
These increases were partially offset by lower investment yields on fixed
maturity securities.
The bond segment of the investment portfolio yielded 4.7% and 5.5% for the
three months ended March 31, 2004 and 2003.
The components of net realized investment results from available-for-sale
securities are presented in the following table:
109
Three Months Ended
March 31,
- ------------------------------------------------------------------------------------------------
2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Realized investment gains (losses):
Fixed maturity securities:
U.S. Government bonds $ 10.2 $ 38.1
Corporate and other taxable bonds 5.5 (118.2)
Tax-exempt bonds 72.7 19.4
Asset-backed bonds 39.0 17.9
Redeemable preferred stock 1.5 (5.1)
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities 128.9 (47.9)
Equity securities 11.1
Derivative securities (32.0) (22.2)
Short-term investments 4.0
Impairment loss on Individual Life business (565.9)
Other 3.4 (13.0)
Allocated to participating policyholders'
and minority interest (0.5) 3.0
- -----------------------------------------------------------------------------------------------
Total investment (losses) gains (455.0) (76.1)
Income tax benefit (expense) 123.7 27.3
Minority Interest 29.1 4.9
- ------------------------------------------------------------------------------------------------
Net realized investment (losses) gains $(302.2) $ (43.9)
================================================================================================
Net realized investment losses were $302.2 and $43.9 million for the three
months ended March 31, 2004 and 2003, or a decrease in net realized investment
results of $258.3 million. The investment losses in 2004 were primarily driven
by an after-tax impairment loss of $368.3 million ($565.9 million pretax)
related to the pending sale of CNA's individual life insurance business
partially offset by realized gains on fixed maturity securities. The
investment losses in 2003 were primarily driven by impairment losses for fixed
maturity and equity securities partially offset by realized gains on the
investment portfolio. The impairment losses recorded in 2003 were primarily
for securities in certain market sectors, including the airline, healthcare
and energy industries.
A primary objective in the management of the fixed maturity and equity
portfolios is to maximize total return relative to underlying liabilities and
respective liquidity needs. In achieving this goal, assets may be sold to take
advantage of market conditions or other investment opportunities or for credit
or tax considerations. This activity will produce realized gains and losses.
CNA classifies substantially all its fixed maturity securities (bonds and
redeemable preferred stocks) and its equity securities as either available-
for-sale or trading, and as such, they are carried at fair value. The
amortized cost of fixed maturity securities is adjusted for amortization of
premiums and accretion of discounts to maturity, which is included in net
investment income. Changes in fair value related to available-for-sale
securities are reported as a component of other comprehensive income.
110
The following table provides further detail of gross realized gains and
gross realized losses on fixed maturity securities and equity securities
available-for-sale:
Three Months Ended
March 31,
- ------------------------------------------------------------------------------------------------
2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Net realized gains (losses) on fixed maturity
and equity securities:
Fixed maturity securities:
Gross realized gains $ 225.0 $ 285.0
Gross realized losses (96.0) (333.0)
- ------------------------------------------------------------------------------------------------
Net realized gains (losses) on fixed
maturity securities 129.0 (48.0)
- ------------------------------------------------------------------------------------------------
Equity securities:
Gross realized gains 13.0 12.0
Gross realized losses (2.0) (12.0)
- ------------------------------------------------------------------------------------------------
Net realized gains on equity
securities 11.0
- ------------------------------------------------------------------------------------------------
Net realized gains (losses) on fixed
maturity and equity securities $ 140.0 $ (48.0)
================================================================================================
The following table provides details of the largest realized losses from
sales of securities aggregated by issuer for the three months ended March 31,
2004, including: the fair value of the securities at sales date, the amount of
the loss recorded and the period of time that the security had been in an
unrealized loss position prior to sale. The period of time that the security
had been in an unrealized loss position prior to sale can vary due to the
timing of individual security purchases. Also footnoted is a narrative
providing the industry sector along with the facts and circumstances giving
rise to the loss.
Months in
Fair Value Unrealized
Date of Loss Loss Prior
Issuer Description and Discussion Sale On Sale To Sale
- ------------------------------------------------------------------------------------------------
(In millions)
A major department store retailer that is
comprised of full-line stores, home services,
credit, and electronic commerce activities. (a) $ 16.0 $ 2.0 0-12
Issues and sells mortgage backed
securities. Issuer was chartered
by United States Congress to
facilitate housing ownership for
low to middle income Americans (b) 215.0 1.0 0-6
- ------------------------------------------------------------------------------
Total $ 231.0 $ 3.0
==============================================================================
111
(a) The issuer's financial condition is in good standing and is investment grade quality. A
decision was made to reduce the portfolio's overall exposure to the issuer.
(b) Volatility of interest rates prompted movement to other asset classes.
Valuation and Impairment of Investments
The following table details the carrying value of CNA's general and separate
account investment portfolios:
March 31, December 31,
2004 2003
- ------------------------------------------------------------------------------------------------
(In millions of dollars)
General account investments:
Fixed maturity securities available-for-sale:
U.S. Treasury securities and obligations of
government agencies $ 1,263.0 3.4% $ 1,900.0 5.0%
Asset-backed securities 7,651.0 20.7 8,757.0 23.0
States, municipalities and political subdivisions-
tax-exempt 9,227.0 24.9 7,970.0 20.9
Corporate securities 6,541.0 17.7 6,482.0 17.0
Other debt securities 3,262.0 8.8 3,264.0 8.6
Redeemable preferred stock 176.0 0.5 104.0 0.3
Options embedded in convertible debt securities 178.0 0.5 201.0 0.5
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities available-for-sale 28,298.0 76.5 28,678.0 75.3
- ------------------------------------------------------------------------------------------------
Fixed maturity trading securities:
U.S. Treasury securities and obligations
of government agencies 69.0 0.2
Asset-backed securities 112.0 0.3
States, municipalities and political
subdivisions - tax-exempt
Corporate securities 166.0 0.4
Other debt securities 40.0 0.1
Redeemable preferred stock 6.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity trading securities 393.0 1.0
- ------------------------------------------------------------------------------------------------
Equity securities:
Common stock 431.0 1.2 383.0 1.0
Non-redeemable preferred stock 73.0 0.2 144.0 0.4
- ------------------------------------------------------------------------------------------------
Total equity securities 504.0 1.4 527.0 1.4
- ------------------------------------------------------------------------------------------------
Short term investments available-for-sale 5,737.0 15.5 7,538.0 19.8
Short term trading securities 390.0 1.0
Limited partnerships 1,659.0 4.5 1,117.0 2.9
Other investments 40.0 0.1 240.0 0.6
- ------------------------------------------------------------------------------------------------
Total general account investments $ 37,021.0 100.0% $38,100.0 100.0%
================================================================================================
112
CNA's general account investment portfolio consists primarily of asset-
backed and mortgage-backed securities, short-term securities, municipal bonds
and corporate bonds.
Investments in the general account had a total net unrealized gain of
$1,524.0 million at March 31, 2004 compared with a net unrealized gain of
$1,348.0 million at December 31, 2003. The net unrealized position at March
31, 2004 was composed of a net unrealized gain of $1,259.0 million for fixed
maturities and a net unrealized gain of $265.0 million for equity securities.
The net unrealized position at December 31, 2003 was composed of a net
unrealized gain of $1,114.0 million for fixed maturities and a net unrealized
gain of $234.0 million for equity securities.
Unrealized gains (losses) on fixed maturity and equity securities are
presented in the following tables:
Gross Unrealized Losses
Cost or Gross ----------------------- Net
Amortized Unrealized Less than Greater than Unrealized
March 31, 2004 Cost Gains 12 Months 12 Months Gain
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity securities available-
for-sale:
U.S. Treasury securities and
obligations of government agencies $ 1,131.0 $ 149.0 $ 10.0 $ 7.0 $ 132.0
Asset-backed securities 7,497.0 174.0 17.0 3.0 154.0
States, municipalities and political
subdivisions-tax-exempt 9,026.0 248.0 45.0 2.0 201.0
Corporate securities 6,095.0 497.0 34.0 17.0 446.0
Other debt securities 2,948.0 328.0 10.0 4.0 314.0
Redeemable preferred stock 164.0 12.0 12.0
Options embedded in convertible
debt securities 178.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities available-
for-sale 27,039.0 1,408.0 116.0 33.0 1,259.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity trading securities 393.0
- ------------------------------------------------------------------------------------------------
Equity securities:
Common stock 180.0 255.0 4.0 251.0
Non-redeemable preferred stock 59.0 14.0 14.0
- ------------------------------------------------------------------------------------------------
Total equity securities 239.0 269.0 4.0 265.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity and equity
securities $27,671.0 $1,677.0 $ 120.0 $ 33.0 $1,524.0
================================================================================================
113
Gross Unrealized Losses
Cost or Gross ---------------------- Net
Amortized Unrealized Less than Greater than Unrealized
December 31, 2003 Cost Gains 12 Months 12 Months Gain
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity securities:
U.S. Treasury securities and
obligations of government agencies $ 1,823.0 $ 91.0 $ 10.0 $ 4.0 $ 77.0
Asset-backed securities 8,634.0 146.0 22.0 1.0 123.0
States, municipalities and political
subdivisions-tax-exempt 7,787.0 207.0 22.0 2.0 183.0
Corporate securities 6,061.0 475.0 40.0 14.0 421.0
Other debt securities 2,961.0 311.0 4.0 4.0 303.0
Redeemable preferred stock 97.0 7.0 7.0
Options embedded in convertible
debt securities 201.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities 27,564.0 1,237.0 98.0 25.0 1,114.0
- ------------------------------------------------------------------------------------------------
Equity securities:
Common stock 163.0 222.0 2.0 220.0
Non-redeemable preferred stock 130.0 16.0 2.0 14.0
- ------------------------------------------------------------------------------------------------
Total equity securities 293.0 238.0 4.0 234.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity and equity
securities $ 27,857.0 $1,475.0 $ 102.0 $ 25.0 $1,348.0
================================================================================================
CNA's investment policies for the general account emphasize high credit
quality and diversification by industry, issuer and issue. Assets supporting
interest rate sensitive liabilities are segmented within the general account
to facilitate asset/liability duration management.
At March 31, 2004, the carrying value of the general account fixed
maturities available-for-sale was $28,298.0 million, representing 76.4% of the
total investment portfolio. The net unrealized gain related to this fixed
maturity portfolio was $1,259.0 million, comprised of $1,408.0 million in
gross unrealized gains and $149.0 million in gross unrealized losses.
Corporate bonds represented 34.0%, municipal securities represented 32.0%,
asset-backed securities represented 13.0%, and all other fixed maturity
securities represented 21.0% of the gross unrealized losses. Within corporate
bonds, the largest industry sectors were financial, consumer cyclical and
consumer non-cyclical, which represented 24.0%, 20.0%, and 18.0% of the gross
unrealized losses. Gross unrealized losses in any single issuer were less than
0.1% of the carrying value of the total general account fixed maturity
portfolio.
The following table provides the composition of fixed maturity securities
available-for-sale with an unrealized loss in relation to the total of all
fixed maturity securities available-for-sale with an unrealized loss by
contractual maturities:
114
Percent of
--------------------
Market Unrealized
March 31, 2004 Value Loss
- ------------------------------------------------------------------------------------------------
Due in one year or less 2.0% 6.0%
Due after one year through five years 5.0 18.0
Due after five years through ten years 21.0 25.0
Due after ten years 54.0 38.0
Asset-backed securities 18.0 13.0
- ------------------------------------------------------------------------------------------------
Total 100.0% 100.0%
================================================================================================
The following table summarizes for fixed maturity and equity securities
available-for-sale in an unrealized loss position at March 31, 2004 and
December 31, 2003, the aggregate fair value and gross unrealized loss by
length of time those securities have been continuously in an unrealized loss
position.
March 31, 2004 December 31, 2003
- ------------------------------------------------------------------------------------------------
Gross Gross
Estimated Unrealized Estimated Unrealized
Fair Value Loss Fair Value Loss
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity securities:
Investment grade:
0-6 months $ 4,575.0 $ 66.0 $ 4,138.0 $ 50.0
7-12 months 651.0 28.0 834.0 36.0
13-24 months 101.0 17.0 76.0 11.0
Greater than 24 months 44.0 4.0 51.0 3.0
- ------------------------------------------------------------------------------------------------
Total investment grade 5,371.0 115.0 5,099.0 100.0
- ------------------------------------------------------------------------------------------------
Non-investment grade:
0-6 months 527.0 21.0 134.0 5.0
7-12 months 19.0 1.0 60.0 7.0
13-24 months 35.0 3.0 16.0 1.0
Greater than 24 months 82.0 9.0 105.0 10.0
- ------------------------------------------------------------------------------------------------
Total non-investment grade 663.0 34.0 315.0 23.0
- ------------------------------------------------------------------------------------------------
Total fixed maturity securities 6,034.0 149.0 5,414.0 123.0
- ------------------------------------------------------------------------------------------------
Equity securities:
0-6 months 13.0 3.0 23.0 2.0
7-12 months 2.0 1.0 10.0 2.0
13-24 months 1.0 3.0
Greater than 24 months 6.0 6.0
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Total equity securities 22.0 4.0 42.0 4.0
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Total fixed maturity and
equity securities $ 6,056.0 $ 153.0 $ 5,456.0 $ 127.0
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115
CNA's non-investment grade fixed maturity securities available-for-sale as
of March 31, 2004 that were in a gross unrealized loss position had a fair
value of $663.0 million. As discussed previously, a significant judgment in
the valuation of investments is the determination of when an other-than-
temporary impairment has occurred. CNA's Impairment Committee analyzes
securities placed on the watch list on at least a quarterly basis. Part of
this analysis is to monitor the length of time and severity of the decline
below book value of the watch list securities. The following tables summarize
the fair value and gross unrealized loss of non-investment grade securities
categorized by the length of time those securities have been in a continuous
unrealized loss position and further categorized by the severity of the
unrealized loss position in 10.0% increments as of March 31, 2004 and December
31, 2003.
Fair Value as a Percentage of Book Value Gross
Estimated ----------------------------------------- Unrealized
March 31, 2004 Fair Value 90-99% 80-89% 70-79% <70% Loss
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(In millions)
Fixed maturity securities:
Non-investment grade:
0-6 months $ 527.0 $16.0 $ 5.0 $ 21.0
7-12 months 19.0 1.0 1.0
13-24 months 35.0 3.0 3.0
Greater than 24 months 82.0 3.0 6.0 9.0
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Total non-investment grade $ 663.0 $20.0 $14.0 $ 34.0
================================================================================================
Fair Value as a Percentage of Book Value Gross
Estimated ----------------------------------------- Unrealized
December 31, 2003 Fair Value 90-99% 80-89% 70-79% <70% Loss
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(In millions)