==============================================================================
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 June 30, 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 July 23, 2004
- ------------------------------ ------------------------------
Common stock, $1.00 par value 185,489,600 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
June 30, 2004 and December 31, 2003 3
Consolidated Condensed Statements of Income
Three and six months ended June 30, 2004 and 2003 4
Consolidated Condensed Statements of Cash Flows
Six months ended June 30, 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 75
Item 3. Quantitative and Qualitative Disclosures about Market Risk 152
Item 4. Disclosure Controls and Procedures 155
Part II. Other Information
Item 1. Legal Proceedings 156
Item 4. Submission of Matters to a Vote of Security Holders 158
Item 6. Exhibits and Reports on Form 8-K 159
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED BALANCE SHEETS
- ------------------------------------------------------------------------------------------------
(In millions)
June 30, December 31,
2004 2003
- ------------------------------------------------------------------------------------------------
Assets:
Investments:
Fixed maturities, amortized cost of $32,187.5 and $27,664.9 $32,330.7 $28,781.3
Equity securities, cost of $388.7 and $593.1 487.3 888.2
Limited partnership investments 1,923.9 1,335.1
Other investments 34.8 245.6
Short-term investments 5,717.4 11,264.6
- ------------------------------------------------------------------------------------------------
Total investments 40,494.1 42,514.8
Cash 190.7 180.8
Receivables-net 21,323.5 20,467.9
Property, plant and equipment-net 3,777.7 3,879.7
Deferred income taxes 996.1 530.2
Goodwill 298.3 311.4
Other assets 2,751.5 3,785.4
Deferred acquisition costs of insurance subsidiaries 1,343.3 2,532.7
Separate account business 576.5 3,678.0
Assets related to businesses held for sale 200.0
- ------------------------------------------------------------------------------------------------
Total assets $71,951.7 $77,880.9
================================================================================================
Liabilities and Shareholders' Equity:
Insurance reserves:
Claim and claim adjustment expense $31,563.2 $31,730.2
Future policy benefits 5,634.2 8,160.9
Unearned premiums 4,610.4 4,891.5
Policyholders' funds 1,787.1 601.4
- ------------------------------------------------------------------------------------------------
Total insurance reserves 43,594.9 45,384.0
Payable for securities purchased 2,067.7 2,147.7
Securities sold under agreements to repurchase 970.1 441.8
Long-term debt, less unamortized discount 5,579.3 5,820.2
Reinsurance balances payable 3,155.6 3,432.0
Other liabilities 3,549.3 4,251.3
Separate account business 576.5 3,678.0
Liabilities related to businesses held for sale 170.0
- ------------------------------------------------------------------------------------------------
Total liabilities 59,663.4 65,155.0
Minority interest 1,607.1 1,671.6
Shareholders' equity 10,681.2 11,054.3
- ------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $71,951.7 $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 Six Months Ended
June 30, June 30,
---------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------
Revenues:
Insurance premiums $ 2,105.3 $ 2,195.6 $ 4,272.3 $ 4,575.8
Investment income, net of expense 397.9 445.2 891.5 901.8
Investment gains (losses) 103.8 419.3 (312.4) 323.7
Manufactured products (including excise
taxes of $169.5, $163.4, $325.7 and
$320.3) 899.3 814.3 1,707.5 1,698.3
Other 408.2 365.1 846.8 685.7
- -----------------------------------------------------------------------------------------------
Total 3,914.5 4,239.5 7,405.7 8,185.3
- -----------------------------------------------------------------------------------------------
Expenses:
Insurance claims and policyholders'
benefits 1,624.5 2,107.7 3,262.9 3,977.9
Amortization of deferred acquisition costs 307.1 481.0 740.3 939.2
Cost of manufactured products sold 547.4 475.7 1,034.9 956.9
Other operating expenses 806.0 796.8 1,560.8 1,576.9
Interest 73.5 75.7 172.6 149.4
- -----------------------------------------------------------------------------------------------
Total 3,358.5 3,936.9 6,771.5 7,600.3
- -----------------------------------------------------------------------------------------------
556.0 302.6 634.2 585.0
- -----------------------------------------------------------------------------------------------
Income tax expense 123.2 88.0 168.6 181.1
Minority interest 25.5 (0.3) 14.7 (1.3)
- -----------------------------------------------------------------------------------------------
Total 148.7 87.7 183.3 179.8
- -----------------------------------------------------------------------------------------------
Income from continuing operations 407.3 214.9 450.9 405.2
Discontinued operations-net (0.1) (0.4)
- -----------------------------------------------------------------------------------------------
Net income $ 407.3 $ 214.8 $ 450.9 $ 404.8
===============================================================================================
Net income attributable to:
Loews common stock:
Income from continuing operations $ 366.7 $ 189.9 $ 375.9 $ 351.6
Discontinued operations-net (0.1) (0.4)
- -----------------------------------------------------------------------------------------------
Loews common stock 366.7 189.8 375.9 351.2
Carolina Group stock 40.6 25.0 75.0 53.6
- ----------------------------------------------------------------------------------------------
Total $ 407.3 $ 214.8 $ 450.9 $ 404.8
==============================================================================================
4
Loews Corporation and Subsidiaries
CONSOLIDATED CONDENSED STATEMENTS OF INCOME (Continued)
- ------------------------------------------------------------------------------------------------
(In millions, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------
Income per share of Loews common stock:
Income from continuing operations $ 1.98 $ 1.02 $ 2.03 $ 1.89
Discontinued operations-net
- ------------------------------------------------------------------------------------------------
Net income $ 1.98 $ 1.02 $ 2.03 $ 1.89
================================================================================================
Net income per share of Carolina Group stock $ 0.70 $ 0.63 $ 1.29 $ 1.34
================================================================================================
Weighted average number of shares outstanding:
Loews common stock 185.49 185.45 185.48 185.45
Carolina Group stock 57.97 39.91 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)
Six Months Ended
June 30,
-------------------------
2004 2003
-------------------------
Operating activities:
Net income $ 450.9 $ 404.8
Adjustments to reconcile net income to net cash
provided (used) by operating activities-net 277.6 (96.1)
Changes in operating assets and liabilities-net:
Reinsurance receivable (1,087.8) (657.3)
Other receivables 150.7 (119.7)
Federal income taxes 633.5 (250.4)
Prepaid reinsurance premiums 224.9 (115.6)
Deferred acquisition costs 118.3 (96.7)
Insurance reserves and claims 805.1 1,276.2
Reinsurance balances payable (242.4) 76.8
Other liabilities (564.0) (133.9)
Trading securities 188.8 206.1
Other-net 181.7 80.4
- -----------------------------------------------------------------------------------------------
1,137.3 574.6
- ------------------------------------------------------------------------------------------------
Investing activities:
Purchases of fixed maturities (41,868.5) (39,296.3)
Proceeds from sales of fixed maturities 29,410.3 34,363.7
Proceeds from maturities of fixed maturities 5,096.4 3,086.9
Securities sold under agreements to repurchase 528.3 837.5
Purchases of equity securities (128.2) (203.7)
Proceeds from sales of equity securities 318.2 279.2
Change in short-term investments 5,261.4 1,437.1
Purchases of property, plant and equipment (124.5) (289.7)
Proceeds from sales of property, plant and equipment 15.4 3.4
Sales of businesses 644.5
Change in other investments 78.0 (29.4)
Purchase of Texas Gas (802.8)
- ------------------------------------------------------------------------------------------------
(768.7) (614.1)
- ------------------------------------------------------------------------------------------------
Financing activities:
Dividends paid to Loews shareholders (108.4) (91.6)
Dividends paid to minority interests (7.4) (15.1)
Issuance of Loews common stock 0.9 0.2
Principal payments on long-term debt (554.3) (543.6)
Issuance of long-term debt 297.5 706.4
Returns and deposits of policyholder account balances on
investment contracts 10.3 (12.6)
Other 2.7 (1.9)
- ------------------------------------------------------------------------------------------------
(358.7) 41.8
- ------------------------------------------------------------------------------------------------
Net change in cash 9.9 2.3
Cash, beginning of period 180.8 185.4
- ------------------------------------------------------------------------------------------------
Cash, end of period $ 190.7 $ 187.7
================================================================================================
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
June 30, 2004 and December 31, 2003 and the statements of income for the three
and six months ended June 30, 2004 and 2003 and changes in cash flows for the
six months ended June 30, 2004 and 2003.
Results of operations for the second quarter and the first half 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.
In the second quarter of 2004, the expenses incurred related to
uncollectible reinsurance receivables were reclassified from "Other operating
expenses" to "Insurance claims and policyholders' benefits" on the
Consolidated Condensed Statements of Income. Prior period amounts have been
reclassified to conform to the current year presentation. This
reclassification had no impact on net income in any period.
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
7
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
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
June 30, January 1,
2004 2004(a)
- ------------------------------------------------------------------------------------------------
(In millions)
Assets:
Investments:
Fixed maturity securities, available-for-sale $ 882.0 $ 1,220.0
Fixed maturity securities, trading 405.0 304.0
Equity securities 4.0 4.0
Limited partnership investments 468.0 419.0
Short-term investments, available-for-sale 10.0 55.0
Short-term investments, trading 315.0 414.0
- ------------------------------------------------------------------------------------------------
Total investments 2,084.0 2,416.0
Accrued investment income 11.0 13.0
Receivables for securities sold 83.0 97.0
Other assets 1.0
- ------------------------------------------------------------------------------------------------
Total assets $ 2,178.0 $ 2,527.0
================================================================================================
Liabilities:
Insurance reserves:
Claim and claim adjustment expense $ 1.0 $ 1.0
Future policy benefits 530.0 617.0
Policyholders' funds 1,223.0 1,324.0
Collateral on loaned securities and derivatives 17.0
Payables for securities purchased 87.0 43.0
Other liabilities 65.0 47.0
- ------------------------------------------------------------------------------------------------
Total liabilities $ 1,906.0 $ 2,049.0
================================================================================================
(a) Includes assets and liabilities of the individual life business sold on April 30, 2004. See
Note 9 for further information.
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 May of 2004, the FASB issued FASB Staff Position ("FSP") 106-2,
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003." The FSP provides guidance on
the accounting for the effects of the Medicare Prescription Drug, Improvement
and Modernization Act of 2003 for employers that provide prescription drug
benefits. FSP 106-2 supersedes FSP 106-1 "Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003." Adoption of this position has not had a material
impact on the Company's results of operations or equity.
In March of 2004, the Emerging Issues Task Force ("EITF") reached consensus
on the guidance provided in EITF Issue No. 03-1, "The Meaning of Other-Than-
9
Temporary Impairment and its Application to Certain Investments" ("EITF 03-1")
as applicable to debt and equity securities that are within the scope of SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity Securities"
and equity securities that are accounted for using the cost method specified
in Accounting Policy Board Opinion No. 18, "The Equity Method of Accounting
for Investments in Common Stock." An investment is impaired if the fair value
of the investment is less than its cost including adjustments for
amortization, accretion, foreign exchange, and hedging. EITF 03-1 outlines
that an impairment would be considered other-than-temporary unless a) the
investor has the ability and intent to hold an investment for a reasonable
period of time sufficient for the recovery of the fair value up to (or beyond)
the cost of the investment and b) evidence indicating that the cost of the
investment is recoverable within a reasonable period of time outweighs
evidence to the contrary. The investor should consider its cash or working
capital needs to assess its intent and ability to hold an investment for a
reasonable period of time for the recovery of fair value up to or beyond the
cost of the investment. Although not presumptive, a pattern of selling
investments prior to the forecasted recovery of fair value may call into
question the investor's intent. In addition, the severity and duration of the
impairment should also be considered in determining whether the impairment is
other-than-temporary. This new guidance for determining whether impairment is
other-than-temporary is effective for reporting periods beginning after June
15, 2004.
The Company is currently evaluating the impact of this new accounting
standard on its process for determining other-than-temporary impairment of
equity and fixed maturity securities. Adoption of this standard may cause the
Company to recognize impairment losses in the Consolidated Condensed
Statements of Income which would not have been recognized under the current
guidance or to recognize such losses in earlier periods, especially those due
to increases in interest rates, and will likely also impact the recognition of
investment income on impaired securities. Since fluctuations in the fair value
for available-for-sale securities are already recorded in Accumulated other
comprehensive income, adoption of this standard is not expected to have a
significant impact on shareholders' equity.
In April of 2004, the EITF reached consensus on the guidance provided in
EITF Issue No. 03-6, "Participating Securities and the Two-Class Method under
SFAS No. 128 Earnings per share" ("EITF 03-6"). EITF 03-6 clarifies whether a
security should be considered a "participating security" for purposes of
computing earnings per share ("EPS") and how earnings should be allocated to a
"participating security" when using the two-class method for computing basic
EPS. The adoption of EITF 03-6 did not have a significant impact on the
Company.
Stock option plans - The Company has elected to follow 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 Condensed
Statements of Income, in accordance with APB No. 25. Several of the Company's
subsidiaries also maintain their own stock option plans. The pro forma effect
of applying SFAS No. 123 includes the Company's share of expense related to
10
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 Six Months Ended
June 30, June 30,
---------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------
(In millions, except per share data)
Net income:
Loews common stock:
Net income as reported $ 366.7 $ 189.8 $ 375.9 $ 351.2
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method, net (1.2) (1.3) (2.5) (2.5)
- ------------------------------------------------------------------------------------------------
Pro forma net income $ 365.5 $ 188.5 $ 373.4 $ 348.7
================================================================================================
Carolina Group stock:
Net income as reported $ 40.6 $ 25.0 $ 75.0 $ 53.6
Deduct: Total stock-based employee
compensation expense determined under
the fair value based method, net (0.1) (0.1)
- ------------------------------------------------------------------------------------------------
Pro forma net income $ 40.5 $ 25.0 $ 74.9 $ 53.6
================================================================================================
Net income per share:
Loews common stock:
As reported $ 1.98 $ 1.02 $ 2.03 $ 1.89
Pro forma 1.97 1.02 2.01 1.88
Carolina Group stock:
As reported 0.70 0.63 1.29 1.34
Pro forma 0.70 0.63 1.29 1.34
================================================================================================
Comprehensive Income - Comprehensive income includes all changes to
shareholders' equity, except those resulting from investments by shareholders
and distributions to shareholders. For the three and six months ended June 30,
2004 and 2003, comprehensive (loss) income totaled $(386.6), $703.0, $(265.7)
and $1,088.6 million, respectively. Comprehensive income includes net income,
unrealized appreciation (depreciation) of investments and foreign currency
translation gains or losses.
11
2. Investments
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------
(In millions)
Investment income consisted of:
Fixed maturity securities $ 395.6 $ 426.1 $ 804.2 $ 855.5
Short-term investments 15.5 26.0 30.6 54.5
Limited partnership investments 32.2 74.4 118.3 97.7
Equity securities 4.2 6.7 9.3 12.0
Interest expense on funds withheld and
other deposits (56.2) (93.5) (106.0) (140.2)
Other 24.6 29.1 62.4 65.5
- ------------------------------------------------------------------------------------------------
Total investment income 415.9 468.8 918.8 945.0
Investment expenses (18.0) (23.6) (27.3) (43.2)
- ------------------------------------------------------------------------------------------------
Investment income, net of expense $ 397.9 $ 445.2 $ 891.5 $ 901.8
================================================================================================
Investment gains (losses) are as follows:
Trading securities:
Derivative instruments $ 13.1 $ (24.3) $ 11.2 $ (17.6)
Equity securities, including short
positions (14.1) 45.9 18.2 8.6
- ------------------------------------------------------------------------------------------------
(1.0) 21.6 29.4 (9.0)
Other than trading:
Fixed maturities (68.3) 395.9 70.2 360.0
Equity securities 166.1 58.1 177.2 58.1
Short?term investments 0.9 (1.7) 1.0 3.6
Other (a) 6.1 (54.6) (590.2) (89.0)
- ------------------------------------------------------------------------------------------------
Investment (losses) gains 103.8 419.3 (312.4) 323.7
Income tax benefit (expense) 14.1 (144.1) 124.2 (110.0)
Minority interest (10.5) (24.5) 18.6 (19.6)
- ------------------------------------------------------------------------------------------------
Investment gains (losses)-net $ 107.4 $ 250.7 $ (169.6) $ 194.1
================================================================================================
(a) Includes a loss of $618.6 ($352.9 after tax and minority interest)
related to CNA's sale of its individual life insurance business for the six
months ended June 30, 2004.
Realized investment gains were $107.4 and $250.7 million for the three
months ended June 30, 2004 and 2003. The decline in pretax realized gains was
primarily driven by unfavorable results in fixed maturity securities,
partially offset by a $162.0 million pretax gain on the disposition of CNA's
equity holdings of Canary Wharf Group PLC ("Canary Wharf"), a London-based
real estate investment, and increased realized gains related to derivative
securities.
Realized investment losses were $169.6 million for the six months ended June
30, 2004 as compared to realized investment gains of $194.1 million for the
six months ended June 30, 2003. The decrease in the pretax realized investment
results was due primarily to a $618.6 million pretax loss on the sale of the
individual life insurance businesses (see Note 9 for further information), and
decreased realized gains related to fixed maturity securities. These decreases
12
were partially offset by a $162.0 million pretax gain on the sale of an
investment in Canary Wharf, and increased realized gains related to derivative
securities.
Realized investment gains for the three and six months ended June 30, 2003
included $31.0 and $286.0 million of pretax impairment losses for other-than-
temporary declines in fair values for fixed maturity and equity securities.
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 and six months ended June 30,
2004.
Investments had a total net unrealized gain of $242.0 million at June 30,
2004 compared with $1,411.8 million at December 31, 2003. The net unrealized
position at June 30, 2004 was primarily composed of a net unrealized gain of
$143.2 million for fixed maturities and a net unrealized gain of $98.6 million
for equity securities. The net unrealized position at December 31, 2003 was
primarily composed of a net unrealized gain of $1,116.4 million for fixed
maturities and a net unrealized gain of $295.1 million for equity securities.
The following tables summarize the unrealized gain (loss) position related
to fixed maturity, equity securities and short-term investments.
13
Gross Unrealized Losses Net
-------------------------- Unrealized
Amortized Unrealized Less than Greater than Gains/ Fair
June 30, 2004 Cost Gains 12 Months 12 Months (Losses) Value
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity
securities:
U.S. government and
obligations of
government agencies $ 965.4 $ 84.1 $ 12.4 $ 5.7 $ 66.0 $ 1,031.4
Asset-backed securities 9,090.8 81.3 147.7 3.1 (69.5) 9,021.3
States, municipalities
and political
subdivision-tax exempt 8,989.0 66.7 187.6 11.2 (132.1) 8,856.9
Corporate 7,036.5 287.3 137.6 26.0 123.7 7,160.2
Other debt 3,134.6 216.8 69.3 6.2 141.3 3,275.9
Redeemable preferred
stocks 154.2 5.6 1.8 2.1 1.7 155.9
Options embedded in
convertible debt
securities 240.3 240.3
- ------------------------------------------------------------------------------------------------
Total fixed maturities
available for sale 29,610.8 741.8 556.4 54.3 131.1 29,741.9
Fixed maturity trading
securities 2,576.7 15.9 3.2 0.6 12.1 2,588.8
- ------------------------------------------------------------------------------------------------
Total fixed maturity 32,187.5 757.7 559.6 54.9 143.2 32,330.7
- ------------------------------------------------------------------------------------------------
Equity Securities:
Equity securities
available for sale 218.3 87.4 5.5 0.5 81.4 299.7
Equity securities,
trading portfolio 170.4 31.3 8.9 5.2 17.2 187.6
- ------------------------------------------------------------------------------------------------
Total equity securities 388.7 118.7 14.4 5.7 98.6 487.3
- ------------------------------------------------------------------------------------------------
Short-term investments
available for sale 5,717.2 0.2 0.2 5,717.4
- ------------------------------------------------------------------------------------------------
$38,293.4 $ 876.6 $ 574.0 $ 60.6 $ 242.0 $38,535.4
================================================================================================
14
Gross Unrealized Losses Net
-------------------------- Unrealized
Amortized Unrealized Less than Greater than Gains/ Fair
December 31, 2003 Cost Gains 12 Months 12 Months (Losses) Value
- ------------------------------------------------------------------------------------------------
(In millions)
Fixed maturity
securities:
U.S. government and
obligations of
government agencies $ 1,827.9 $ 90.4 $ 9.6 $ 4.7 $ 76.1 $ 1,904.0
Asset-backed securities 8,633.7 146.7 21.9 1.3 123.5 8,757.2
States, municipalities
and political
subdivision-tax exempt 7,787.1 207.1 21.3 2.5 183.3 7,970.4
Corporate 6,156.7 478.9 40.2 14.7 424.0 6,580.7
Other debt 2,961.6 310.7 4.3 3.7 302.7 3,264.3
Redeemable preferred
stocks 96.9 6.9 0.1 6.8 103.7
Options embedded in
convertible debt
securities 201.0 201.0
- ------------------------------------------------------------------------------------------------
Total fixed maturities
available for sale 27,664.9 1,240.7 97.4 26.9 1,116.4 28,781.3
- ------------------------------------------------------------------------------------------------
Equity Securities:
Equity securities
available for sale 293.2 237.9 3.4 0.7 233.8 527.0
Equity securities,
trading portfolio 299.9 88.7 6.8 20.6 61.3 361.2
- ------------------------------------------------------------------------------------------------
Total equity securities 593.1 326.6 10.2 21.3 295.1 888.2
- ------------------------------------------------------------------------------------------------
Short-term investments
available for sale 11,264.3 0.3 0.3 11,264.6
- ------------------------------------------------------------------------------------------------
$39,522.3 $ 1,567.6 $ 107.6 $ 48.2 $1,411.8 $40,934.1
================================================================================================
15
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 and six
months ended June 30, 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 0.29, 0.88, 0.33 and 0.84 million shares of Loews common
stock were outstanding for the three and six months ended June 30, 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 0.28, 0.39, 0.20 and 0.37 million shares of Carolina Group
stock were outstanding for the three and six months ended June 30, 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 Six Months Ended
June 30, June 30,
---------------------------------------------------
2004 2003 2004 2003
---------------------------------------------------
(In millions)
Loews common stock:
Consolidated net income $ 407.3 $ 214.8 $ 450.9 $ 404.8
Less income attributable to
Carolina Group stock 40.6 25.0 75.0 53.6
- ------------------------------------------------------------------------------------------------
Income attributable to Loews common stock $ 366.7 $ 189.8 $ 375.9 $ 351.2
================================================================================================
Carolina Group stock:
Income available to Carolina Group stock $ 121.4 $ 108.4 $ 224.4 $ 232.8
Weighted average economic interest of
the Carolina Group stock 33.43% 23.01% 33.43% 23.01%
- ------------------------------------------------------------------------------------------------
Income attributable to Carolina Group stock $ 40.6 $ 25.0 $ 75.0 $ 53.6
================================================================================================
16
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 June 30, 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
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 June 30, 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.
17
Loews and Carolina Group
Consolidating Condensed Balance Sheet Information
Carolina Group Adjustments
---------------------------------- Loews and
June 30, 2004 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Assets:
Investments $ 528.9 $ 100.0 $ 628.9 $ 39,865.2 $ 40,494.1
Cash 3.0 0.3 3.3 187.4 190.7
Receivables-net 918.3 918.3 20,431.7 $ (26.5) (a) 21,323.5
Property, plant and
equipment-net 234.4 234.4 3,543.3 3,777.7
Deferred income taxes 440.3 440.3 555.8 996.1
Goodwill 298.3 298.3
Other assets 378.3 378.3 2,373.2 2,751.5
Investment in combined
attributed net assets
of the Carolina Group 1,539.2 (1,980.4) (a)
441.2 (b)
Deferred acquisition
costs of insurance
subsidiaries 1,343.3 1,343.3
Separate account
business 576.5 576.5
Assets related to
businesses held for
sale 200.0 200.0
- ------------------------------------------------------------------------------------------------
Total assets $ 2,503.2 $ 100.3 $ 2,603.5 $ 70,913.9 $ (1,565.7) $ 71,951.7
================================================================================================
Liabilities and
Shareholders' Equity:
Insurance reserves $ 43,594.9 $ 43,594.9
Payable for securities
purchased 2,067.7 2,067.7
Securities sold under
agreements to
repurchase 970.1 970.1
Long-term debt, less
unamortized discounts $ 1,980.4 $ 1,980.4 5,579.3 $ (1,980.4) (a) 5,579.3
Reinsurance balances
payable 3,155.6 3,155.6
Other liabilities $ 1,269.3 16.5 1,285.8 2,290.0 (26.5) (a) 3,549.3
Separate account
business 576.5 576.5
Liabilities related
to businesses held
for sale 170.0 170.0
- ------------------------------------------------------------------------------------------------
Total liabilities 1,269.3 1,996.9 3,266.2 58,404.1 (2,006.9) 59,663.4
Minority interest 1,607.1 1,607.1
Shareholders' equity 1,233.9 (1,896.6) (662.7) 10,902.7 441.2 (b) 10,681.2
- ------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $ 2,503.2 $ 100.3 $ 2,603.5 $ 70,913.9 $ (1,565.7) $ 71,951.7
================================================================================================
(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.
18
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.
19
Loews and Carolina Group
Consolidating Condensed Statement of Income Information
Carolina Group Adjustments
Three Months Ended ---------------------------------- Loews and
June 30, 2004 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $ 2,105.3 $ 2,105.3
Investment income,
net $ 5.7 $ 0.3 $ 6.0 431.7 $ (39.8) (a) 397.9
Investment gains 0.6 0.6 103.2 103.8
Manufactured products 868.1 868.1 31.2 899.3
Other 0.2 0.2 408.0 408.2
- -----------------------------------------------------------------------------------------------
Total 874.6 0.3 874.9 3,079.4 (39.8) 3,914.5
- ------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders'
benefits 1,624.5 1,624.5
Amortization of
deferred acquisition
costs 307.1 307.1
Cost of manufactured
products sold 532.3 532.3 15.1 547.4
Other operating
expenses 103.4 0.2 103.6 702.4 806.0
Interest 39.8 39.8 73.5 (39.8) (a) 73.5
- ------------------------------------------------------------------------------------------------
Total 635.7 40.0 675.7 2,722.6 (39.8) 3,358.5
- ------------------------------------------------------------------------------------------------
238.9 (39.7) 199.2 356.8 556.0
- ------------------------------------------------------------------------------------------------
Income tax (benefit)
expense 93.3 (15.5) 77.8 45.4 123.2
Minority interest 25.5 25.5
- ------------------------------------------------------------------------------------------------
Total 93.3 (15.5) 77.8 70.9 148.7
- ------------------------------------------------------------------------------------------------
Income from operations 145.6 (24.2) 121.4 285.9 407.3
Equity in earnings
of the Carolina Group 80.8 (80.8) (b)
- ------------------------------------------------------------------------------------------------
Net income $ 145.6 $ (24.2) $ 121.4 $ 366.7 $ (80.8) $ 407.3
================================================================================================
(a) To eliminate interest on the intergroup notional debt.
(b) To eliminate the Loews Group's intergroup interest in the earnings of the Carolina Group.
20
Loews and Carolina Group
Consolidating Condensed Statement of Income Information
Carolina Group Adjustments
Three Months Ended ------------------------------------ Loews and
June 30, 2003 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $2,195.6 $2,195.6
Investment income, net $ 10.6 $ 0.6 $ 11.2 481.3 $(47.3)(a) 445.2
Investment (losses) gains (2.1) (2.1) 421.4 419.3
Manufactured products 780.9 780.9 33.4 814.3
Other 365.1 365.1
- ------------------------------------------------------------------------------------------------
Total 789.4 0.6 790.0 3,496.8 (47.3) 4,239.5
- ------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 2,107.7 2,107.7
Amortization of deferred
acquisition costs 481.0 481.0
Cost of manufactured
products sold 461.7 461.7 14.0 475.7
Other operating expenses 113.4 0.1 113.5 683.3 796.8
Interest 47.3 47.3 75.7 (47.3)(a) 75.7
- ------------------------------------------------------------------------------------------------
Total 575.1 47.4 622.5 3,361.7 (47.3) 3,936.9
- ------------------------------------------------------------------------------------------------
214.3 (46.8) 167.5 135.1 302.6
- -----------------------------------------------------------------------------------------------
Income tax expense (benefit) 75.7 (16.6) 59.1 28.9 88.0
Minority interest (0.3) (0.3)
- ------------------------------------------------------------------------------------------------
Total 75.7 (16.6) 59.1 28.6 87.7
- ------------------------------------------------------------------------------------------------
Income from operations 138.6 (30.2) 108.4 106.5 214.9
Equity in earnings of the
Carolina Group 83.4 (83.4)(b)
- ------------------------------------------------------------------------------------------------
Income from continuing
operations 138.6 (30.2) 108.4 189.9 (83.4) 214.9
Discontinued operations
-net (0.1) (0.1)
- ------------------------------------------------------------------------------------------------
Net income $ 138.6 $(30.2) $ 108.4 $ 189.8 $(83.4) $ 214.8
================================================================================================
(a) To eliminate interest on the intergroup notional debt.
(b) To eliminate the Loews Group's intergroup interest in the earnings of the Carolina Group.
21
Loews and Carolina Group
Consolidating Condensed Statement of Income Information
Carolina Group Adjustments
Six Months Ended ---------------------------------- Loews and
June 30, 2004 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $ 4,272.3 $ 4,272.3
Investment income,
net $ 13.7 $ 0.7 $ 14.4 957.2 $ (80.1) (a) 891.5
Investment gains
(losses) 0.6 0.6 (313.0) (312.4)
Manufactured products 1,636.0 1,636.0 71.5 1,707.5
Other 846.8 846.8
- -----------------------------------------------------------------------------------------------
Total 1,650.3 0.7 1,651.0 5,834.8 (80.1) 7,405.7
- ------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders'
benefits 3,262.9 3,262.9
Amortization of
deferred acquisition
costs 740.3 740.3
Cost of manufactured
products sold 999.6 999.6 35.3 1,034.9
Other operating
expenses 203.0 0.3 203.3 1,357.5 1,560.8
Interest 80.1 80.1 172.6 (80.1) (a) 172.6
- ------------------------------------------------------------------------------------------------
Total 1,202.6 80.4 1,283.0 5,568.6 (80.1) 6,771.5
- ------------------------------------------------------------------------------------------------
447.7 (79.7) 368.0 266.2 634.2
- ------------------------------------------------------------------------------------------------
Income tax (benefit)
expense 174.7 (31.1) 143.6 25.0 168.6
Minority interest 14.7 14.7
- ------------------------------------------------------------------------------------------------
Total 174.7 (31.1) 143.6 39.7 183.3
- ------------------------------------------------------------------------------------------------
Income from operations 273.0 (48.6) 224.4 226.5 450.9
Equity in earnings
of the Carolina Group 149.4 (149.4) (b)
- ------------------------------------------------------------------------------------------------
Net income $ 273.0 $ (48.6) $ 224.4 $ 375.9 $ (149.4) $ 450.9
================================================================================================
(a) To eliminate interest on the intergroup notional debt.
(b) To eliminate the Loews Group's intergroup interest in the earnings of the Carolina Group.
22
Loews and Carolina Group
Consolidating Condensed Statement of Income Information
Carolina Group Adjustments
Six Months Ended ---------------------------------- Loews and
June 30, 2003 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $4,575.8 $4,575.8
Investment income,
net $ 18.5 $ 1.2 $ 19.7 977.6 $ (95.5)(a) 901.8
Investment (losses)
gains (1.8) (1.8) 325.5 323.7
Manufactured products 1,625.1 1,625.1 73.2 1,698.3
Other (0.2) (0.2) 685.9 685.7
- ------------------------------------------------------------------------------------------------
Total 1,641.6 1.2 1,642.8 6,638.0 (95.5) 8,185.3
- ------------------------------------------------------------------------------------------------
Expenses:
Insurance claims
and policyholders'
benefits 3,977.9 3,977.9
Amortization of deferred
acquisition costs 939.2 939.2
Cost of manufactured
products sold 921.4 921.4 35.5 956.9
Other operating
expenses 254.6 0.2 254.8 1,322.1 1,576.9
Interest 95.5 95.5 149.4 (95.5)(a) 149.4
- ------------------------------------------------------------------------------------------------
Total 1,176.0 95.7 1,271.7 6,424.1 (95.5) 7,600.3
- ------------------------------------------------------------------------------------------------
465.6 (94.5) 371.1 213.9 585.0
- -----------------------------------------------------------------------------------------------
Income tax expense
(benefit) 173.5 (35.2) 138.3 42.8 181.1
Minority interest (1.3) (1.3)
- ------------------------------------------------------------------------------------------------
Total 173.5 (35.2) 138.3 41.5 179.8
- ------------------------------------------------------------------------------------------------
Income from operations 292.1 (59.3) 232.8 172.4 405.2
Equity in earnings
of the Carolina Group 179.2 (179.2)(b)
- ------------------------------------------------------------------------------------------------
Income from continuing
operations 292.1 (59.3) 232.8 351.6 (179.2) 405.2
Discontinued
operations-net (0.4) (0.4)
- ------------------------------------------------------------------------------------------------
Net income $ 292.1 $(59.3) $ 232.8 $ 351.2 $(179.2) $ 404.8
================================================================================================
(a) To eliminate interest on the intergroup notional debt.
(b) To eliminate the Loews Group's intergroup interest in the earnings of the Carolina Group.
23
Loews and Carolina Group
Consolidating Condensed Statement of Cash Flows Information
Carolina Group Adjustments
Six Months Ended ---------------------------------- Loews and
June 30, 2004 Lorillard Other Consolidated Group Eliminations Total
- ------------------------------------------------------------------------------------------------
(In millions)
Net cash (used)
provided by
operating
activities $ 184.9 $ (49.6) $ 135.3 $ 1,107.0 $ (105.0) $ 1,137.3
- ------------------------------------------------------------------------------------------------
Investing activities:
Purchases of property
and equipment (33.3) (33.3) (91.2) (124.5)
Change in short-term
investments 108.5 108.5 5,152.9 5,261.4
Other investing
activities 0.4 0.4 (5,854.3) (51.7) (5,905.6)
- ------------------------------------------------------------------------------------------------
75.6 75.6 (792.6) (51.7) (768.7)
- ------------------------------------------------------------------------------------------------
Financing activities:
Dividends paid to
shareholders (259.0) 101.2 (157.8) (55.6) 105.0 (108.4)
Reduction of
intergroup notional
debt (51.7) (51.7) 51.7
Other financing
activities (250.3) (250.3)
- ------------------------------------------------------------------------------------------------
(259.0) 49.5 (209.5) (305.9) 156.7 (358.7)
- ------------------------------------------------------------------------------------------------
Net change in cash 1.5 (0.1) 1.4 8.5 9.9
Cash, beginning of
period 1.5 0.4 1.9 178.9 180.8
- ------------------------------------------------------------------------------------------------
Cash, end of period $ 3.0 $ 0.3 $ 3.3 $ 187.4 $ 190.7
================================================================================================
24
Loews and Carolina Group
Consolidating Condensed Statement of Cash Flows Information
Carolina Group Adjustments
Six Months Ended ---------------------------------- Loews and
June 30, 2003 Lorillard Other Consolidated Group Eliminations Total
- -----------------------------------------------------------------------------------------------
(In millions)
Net cash provided (used)
by operating activities $ 289.8 $ (58.9) $ 230.9 $ 463.8 $(120.1) $ 574.6
- ------------------------------------------------------------------------------------------------
Investing activities:
Purchases of property
and equipment (27.8) (27.8) (261.9) (289.7)
Change in short-term
investments 54.4 0.5 54.9 1,382.2 1,437.1
Other investing
activities (1,659.4) (102.1) (1,761.5)
- ------------------------------------------------------------------------------------------------
26.6 0.5 27.1 (539.1) (102.1) (614.1)
- ------------------------------------------------------------------------------------------------
Financing activities:
Dividends paid to
shareholders (317.0) 160.9 (156.1) (55.6) 120.1 (91.6)
Reduction of
intergroup notional
debt (102.1) (102.1) 102.1
Other financing
activities 133.4 133.4
- ------------------------------------------------------------------------------------------------
(317.0) 58.8 (258.2) 77.8 222.2 41.8
- ------------------------------------------------------------------------------------------------
Net change in cash (0.6) 0.4 (0.2) 2.5 2.3
Cash, beginning of
period 2.0 0.2 2.2 183.2 185.4
- ------------------------------------------------------------------------------------------------
Cash, end of period $ 1.4 $ 0.6 $ 2.0 $ 185.7 $ 187.7
================================================================================================
25
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 net investment income, was $56.2
and $93.5 million for the three months ended June 30, 2004 and 2003, and
$106.0 and $140.2 million for the six months ended June 30, 2004 and 2003. The
amount subject to interest crediting rates on such contracts was $2,696.0 and
$2,789.0 million at June 30, 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.
The following table summarizes the amounts receivable from reinsurers at
June 30, 2004 and December 31, 2003.
Components of reinsurance receivables June 30, 2004 December 31, 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Reinsurance receivables related to insurance reserves:
Ceded claim and claim adjustment expense $ 14,135.2 $ 14,215.9
Ceded future policy benefits 1,229.1 1,218.2
Ceded policyholders' funds 68.1 6.6
Billed reinsurance receivables 722.5 813.1
- ------------------------------------------------------------------------------------------------
Reinsurance receivables 16,154.9 16,253.8
Allowance for uncollectible reinsurance (503.6) (572.6)
- ------------------------------------------------------------------------------------------------
Reinsurance receivables, net of allowance
for uncollectible reinsurance $ 15,651.3 $ 15,681.2
================================================================================================
CNA has established an allowance for uncollectible reinsurance. The
allowance for uncollectible reinsurance was $503.6 and $572.6 million at June
30, 2004 and December 31, 2003. The net decrease in the allowance for
uncollectible reinsurance was primarily due to a release of a previously
established allowance related to the Trenwick Group resulting from the
finalization of commutation agreements in the second quarter of 2004,
partially offset by a net increase in the allowance for other reinsurance
receivables. The expenses incurred related to uncollectible reinsurance
26
receivables are presented as a component of "Insurance claims and
policyholders' benefits" on the Consolidated Condensed Statements of Income.
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.
The effects of reinsurance on earned premiums are shown in the following
table.
Assumed/
Direct Assumed Ceded Net Net%
------------------------------------------------------
Six Months Ended June 30, 2004
------------------------------------------------------
(In millions)
Property and casualty $5,393.0 $ 127.0 $1,758.0 $ 3,762.0 3.4%
Accident and health 657.0 26.0 291.0 392.0 6.6
Life 323.0 205.0 118.0
------------------------------------------------------
Total earned premiums $6,373.0 $ 153.0 $2,254.0 $ 4,272.0 3.6%
======================================================
Six Months Ended June 30, 2003
------------------------------------------------------
Property and casualty $5,281.0 $ 376.0 $2,222.0 $ 3,435.0 10.9%
Accident and health 788.0 55.0 29.0 814.0 6.8
Life 529.0 9.0 211.0 327.0 2.8
------------------------------------------------------
Total earned premiums $6,598.0 $ 440.0 $2,462.0 $ 4,576.0 9.6%
======================================================
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. This rate
will increase to 8.25% per annum commencing in 2006. The aggregate loss ratio
for the three-year period has exceeded certain thresholds which require
additional ceded premiums. During the second quarter of 2004, CNA recorded
27
$3.0 million of ceded premiums under this provision. The aggregate limits
under both sections of the Aggregate Cover were fully utilized in 2003.
The pretax impact of the Aggregate Cover was as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------
2004 2003 2004 2003
- -----------------------------------------------------------------------------------------------
(In millions)
Ceded earned premiums $ (3.0) $(28.0) $ (3.0) $(28.0)
Ceded claim and claim adjustment expense 78.0 78.0
Interest charges (22.0) (22.0) (42.0) (35.0)
- ------------------------------------------------------------------------------------------------
Pretax benefit (expense) $(25.0) $ 28.0 $(45.0) $ 15.0
================================================================================================
In 2001, CNA entered into a one-year aggregate reinsurance treaty related to
the 2001 accident year covering substantially all property and casualty lines
of business in the Continental Casualty Company pool (the "CCC Cover"). The
loss protection provided by the CCC Cover has an aggregate limit of
approximately $761.0 million of ceded losses. The ceded premiums are a
percentage of ceded losses. The ceded premium related to full utilization of
the $761.0 million of limit is $456.0 million. The CCC Cover provides
continuous coverage in excess of the second section of the Aggregate Cover
discussed above. Under the CCC Cover, interest charges on the funds withheld
generally accrue at 8.0% per annum. The interest rate increases to 10.0% per
annum if the aggregate loss ratio exceeds certain thresholds. During 2003, the
aggregate limits under the CCC Cover were fully utilized.
The pretax impact of the CCC Cover was as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Ceded earned premiums $(91.0) $(91.0)
Ceded claim and claim adjustment expense 126.0 126.0
Interest charges $ (11.0) (27.0) $(22.0) (35.0)
- -----------------------------------------------------------------------------------------------
Pretax benefit (expense) $ (11.0) $ 8.0 $(22.0) $
================================================================================================
28
6. Receivables
June 30, December 31,
2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Reinsurance $16,154.9 $16,253.8
Other insurance 2,907.0 3,070.4
Security sales 2,521.1 890.7
Accrued investment income 328.7 343.3
Federal income taxes 517.4
Other 308.7 348.4
- -----------------------------------------------------------------------------------------------
Total 22,220.4 21,424.0
Less: Allowance for doubtful accounts on reinsurance receivables 503.6 572.6
Allowance for other doubtful accounts and cash discounts 393.3 383.5
- -----------------------------------------------------------------------------------------------
Receivables-net $21,323.5 $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.
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.
29
Asbestos, Environmental Pollution and Mass Tort ("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 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 regularly performs ground up reviews of all open APMT claims to evaluate
the adequacy of the CNA's APMT reserves. In performing its comprehensive
ground up analysis, the Company 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.
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
30
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:
June 30, 2004 December 31, 2003
- ------------------------------------------------------------------------------------------------
Environmental Environmental
Pollution and Pollution and
Asbestos Mass Tort Asbestos Mass Tort
- ------------------------------------------------------------------------------------------------
(In millions)
Gross reserves $ 3,282.0 $ 812.0 $ 3,347.0 $ 839.0
Ceded reserves (1,541.0) (288.0) (1,580.0) (262.0)
- ------------------------------------------------------------------------------------------------
Net reserves $ 1,741.0 $ 524.0 $ 1,767.0 $ 577.0
================================================================================================
Abestos
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
31
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 June 30, 2004 and December 31, 2003, CNA carried approximately
$1,741.0 and $1,767.0 million of claim and claim adjustment expense reserves,
net of reinsurance recoverables, for reported and unreported asbestos-related
claims. CNA recorded $40.0 million of unfavorable asbestos-related net claim
and claim adjustment expense reserve development for the six months ended June
30, 2004 and no asbestos-related net claim and claim adjustment expense
development for the same period in 2003. The unfavorable net prior year
development was primarily related to a commutation loss related to The
Trenwick Group Ltd. ("Trenwick"). See Note 5 for further details. CNA paid
asbestos-related claims, net of reinsurance recoveries, of $66.0 and $70.0
million for the six months ended June 30, 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.
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
32
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 76,800 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
two Ohio actions, plaintiffs allege the defendants negligently performed
duties undertaken to protect workers and the public from the effects of
asbestos (Varner v. Ford Motor Co., et al. (Cuyahoga County, Ohio) and
Peplowski v. Ace American Ins. Co., et al. (U.S.D.C. N.D. Ohio)). The state
trial court recently granted insurers, including CNA, summary judgment against
a representative group of plaintiffs, ruling that insurers had no duty to warn
plaintiffs about asbestos. 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.
33
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
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
34
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
half 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 June 30, 2004 and December 31, 2003, CNA carried approximately $524.0
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 six months
ended June 30, 2004 and 2003. CNA paid environmental pollution-related claims
and mass tort-related claims, net of reinsurance recoveries, of $59.0 and
$36.0 million for the six months ended June 30, 2004 and 2003. Additionally,
CNA recorded $6.0 million of current accident year losses related to mass tort
in the second quarter of 2004.
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
35
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 tort reform. The most significant silica exposures identified to
date include a relatively small number of accounts with significant numbers of
new claims reported in 2003 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 liabilities, impede CNA's ability to
estimate its ultimate liability for such claims.
Net Prior Year Development
Unfavorable net prior year development of $146.0 million, including $255.0
million of unfavorable claim and allocated claim adjustment expense reserve
development and $109.0 million of favorable premium development, was recorded
for the six months ended June 30, 2004. Unfavorable net prior year development
of $534.0 million, including $370.0 million of unfavorable claim and allocated
claim adjustment expense reserve development and $164.0 million of unfavorable
premium development, was recorded for the same period in 2003. The gross
carried claim and claim adjustment expense reserves for CNA were $31,563.0 and
$31,730.0 million at June 30, 2004 and December 31, 2003. The net carried
claim and claim adjustment expense reserves for CNA were $17,428.0 and
$17,514.0 million at June 30, 2004 and December 31, 2003.
Standard Lines
Unfavorable net prior year development of $7.0 million, including $113.0
million of unfavorable claim and allocated claim adjustment expense reserve
development and $106.0 million of favorable premium development, was recorded
for the six months ended June 30, 2004 for Standard Lines. Unfavorable net
prior year development of $314.0 million, including $134.0 million of
unfavorable claim and allocated claim adjustment expense reserve development
and $180.0 million of unfavorable premium development, was recorded for the
same period in 2003. The gross and net carried claim and claim adjustment
expense reserves were $14,275.0 and $9,083.0 million at June 30, 2004. The
gross and net carried claim and claim adjustment expense reserves for Standard
Lines were $14,282.0 and $8,967.0 million at December 31, 2003.
In the second quarter of 2004, CNA finalized commutation agreements with
several members of the Trenwick Group. These commutations resulted in
unfavorable claim and claim adjustment expense reserve development which was
more than offset by a release of a previously established allowance for
uncollectible reinsurance.
In addition, approximately $75.0 million of unfavorable net prior year claim
and allocated claim adjustment expense development recorded in the second
quarter of 2004 resulted from increased severity trends for workers
compensation on large account policies primarily in accident years 2002 and
prior. Favorable premium development on retrospectively rated large account
policies of $25.0 million was recorded in relation to this unfavorable net
prior year claim and allocated claim adjustment expense development. Also,
36
favorable net prior year premium development of approximately $60.0 million
resulted primarily from higher audit and endorsement premiums on workers
compensation and general liability policies. Approximately $30.0 million of
the unfavorable net prior year claim and allocated claim adjustment expense
reserve development was recorded related to the higher audit and endorsement
premium.
The following discusses net prior year development for Standard Lines
recorded for the six months ended June 30, 2003.
Unfavorable net prior year development of approximately $310.0 million,
including $233.0 million of unfavorable claim and allocated claim adjustment
expense reserve development and $77.0 million of unfavorable premium
development, was recorded for large account business, driven by workers
compensation exposures. This development resulted from the completion of
reserve reviews for large account business where the insured is often
responsible for a portion of the losses and claims are handled by CNA. The
review did not cover the large account business where the claims are handled
by a third-party administrator. Initial reserves for this business are set
based on the expected losses associated with the individual accounts covered
and the terms of the individual plans. Based on analyses completed during the
second quarter of 2003, it became apparent that the assumptions regarding the
number and size of the losses, which were used to estimate the expected
losses, were no longer appropriate. The analysis showed that the actual number
of claims and the average claim size were larger than expected. The
development was recorded in accident years prior to 2002.
Approximately $21.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development resulted from a program
covering facilities that provide services to developmentally disabled
individuals. The development was due to an increase in the size of known
claims and increases in policyholder defense costs. The reserve development
was recorded in accident years prior to 2001.
Approximately $25.0 million of unfavorable net prior year premium
development was recorded related to a second quarter 2003 reevaluation of
losses ceded to a reinsurance contract covering middle market workers
compensation exposures. The reevaluation of losses led to a new estimate of
the number and dollar amount of claims that would be ceded under the
reinsurance contract. As a result of the reevaluation of losses, CNA recorded
approximately $36.0 million of unfavorable claim and allocated claim
adjustment expense reserve development, which was ceded under the contract.
The development was recorded in accident year 2000.
Unfavorable net prior year claim and allocated claim adjustment expense
reserve development of approximately $36.0 million was recorded for a program
covering tow truck and ambulance operators, primarily impacting the 2001
accident year. CNA had previously expected that loss ratios for this business
would be similar to its middle market commercial automobile liability
business. During 2002, CNA ceased writing business under this program.
Offsetting these unfavorable developments was a $75.0 million underwriting
benefit from cessions to corporate aggregate reinsurance treaties. The benefit
is comprised of $180.0 million of ceded losses and $105.0 million of ceded
premiums for accident years 2000 and 2001. See Note 5 for further discussion.
Favorable prior year claim and allocated claim adjustment expense reserve
development was also recorded in property lines during 2003. The favorable
37
reserve development was principally from accident years 2001 and 2002 and was
the result of the lower than expected number of large losses in recent years.
Specialty Lines
Unfavorable net prior year development of $60.0 million, including $74.0
million of unfavorable net claim and allocated claim adjustment expense
reserve development and $14.0 million of favorable premium development, was
recorded for the six months ended June 30, 2004 for Specialty Lines.
Unfavorable net prior year development of $92.0 million, including $99.0
million of unfavorable net claim and allocated claim adjustment expense
reserve development and $7.0 million of favorable premium development, was
recorded for the same period in 2003. The gross and net carried claim and
claim adjustment expense reserves were $4,576.0 and $3,130.0 million at June
30, 2004. The gross and net carried claim and claim adjustment expense
reserves for Specialty Lines were $4,200.0 and $2,919.0 million at December
31, 2003.
In the second quarter of 2004, CNA finalized commutation agreements with
several members of the Trenwick Group. These commutations resulted in
unfavorable claim and claim adjustment expense reserve development which was
more than offset by a release of a previously established allowance for
uncollectible reinsurance. The remaining unfavorable net prior year claim and
allocated claim adjustment expense reserve development was principally the
result of the increased emergence of several large directors and officers
("D&O") claims primarily in recent accident years.
The following discusses net prior year development for Specialty Lines
recorded for the six months ended June 30, 2003.
Approximately $50.0 million of unfavorable net prior year claim and
allocated claim adjustment expense reserve development was recorded for
directors and officers exposures. The reserve development was a result of a
claims review that was completed during the second quarter of 2003. The
unfavorable net prior year reserve development was primarily due to securities
class action cases related to certain known corporate malfeasance cases and
investment banking firms. The reserve development was recorded primarily in
accident years 2001 and 2002.
Approximately $37.0 million of losses were recorded as the result of a
commutation of three ceded reinsurance treaties covering CNA HealthPro,
relating to accident years 1999 through 2001. Approximately $21.0 million of
unfavorable net prior year claim and allocated claim adjustment expense
reserve development was recorded in the Surety line of business as the result
of developments on one large claim.
Other Insurance
Unfavorable net prior year development of $64.0 million, including $53.0
million of net unfavorable claim and allocated claim adjustment expense
reserve development and $11.0 million of unfavorable premium development was
recorded for the six months ended June 30, 2004 for other insurance.
Unfavorable net prior year development of $115.0 million, including $124.0
million of net unfavorable claim and allocated claim adjustment expense
reserve development and $9.0 million of favorable premium development was
recorded for the same period in 2003. The gross and net carried claim and
claim adjustment expense reserves were $8,979.0 and $3,391.0 million at June
30, 2004. The gross and net carried claim and claim adjustment expense
38
reserves for other insurance were $9,672.0 and $3,737.0 million at December
31, 2003.
In the second quarter of 2004, CNA finalized commutation agreements with
several members of the Trenwick Group. These commutations resulted in
unfavorable net prior year development partially offset by a release of a
previously established allowance for uncollectible reinsurance.
The following discusses net prior year development for Other Insurance
recorded for the six months ended June 30, 2003.
Unfavorable net prior year claim and allocated claim adjustment expense
reserve development of approximately $75.0 million was recorded related to an
adverse arbitration decision involving a single large property and business
interruption loss. The decision was rendered against a voluntary insurance
pool in which CNA was a participant. The loss was caused by a fire which
occurred in 1995. CNA no longer participates in this pool.
Unfavorable net prior year claim and allocated claim adjustment expense
reserve development of approximately $25.0 million was recorded in CNA Re
primarily for directors and officers exposures. The reserve development was a
result of a claims review that was completed during the second quarter of
2003. The unfavorable net prior year reserve development was primarily due to
securities class action cases related to certain known corporate malfeasance
cases and investment banking firms. The reserve development was recorded in
accident years 2000 and 2001.
Offsetting this unfavorable development was a $10.0 million underwriting
benefit from cessions to corporate aggregate reinsurance treaties. The benefit
is comprised of $24.0 million of ceded losses and $14.0 million of ceded
premiums for accident years 2000 and 2001. See Note 5 for further discussion.
8. Shareholders' Equity
June 30, 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 - 185,489,600 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 1,514.6 1,513.7
Earnings retained in the business 8,944.6 8,602.1
Accumulated other comprehensive income 43.6 760.2
- -----------------------------------------------------------------------------------------------
10,688.9 11,062.0
Less treasury stock, at cost (340,000 shares of Carolina Group stock) 7.7 7.7
- -----------------------------------------------------------------------------------------------
Total shareholders' equity $10,681.2 $11,054.3
===============================================================================================
39
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.
June 30, 2003
---------------------------------------------
Three Months Ended Six Months Ended
---------------------------------------------
(In millions, except per share data)
Total revenues $4,269.9 $8,301.5
Income from continuing operations 219.3 438.7
Net income 219.2 438.3
Income per share of Loews common stock:
Income from continuing operations 1.05 2.08
Net income 1.05 2.07
================================================================================================
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.
Individual Life Sale
On April 30, 2004, CNA completed the sale of its individual life insurance
business to Swiss Re for approximately $700.0 million. The business sold
included term, universal and permanent life insurance policies and individual
annuity products. CNA's individual long term care and structured settlement
businesses were excluded from the sale. Swiss Re acquired Valley Forge Life
Insurance Company ("VFL"), a wholly owned subsidiary of CAC, and CNA's
Nashville, Tennessee insurance servicing and administration building as part
of the sale. In connection with the sale, CNA entered into a reinsurance
agreement in which CAC ceded its individual life insurance business to Swiss
Re on a 100.0% indemnity reinsurance basis. As a result of this reinsurance
agreement, approximately $1.0 billion of future policy benefit reserves were
ceded to Swiss Re. The Company recorded a realized investment loss of $53.0
million pretax ($15.5 million gain after-tax and minority interest) and $618.6
million pretax loss ($352.9 million after-tax and minority interest) for the
three and six months ended June 30, 2004. An estimated impairment loss was
recorded in the first quarter of 2004 in anticipation of the pending sale. The
disproportionate income tax provision on the loss related to the life sale for
40
the three months ended June 30, 2004 arose from a change in estimate related
to the estimated tax benefit recorded at March 31, 2004. The change in
estimate is due to the completion of a formal study of the final tax basis of
VFL.
Swiss Re assumed assets and liabilities of $6.6 and $5.2 billion at April
30, 2004. The assets and liabilities of the individual life business sold were
$6.6 and $5.4 billion at December 31, 2003. The revenues of the individual
life business through the sale date were $(9.0) and $173.0 million for the
three months ended June 30, 2004 and 2003, and $151.0 and $306.0 million for
the six months ended June 30, 2004 and 2003. The net results for this business
through the sale date were a loss of $12.8 million and net income of $18.9
million for the three months ended June 30, 2004 and 2003 and a loss of $5.5
and net income of $3.6 million for the six months ended June 30, 2004 and
2003.
Group Benefits Sale
On December 31, 2003, CNA completed the sale of the majority of its group
benefits business through the sale of CNA Group Life Assurance Company
("CNAGLA") to Hartford Financial Services Group, Inc. ("Hartford"). 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. In connection with the sale, CNA
received consideration of approximately $530.0 million and recorded an after-
tax realized investment loss on the sale of $109.1 million ($163.0 million
pretax) including an after tax and minority interest realized investment gain
of $7.3 million ($13.0 million pretax) recorded in the second quarter of 2004.
As a result of this agreement, Hartford assumed assets and liabilities of
$2.4 and $1.6 billion at December 31, 2003. The revenues of the group benefits
business were $316.0 and $596.0 million for the three and six months ended
June 30, 2003. Net income was $16.2 and $13.5 million for the three and six
months ended June 30, 2003.
Personal Insurance Transaction
As part of the sale of CNA's personal insurance business to The Allstate
Corporation on October 1, 1999, CNA shared in claim and allocated claim
adjustment expenses if payments related to losses incurred prior to October 1,
1999 on the CNA policies transferred to Allstate exceeded 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 claim 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 results of operations of the
Company for the three and six months ended June 30, 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.
41
CNA's insurance subsidiaries are domiciled in various jurisdictions. These
subsidiaries prepare statutory financial statements in accordance with
accounting practices prescribed or permitted by the respective jurisdictions'
insurance regulators. Prescribed statutory accounting practices are set forth
in a variety of publications of the NAIC as well as state laws, regulations
and general administrative rules.
CNA follows a permitted practice that allows CIC to classify voluntary pools
that are unauthorized in South Carolina but were classified as authorized in
New Hampshire, CIC's former state of domicile, as authorized in order to allow
credit for the related reinsurance balances. Due to CIC's redomestication to
South Carolina effective January 1, 2004, this permitted practice was
requested and has been granted through the period ended December 31, 2004, and
is intended to allow CIC time to pursue the authorization of certain
reinsurers on a South Carolina basis. The impact of this permitted practice
was to increase statutory surplus by approximately $348.0 million at June 30,
2004.
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 June 30, 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. As of June 30, 2004, there is approximately $55.0 million of
dividend capacity available.
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.
42
Statutory Captial Statutory Net Income (Loss)
and Surplus --------------------------------------------------------
-------------------- Three Months ended June 30, Six Months Ended June 30,
June 30, December 31, -------------------------- ---------------------------
Unaudited 2004 2003 2004 2003 2004 2003
- ------------------------------------- ---------------------------------------------------------
(In millions)
Property and
casualty
companies $6,563.0 $6,170.0 $ 139.0 $ (59.0) $ 377.0
Life insurance
companies (a) 1,238.0 707.0 376.0 30.0 679.0 $ (62.0)
- ------------------------------------------------------------------------------------------------
(a) The December 31, 2003 Statutory Capital and Surplus includes the individual life insurance
business which was sold on April 30, 2004. The Statutory Net Income (Loss) for the three and
six months ended June 30, 2004 and 2003 includes the individual life insurance business. The
Statutory Net Income (Loss) for the three and six months ended June 30, 2003 includes the
group benefits business sold on December 31, 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.
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.
43
Net periodic benefit cost components:
Pension Benefits
- ------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
- ------------------------------------------------------------------------------------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Service cost $ 20.3 $ 13.2 $ 35.3 $ 26.4
Interest cost 92.3 51.6 152.5 103.2
Expected return on plan assets (101.1) (54.2) (165.5) (108.4)
Amortization of unrecognized net loss (gain) 0.7 0.3 1.4 0.7
Amortization of unrecognized prior service cost 2.7 2.2 4.6 4.5
Actuarial loss 3.2 1.6 9.9 3.2
- ------------------------------------------------------------------------------------------------
Net periodic benefit cost $ 18.1 $ 14.7 $ 38.2 $ 29.6
================================================================================================
Other Postretirement Benefits
- ------------------------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
- ------------------------------------------------------------------------------------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Service cost $ 4.1 $ 3.2 $ 7.8 $ 6.4
Interest cost 17.2 9.4 28.2 18.9
Expected return on plan assets (1.3) (0.8) (2.6) (1.6)
Amortization of unrecognized net loss (gain) (0.2) (0.9) (0.4) (1.8)
Amortization of unrecognized prior service cost (12.7) (4.5) (18.1) (9.0)
Actuarial loss 1.3 1.1 2.9 2.1
- ------------------------------------------------------------------------------------------------
Net periodic benefit cost $ 8.4 $ 7.5 $ 17.8 $ 15.0
================================================================================================
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 decisions 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
44
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. 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.
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; and 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
45
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.
46
The following tables set forth the Company's consolidated revenues and
income (loss) by business segment:
Three Months Ended Six Months Ended
June 30, June 30,
- ------------------------------------------------------------------------------------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues (a):
CNA Financial:
Standard Lines $ 1,542.1 $ 1,368.0 $ 3,034.8 $ 2,794.2
Specialty Lines 686.7 600.3 1,323.4 1,098.0
Life and Group Non-core 313.8 902.2 321.7 1,627.9
Other Insurance 121.1 237.8 251.4 433.7
- ------------------------------------------------------------------------------------------------
Total CNA Financial 2,663.7 3,108.3 4,931.3 5,953.8
Lorillard 873.8 791.5 1,649.5 1,643.4
Loews Hotels 86.3 74.6 167.0 147.6
Diamond Offshore 187.7 167.9 373.6 319.9
Texas Gas 52.1 23.1 138.1 23.1
Corporate and other 50.9 74.1 146.2 97.5
- ------------------------------------------------------------------------------------------------
Total $ 3,914.5 $ 4,239.5 $ 7,405.7 $ 8,185.3
================================================================================================
Pretax income (loss)(a):
CNA Financial:
Standard Lines $ 203.2 $ (36.5) $ 409.8 $ 20.5
Specialty Lines 149.0 46.1 282.4 122.9
Life and Group Non-core (100.6) 107.3 (634.9) 45.7
Other Insurance 83.0 (25.3) 111.4 10.5
- ------------------------------------------------------------------------------------------------
Total CNA Financial 334.6 91.6 168.7 199.6
Lorillard 238.3 216.4 447.1 467.4
Loews Hotels 13.0 9.2 24.3 17.7
Diamond Offshore (14.4) (18.9) (30.5) (47.7)
Texas Gas 8.4 2.6 51.5 2.6
Corporate and other (23.9) 1.7 (26.9) (54.6)
- ------------------------------------------------------------------------------------------------
Total $ 556.0 $ 302.6 $ 634.2 $ 585.0
================================================================================================
Net income (loss)(a):
CNA Financial:
Standard Lines $ 135.1 $ (10.5) $ 273.4 $ 31.4
Specialty Lines 90.1 27.9 170.6 72.6
Life and Group Non-core (11.0) 65.5 (357.4) 30.6
Other Insurance 57.2 (8.6) 76.8 19.2
- ------------------------------------------------------------------------------------------------
Total CNA Financial 271.4 74.3 163.4 153.8
Lorillard 145.2 140.0 272.6 293.3
Loews Hotels 7.9 5.8 14.8 11.2
Diamond Offshore (6.7) (9.3) (13.6) (21.4)
Texas Gas 5.0 1.6 31.0 1.6
Corporate and other (15.5) 2.5 (17.3) (33.3)
- ------------------------------------------------------------------------------------------------
Income from continuing operations 407.3 214.9 450.9 405.2
Discontinued operations-net (0.1) (0.4)
- ------------------------------------------------------------------------------------------------
Total $ 407.3 $ 214.8 $ 450.9 $ 404.8
================================================================================================
47
(a) Investment gains (losses) included in Revenues, Pretax income (loss) and
Net income (loss) are as follows:
Three Months Ended Six Months Ended
June 30, June 30,
- ------------------------------------------------------------------------------------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Revenues and pretax income (loss):
CNA Financial:
Standard Lines $ 77.5 $ 184.4 $ 134.4 $ 191.4
Specialty Lines 29.3 59.4 49.6 62.3
Life and Group Non-core (56.3) 53.7 (614.7) (50.7)
Other Insurance 55.3 91.2 81.5 109.6
- ------------------------------------------------------------------------------------------------
Total CNA Financial 105.8 388.7 (349.2) 312.6
Corporate and other (2.0) 30.6 36.8 11.1
- ------------------------------------------------------------------------------------------------
Total $ 103.8 $ 419.3 $(312.4) $ 323.7
================================================================================================
Net income (loss):
CNA Financial:
Standard Lines $ 45.9 $ 110.2 $ 80.1 $ 112.4
Specialty Lines 16.8 34.7 28.7 35.9
Life and Group Non-core 13.3 31.4 (350.6) (29.7)
Other Insurance 32.8 54.1 48.4 67.9
- ------------------------------------------------------------------------------------------------
Total CNA Financial 108.8 230.4 (193.4) 186.5
Corporate and other (1.4) 20.3 23.8 7.6
- ------------------------------------------------------------------------------------------------
Total $ 107.4 $ 250.7 $(169.6) $ 194.1
================================================================================================
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.
48
Some of these premiums were received from John Hancock Financial Services,
Inc. ("John Hancock"). CNA is aware that a number of reinsurers with workers
compensation carve-out insurance exposure, including John Hancock, have
disavowed their obligations under various legal theories. If one or more such
companies are successful in avoiding or reducing their liabilities, then it is
likely that CNA's potential liability will also be reduced. Moreover, based on
information known at this time, CNA believes it has strong grounds to
successfully challenge its alleged exposure on a substantial portion of its
United States workers compensation carve-out business, including all purported
exposure derived from John Hancock, through legal action.
As noted, CNA arranged substantial reinsurance protection to manage its
exposures under the IGI Program. CNA believes it has valid and enforceable
reinsurance contracts with the AAHRU Facility and other reinsurers with
respect to the IGI Program, including the United States workers compensation
carve-out business. However, certain reinsurers have disputed their
liabilities to CNA, and CNA has commenced arbitration proceedings against such
reinsurers. CNA has resolved its dispute with respect to the validity and
enforceability of ceding IGI Program losses to the AAHRU Facility, including
the United States workers compensation carve-out business; however, an
arbitration is still pending with certain members of the AAHRU Facility
related to a dispute over the allocation of such losses to pool years. As a
result, CNA increased its insurance reserves related to the IGI program by
$18.0 million in the second quarter of 2004. An arbitration with another
reinsurer is also still pending.
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.
49
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
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 4,200 product liability cases are pending against cigarette
manufacturers in the United States. Lorillard is a defendant in approximately
3,800 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 1,400 cases are pending, including
approximately 1,075 cases against Lorillard. The 1,400 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. One of the cases pending against Lorillard and
other cigarette manufacturers, McLaughlin v. Philip Morris USA, Inc., et al.,
is on behalf of a purported nationwide class composed of purchasers of "light"
cigarettes. Lorillard is not a defendant in approximately 30 additional
"lights" class actions that are pending against other cigarette manufacturers.
"Reimbursement cases" are brought by or on behalf of entities who seek
reimbursement of expenses incurred in providing health care to individuals who
50
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 10 of the 13 pending Reimbursement cases. Lorillard and the
Company also are named as defendants in a case pending in Israel.
Included in this category is the suit filed by the federal government,
United States of America v. Philip Morris USA, Inc., et al., that seeks
disgorgement and injunctive relief. Trial of this matter is scheduled to begin
during September of 2004.
"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 three pending Contribution cases.
Excluding the flight attendant and the consolidated West Virginia suits,
approximately 400 product liability cases are pending against U.S. cigarette
manufacturers. Lorillard is a defendant in approximately 150 of the 400 cases.
The Company, which is not a defendant in any of the flight attendant or the
consolidated West Virginia matters, is a defendant in five 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 1,400 cases are pending
in the United States, including approximately 1,075 cases against Lorillard.
The 1,400 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 two 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 21 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
51
verdict in favor of the plaintiffs was not supported by the evidence and it
entered judgment in the defendant's favor.
Fifteen cases are listed below in which verdicts were returned in favor of
the plaintiffs since January 1, 2002, or defendants' appeals remain pending
from verdicts returned prior to 2002. As of July 16, 2004, appeals were
pending in eleven of these fifteen cases. The four other cases are in various
stages of activity. In one of them, a cigarette manufacturer was unsuccessful
in all of its appeals and has paid the damages awarded by the jury. In another
suit, an appellate court vacated the jury's award and ordered a new trial. In
a third case, all post-trial activity has not been resolved and the time for
the defendants to pursue an appeal has not expired. In the fourth case, no
information is available as to whether the defendant paid the judgment, or
whether it filed any post-trial motions or has pursued an appeal. Neither the
Company nor Lorillard were defendants in any of these cases. These 15 cases,
and the verdict amounts, are below:
Davis v. Liggett Group, Inc. (Circuit Court, Palm Beach County, Florida).
During May of 2004, the jury returned a verdict in favor of the plaintiff and
awarded her a total of $550,000 in actual damages. The jury did not award
punitive damages.
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. During January of 2004, plaintiff was awarded $20.0
million in punitive damages. During June of 2004, the court granted in part
the plaintiff's motion for a larger actual damages award and increased the
award to $500,000. The court also granted in part defendants' motion to reduce
the amount of punitive damages awarded by the jury and reduced the award to
$5.0 million. As of July 16, 2004, 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. During May of 2004, the Florida Court of Appeal
affirmed the judgment. As of July 16, 2004, the court had not ruled on
defendants' petition for rehearing of the decision.
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
52
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. Plaintiffs have
filed a petition for writ of certiorari with the U.S. Supreme Court that seeks
review of the judgment. As of July 16, 2004, the Court had not ruled whether
it would grant review of plaintiffs' petition.
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.
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. The court denied
plaintiffs' petition for rehearing. Plaintiffs did not seek further appellate
review and the case has been remanded to the Superior Court of California, San
Francisco County, for a second trial.
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
53
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. During June of 2004, the Oregon Court of Appeals
reaffirmed its 2002 ruling and reinstated the full amount of the jury's
punitive damages award. Philip Morris has stated it intends to appeal this
decision to the Oregon Supreme Court.
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 July 16, 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. During June of 2004, the court denied plaintiff's
motion to set aside the verdict and for new trial. As of July 16, 2004, a
judgment reflecting the verdict had not been entered.
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.
Carter v. Philip Morris USA (Court of Common Pleas, Philadelphia County,
Pennsylvania). A defense verdict was returned during January of 2003. During
April of 2004, the Superior Court of Pennsylvania, an intermediate appellate
court, affirmed the judgment.
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.
54
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 was 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. Plaintiff did not seek further appellate review of this
matter and it is concluded.
As of July 16, 2004, trial was not proceeding in any Conventional Product
Liability case in the United States. Some cases against U.S. cigarette
manufacturers and manufacturers of smokeless tobacco products are scheduled
for trial during 2004 and beyond. As of July 16, 2004, Lorillard is a
defendant in one case 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,
was scheduled for March of 2005, but that trial date has been continued and a
new date had not been set as of July 16, 2004. As of July 16, 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 July 16, 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.
The judges that have presided over the cases that have been tried through
July 16, 2004, have relied upon an order entered during October of 2000 by the
Circuit Court of Miami-Dade County, Florida. The October 2000 order has been
construed by these judges as holding that the flight attendants are not
required to prove the substantive liability elements of their claims for
negligence, strict liability and breach of implied warranty in order to
recover damages. The court further ruled that the trials of these suits are to
address whether the plaintiffs' alleged injuries were caused by their exposure
to environmental tobacco smoke and, if so, the amount of damages to be
awarded. Defendants are continuing to seek review of the October 2000 order by
the appellate court.
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 July 16, 2004, one flight attendant case was scheduled for trial
during 2004. Trial dates are subject to change.
55
CLASS ACTION CASES - Lorillard is a defendant in 11 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. One of the 11 pending cases, McLaughlin v. Philip Morris
USA, Inc., et al., is a purported national class action of purchasers of
"light" cigarettes. Neither Lorillard nor the Company are defendants in
approximately 30 additional class action cases pending against other cigarette
manufacturers in various courts throughout the nation. All of these 30
additional 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. The
Florida Supreme Court has agreed to hear plaintiffs' appeal and argument is
scheduled for November 3, 2004. Even if the Florida Supreme Court were to rule
in favor of the defendants, plaintiffs will not have exhausted all of the
appellate options available to them as they could seek review of the case by
the U.S. Supreme Court. 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.
56
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 10.0% 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 June 30, 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.
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
57
they are members of the Engle class are now expected to proceed until all
appellate activity in Engle is concluded.
The Scott case - Another class action pending against Lorillard is Scott v.
The American Tobacco Company, et al. (District Court, Orleans Parish,
Louisiana, filed May 24, 1996). During 1997, 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.
Trial in Scott was heard in two phases. While the jury in its July 2003
Phase I verdict rejected medical monitoring, the primary relief requested by
plaintiffs, it returned sufficient findings in favor of the class to proceed
to a Phase II trial on plaintiffs' request for a state-wide smoking cessation
program. The second phase of the trial began in March of 2004.
During May of 2004, the jury returned its verdict in the trial's second
phase and awarded approximately $591.0 million to fund cessation programs for
Louisiana smokers. The court's final judgment, entered during June of 2004,
reflects the jury's award of damages and also awarded judicial interest. As of
the date of the entry of judgment (June 30, 2004), judicial interest totaled
an additional amount of approximately $340.0 million. The judicial interest
award will continue to accrue until the judgment is paid. Lorillard's share of
the judgment and the judicial interest has not been determined. As of July 16,
2004, all post-verdict activity, including defendants' motion for judgment
notwithstanding the verdict or, in the alternative, for new trial, had not
been resolved. Lorillard and the other defendants will pursue an appeal to the
Louisiana Court of Appeals from the judgment by the appropriate deadline.
Other Class Action Cases - In five additional class actions in which Lorillard
has been 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 five 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. During May of 2004,
the West Virginia Supreme Court of Appeals affirmed the judgment entered in
favor of the defendants, and it denied plaintiffs' petition for rehearing
during July of 2004. As of July 16, 2004, the deadline for plaintiffs to seek
further appellate review of the case had not expired.
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.
58
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
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.
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. While
Lorillard had not been a defendant in any of the purported "lights" class
actions, Lorillard is now a defendant in one such case, McLaughlin v. Philip
Morris USA, Inc., et al., a purported national class action filed during May
of 2004 in which class certification has not been decided.
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 10
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,
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
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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 and racketeering 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 ("RICO")
Act. The court has dismissed plaintiff's Medical Care Recovery Act and the
Medicare as Secondary Payer provisions of the Social Security Act claims. RICO
claims remain pending against all of the defendants, including Lorillard.
Under RICO, the government is seeking an aggregate of approximately $280.0
billion in disgorgement of profits from the defendants, including Lorillard,
as well as injunctive relief. Trial of this matter, United States of America
v. Philip Morris USA, Inc., et al., is scheduled to begin during September of
2004. This is scheduled to be a bench trial and a jury will not be impaneled.
Reimbursement Cases filed by Foreign Governments in U.S. Courts - As of July
16, 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
jurisdiction. As of July 16, 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,"
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entered into a Master Settlement Agreement ("MSA") 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 $234.3, $180.1, $435.4 and $377.6
million ($142.8, $116.3, $265.5 and $236.9 million after taxes), for the three
and six months ended June 30, 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. As of July 16, 2004, Lorillard was a
defendant in one such case. Lorillard understands that additional such cases
are proceeding against other defendants.
In addition, in connection with the MSA, 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 $2.1 billion has been paid
since 1999 through June 30, 2004, $189.1 million of which has been paid by
Lorillard. Lorillard estimates its remaining payments under the agreement will
total approximately $300 - $350 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.
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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. Three 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 65 such
matters are pending against Lorillard. The Company is not a defendant in any
of these matters. Since January 1, 2002 and through July 16, 2004, Lorillard
has paid, or has reached agreement to pay, a total of approximately $13.1
million in payments of judgments and settlements to finally resolve
approximately 35 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. 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. Discovery is proceeding in the Kansas case, 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.
Tobacco Growers Suit - DeLoach v. Philip Morris Inc., et al. (U.S. District
Court, Middle District of North Carolina, filed February 16, 2000). On October
1, 2003, the Court approved a settlement by Lorillard with a class consisting
of all persons holding a quota (the licenses that a farmer must either own or
rent to sell the crop) to grow, and all domestic producers who sold flue-cured
or burley tobacco at anytime from February 1996 to present. In addition to
payments previously made, Lorillard has committed to buy 20 million pounds of
domestic tobacco for each year through 2012. Lorillard has also committed to
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purchase at least 35% of its annual total requirements for flue-cured and
burley tobacco domestically for the same period. The other major domestic
tobacco companies and the major leaf buyers are also defendants, and all of
the defendants with the exception of R.J. Reynolds were parties to the
settlement agreement entered on October 1, 2003. R.J. Reynolds signed a
settlement agreement with the class on April 22, 2004. That agreement has not
received final approval from the court. Lorillard contends that the R.J.
Reynolds settlement agreement triggers a clause in Lorillard's settlement
agreement that would substantially reduce Lorillard's commitments to buy
domestic tobacco. The court has ruled against Lorillard on that issue and the
matter is currently under appeal to the United States Court of Appeals for the
Fourth Circuit.
MSA Federal Antitrust Suit - Sanders v. Lockyer, et al. (U.S. District Court,
Northern District of California, filed June 9, 2004). Lorillard and the other
major cigarette manufacturers, along with the Attorney General of the State of
California, have been sued by a consumer purchaser of cigarettes in a putative
class action alleging violations of the Sherman Act and California state
antitrust and unfair competition laws. The plaintiff seeks treble damages of
an unstated amount for the putative class as well as declaratory and
injunctive relief. All claims are based on the assertion that the Master
Settlement Agreement that Lorillard and the other cigarette manufacturer
defendants entered into with the State of California and more than forty other
states, together with certain implementing legislation enacted by California,
constitute unlawful restraints of trade. No discovery has commenced in this
action.
Vending Machine Operators Antitrust Suit - Genessee Vending, Inc., et al. v.
Lorillard Tobacco Co. (U.S. District Court, Eastern District of Michigan,
filed May 14, 2004). More than 220 cigarette vending machine operators have
instituted a suit against Lorillard individually and on behalf of a putative
class of all domestic cigarette vending machine operators, claiming that
Lorillard has violated the federal Robinson-Patman Act by allegedly
discriminating against them in price and with respect to advertising and
promotional payments and services provided in connection with the sale of
cigarettes to competing convenience stores, gasoline stations, mini-marts,
kiosks and discount stores. Lorillard filed a motion to dismiss the action on
July 2, 2004, for failure to state claims upon which relief can be granted.
Virtually identical suits have been filed against Philip Morris and R.J.
Reynolds.
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. These three 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, another Reparations
case was filed in the U.S. District Court for the Northern District of
Illinois. This suit, however, named Lorillard, but not the Company, as a
defendant. This suit was voluntarily dismissed by the plaintiffs during June
of 2004. Lorillard never received service of this matter.
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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
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 June
30, 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
64
obligor fails to observe and perform its covenants under the lease agreements.
The maximum potential amount of future payments that the Company could be
required to pay under these guarantees are approximately $8.0 million at June
30, 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 June 30, 2004 that the
Company could be required to pay under this guarantee are approximately $315.0
million. 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 June 30, 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 June 30, 2004, the aggregate amount of quantifiable
indemnification agreements in effect for sales of business entities, assets
and third party loans was $959.0 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 June 30, 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
65
indemnification agreements survive until the applicable statutes of limitation
expire, or until the agreed upon contract terms expire. Additionally, CNA has
provided a contingent guarantee to the lenders of two third parties, related
to loans extended by their lenders. CNA has recorded approximately $21.0 and
$16.0 million of other liabilities related to these indemnification agreements
as of June 30, 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 June 30, 2004 and December 31, 2003, there were
approximately $50.0 and $58.0 million of outstanding letters of credit.
The Company is obligated to make future payments totaling $410.2 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: $41.0
million in 2004; $68.9 million in 2005; $59.3 million in 2006; $49.8 million
in 2007; $42.0 million in 2008; and $149.2 million in 2009 and beyond.
Additionally, CNA has entered into a limited number of guaranteed payment
contracts, primarily relating to telecommunication services, amounting to
approximately $15.0 million. Estimated future minimum payments under these
contracts are as follows: $10.0 million in 2004 and $5.0 million in 2005.
As of June 30, 2004 and December 31, 2003, CNA had committed approximately
$141.0 million 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.
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
June 30, 2004, the Company had commitments to purchase $103.3 million and sell
$46.5 million of various bank loan participations.
In the normal course of investing activities, CCC had committed
approximately $51.0 million as of June 30, 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 $86.0 million credit facility. CNA Surety has
provided significant surety bond protection for projects by this contractor
through surety bonds underwritten by CCC or its affiliates. The loans were
provided by CNA to help the contractor meet its liquidity needs. 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 the
interest of 3.0% 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
66
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
$16.0 million. The contractor purchased the bank debt from CNA and retired it,
with $11.0 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
$3.0 million. CNA has also provided collateral for letters of credit issued by
another bank for the contractor's benefit in the aggregate amount of $8.0
million. Any CNA reimbursements or access of CNA collateral for draws upon the
banks' letters of credit will become obligations of the contractor to CNA as
draws upon the credit facility. As of June 30, 2004, the aggregate amount of
outstanding principal and accrued interest under the credit facility was $85.0
million, including accrued interest.
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
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% 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.
CNA Surety is presently in discussions with regulatory authorities concerning
the level of bonds written for the national contractor.
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
67
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 and/or equity. 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 June 30, 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 exposure that exceeds
$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 excess of loss contract with CNA Surety.
The reinsurance premium for the coverage provided by the $3.0 million excess
of $12.0 million contract was $0.3 million plus, if applicable, additional
premiums based on paid losses. The contract provided for aggregate coverage of
$12.0 million. This contract was to expire on December 31, 2004. Effective
January 1, 2004, CNA obtained replacement coverage from third party reinsurers
as part of the 2004 Excess of Loss Treaty.
15. Consolidating Financial Information
The following schedules present the Company's Consolidating Balance Sheet
Information at June 30, 2004 and December 31, 2003, and Consolidating
Statements of Income Information for the six months ended June 30, 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 Loews and
Carolina Group Consolidating Condensed Financial Information.
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
68
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.
69
Loews Corporation
Consolidating Balance Sheet Information
CNA Loews Diamond Texas Corporate
June 30, 2004 Financial Lorillard Hotels Offshore Gas and Other Eliminations Total
- ---------------------------------------------------------------------------------------------------------------------------------
(In millions)
Assets:
Investments $ 36,007.1 $ 528.9 $ 91.1 $ 143.0 $ 30.0 $ 3,694.0 $40,494.1
Cash 103.2 3.0 10.7 22.1 5.4 46.3 190.7
Receivables-net 19,695.0 918.3 25.0 596.0 34.5 146.1 $ (91.4) 21,323.5
Property, plant and equipment 206.3 234.4 359.7 2,257.4 694.9 25.0 3,777.7
Deferred income taxes 1,073.8 440.3 68.6 32.8 (619.4) 996.1
Goodwill 118.2 2.6 14.0 163.5 298.3
Investments in capital stocks
of subsidiaries 10,902.8 (10,902.8)
Other assets 1,792.0 378.3 105.4 85.2 203.1 349.6 (162.1) 2,751.5
Deferred acquisition costs
of insurance subsidiaries 1,343.3 1,343.3
Separate account business 576.5 576.5
Assets related to businesses held
for sale 200.0 200.0
- ---------------------------------------------------------------------------------------------------------------------------------
Total assets $ 61,115.4 $ 2,503.2 $ 594.5 $3,117.7 $1,200.0 $15,196.6 $(11,775.7) $71,951.7
=================================================================================================================================
Liabilities and Shareholders' Equity:
Insurance reserves $ 43,594.9 $ 43,594.9
Payable for securities purchased 1,308.5 $ 0.5 $ $ 758.7 2,067.7
Securities sold under agreements
to repurchase 222.9 747.2 970.1
Long-term debt, less unamortized
discounts 1,668.3 145.0 931.3 531.0 2,303.7 5,579.3
Reinsurance balances payable 3,155.6 3,155.6
Deferred income taxes 28.0 365.2 226.2 $ (619.4)
Other liabilities 1,851.4 $ 1,269.3 214.1 130.7 144.6 124.1 (184.9) 3,549.3
Separate account business 576.5 576.5
Liabilities related to businesses held 170.0 170.0
for sale
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities 52,548.1 1,269.3 387.6 1,427.2 675.6 4,159.9 (804.3) 59,663.4
Minority interest 849.6 752.3 5.2 1,607.1
Shareholders' equity 7,717.7 1,233.9 206.9 938.2 524.4 11,031.5 (10,971.4) 10,681.2
- ---------------------------------------------------------------------------------------------------------------------------------
Total liabilities and
shareholders' equity $ 61,115.4 $ 2,503.2 $ 594.5 $3,117.7 $1,200.0 $15,196.6 $(11,775.7) $71,951.7
=================================================================================================================================
70
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
=================================================================================================================================
71
Loews Corporation
Consolidating Statement of Income Information
CNA Loews Diamond Texas Corporate
Six Months Ended June 30, 2004 Financial Lorillard Hotels Offshore Gas and Other Eliminations Total
- ---------------------------------------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $ 4,274.1 $ (1.8) $ 4,272.3
Investment income, net 852.7 $ 13.7 $ 1.1 $ 4.7 $ 19.3 891.5
Intercompany interest and dividends 303.0 (303.0)
Investment gains (losses) (349.2) 0.6 0.3 35.9 (312.4)
Manufactured products 1,636.0 71.5 1,707.5
Other 153.7 165.9 368.9 $ 138.1 20.2 846.8
- ---------------------------------------------------------------------------------------------------------------------------------
Total 4,931.3 1,650.3 167.0 373.9 138.1 449.9 (304.8) 7,405.7
- ---------------------------------------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 3,262.9 3,262.9
Amortization of deferred
acquisition costs 740.3 740.3
Cost of manufactured products sold 999.6 35.3 1,034.9
Other operating expenses 693.4 203.0 139.4 391.4 71.4 64.0 (1.8) 1,560.8
Interest 66.0 3.3 12.7 15.2 80.7 (5.3) 172.6
- ---------------------------------------------------------------------------------------------------------------------------------
Total 4,762.6 1,202.6 142.7 404.1 86.6 180.0 (7.1) 6,771.5
- ---------------------------------------------------------------------------------------------------------------------------------
168.7 447.7 24.3 (30.2) 51.5 269.9 (297.7) 634.2
- ---------------------------------------------------------------------------------------------------------------------------------
Income tax expense (benefit) (19.1) 174.7 9.5 (6.8) 20.5 (10.2) 168.6
Minority interest 24.4 (9.8) 0.1 14.7
- ---------------------------------------------------------------------------------------------------------------------------------
Total 5.3 174.7 9.5 (16.6) 20.5 (10.1) 183.3
- ---------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 163.4 $ 273.0 $ 14.8 $ (13.6) $ 31.0 $ 280.0 $ (297.7) $ 450.9
=================================================================================================================================
72
Loews Corporation
Consolidating Statement of Income Information
CNA Loews Diamond Texas Corporate
Six Months Ended June 30, 2003 Financial Lorillard Hotels Offshore Gas and Other Eliminations Total
- ---------------------------------------------------------------------------------------------------------------------------------
(In millions)
Revenues:
Insurance premiums $ 4,577.6 $ (1.8) $ 4,575.8
Investment income, net 859.1 $ 18.5 $ 0.9 $ 7.5 $ 15.8 901.8
Intercompany interest
and dividends 335.4 (335.4)
Investment gains (losses) 312.6 (1.8) (1.1) 14.0 323.7
Manufactured products 1,625.1 73.2 1,698.3
Other 204.5 (0.2) 146.7 312.4 $ 23.1 (0.8) 685.7
- ---------------------------------------------------------------------------------------------------------------------------------
Total 5,953.8 1,641.6 147.6 318.8 23.1 437.6 (337.2) 8,185.3
- --------------------------------------------------------------------------------------------------------------------------------
Expenses:
Insurance claims and
policyholders' benefits 3,977.9 3,977.9
Amortization of deferred
acquisition costs 939.2 939.2
Cost of manufactured
products sold 921.4 35.5 956.9
Other operating expenses 770.1 254.6 125.3 356.7 15.8 56.2 (1.8) 1,576.9
Interest 67.0 4.6 10.9 4.7 62.2 149.4
- --------------------------------------------------------------------------------------------------------------------------------
Total 5,754.2 1,176.0 129.9 367.6 20.5 153.9 (1.8) 7,600.3
- ---------------------------------------------------------------------------------------------------------------------------------
199.6 465.6 17.7 (48.8) 2.6 283.7 (335.4) 585.0
- ---------------------------------------------------------------------------------------------------------------------------------
Income tax expense (benefit) 29.6 173.5 6.5 (9.4) 1.0 (20.1) 181.1
Minority interest 16.2 (17.6) 0.1 (1.3)
- ---------------------------------------------------------------------------------------------------------------------------------
Total 45.8 173.5 6.5 (27.0) 1.0 (20.0) 179.8
- --------------------------------------------------------------------------------------------------------------------------------
Income (loss) from
continuing operations 153.8 292.1 11.2 (21.8) 1.6 303.7 (335.4) 405.2
Discontinued operations-net (0.4) (0.4)
- ---------------------------------------------------------------------------------------------------------------------------------
Net income (loss) $ 153.8 $ 292.1 $ 10.8 $ (21.8) $ 1.6 $ 303.7 $(335.4) $ 404.8
=================================================================================================================================
73
16. Assets and Liabilities Related to Businesses Held for Sale
In connection with CNA's decision to focus on its property and casualty
business, CNA has entered into a definitive agreement to sell the business of
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 of 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 June 30, 2004. The estimated fair value of the business less
costs to sell exceeds the carrying value of CNA Trust, and therefore the gain
will be recorded at the closing date. The transaction closed on August 1,
2004.
The following table provides the components of the assets and liabilities
related to CNA Trust at June 30, 2004:
(In millions)
Investments:
Fixed maturity securities, available-for-sale $ 8.0
Short-term investments, available-for-sale 177.0
- ------------------------------------------------------------------------------------------------
Total investments 185.0
Cash 7.0
Accrued investment income 3.0
Other assets 3.0
Property & equipment 2.0
- ------------------------------------------------------------------------------------------------
Total assets related to businesses held for sale $ 200.0
================================================================================================
Deferred income taxes $ 1.0
Other liabilities 169.0
- ------------------------------------------------------------------------------------------------
Total liabilities related to businesses held for sale $ 170.0
================================================================================================
The assets and liabilities of CNA Trust were $216.0 and $184.0 million at
December 31, 2003. The revenues of CNA Trust were $4.0 and $7.0 million for
the three months ended June 30, 2004 and 2003, and $10.0 and $14.0 million for
the six months ended June 30, 2004 and 2003. Net results for this business
were a net loss of $1.6 million and net income of $0.6 million for the three
months ended June 30, 2004 and 2003, and a net loss of $1.9 million and net
income of $0.4 million for the six months ended June 30, 2004 and 2003.
17. Subsequent Events
Hellespont Shipping Corporation ("Hellespont"), in which the Company holds a
49% common stock interest, has sold each of its four ultra-large crude oil
tankers to Euronav Luxembourg SA in July of 2004 and the Company received cash
distributions of approximately $275.0 million. The Company estimates it will
record a pretax gain of approximately $155.0 million in the third quarter of
2004.
74
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 75
Consolidated Financial Results 76
CNA Recent Developments 77
Classes of Common Stock 79
Parent Company Structure 80
Critical Accounting Estimates 80
Results of Operations by Business Segment 84
CNA Financial 85
Net Prior Year Development 85
Reserves - Estimates and Uncertainties 90
Reinsurance 92
Terrorism Insurance 96
Restructuring 97
Non-GAAP Financial Measures 97
Standard Lines 100
Specialty Lines 105
Life and Group Non-core 107
Other Insurance 108
APMT Reserves 110
Lorillard 122
Results of Operations 122
Selected Market Share Data 123
Business Environment 125
Loews Hotels 128
Diamond Offshore 128
Texas Gas 130
Corporate and other 130
Liquidity and Capital Resources 131
CNA Financial 131
Lorillard 134
Loews Hotels 135
Diamond Offshore 135
Texas Gas 136
Majestic Shipping 136
Corporate and other 137
Investments 137
Forward-Looking Statements Disclaimer 149
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
hotels (Loews Hotels Holding Corporation ("Loews Hotels"), a wholly owned
75
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
Loews Corporation reported consolidated net income (including both the Loews
Group and Carolina Group) for the 2004 second quarter of $407.3 million,
compared to $214.8 million in the 2003 second quarter. Income before net
investment gains attributable to Loews common stock amounted to $259.4 million
in the second quarter of 2004 compared to a loss of $61.1 million in the
comparable 2003 quarter. Net income attributable to Loews common stock
includes net investment gains of $107.3 million (after tax and minority
interest) compared to $251.0 million (after tax and minority interest) in the
comparable period of the prior year.
Results for 2004 reflect improved underwriting performance for the property
and casualty operations of CNA. The improved results are primarily due to
significant unfavorable net prior year development recorded in the second
quarter of 2003 as well as the continued favorable impact of rate increases in
2004 and CNA's focus on underwriting discipline and expense management.
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 Six Months Ended
June 30, June 30,
- ------------------------------------------------------------------------------------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Net income attributable to Loews
common stock:
Income (loss) before net investment
(losses) gains $ 259.4 $ (61.1) $ 545.6 $ 157.2
Net investment (losses) gains (a) 107.3 251.0 (169.7) 194.4
- ------------------------------------------------------------------------------------------------
Income from continuing operations 366.7 189.9 375.9 351.6
Discontinued operations-net (0.1) (0.4)
- ------------------------------------------------------------------------------------------------
Net income attributable to Loews
common stock 366.7 189.8 375.9 351.2
Net income attributable to Carolina
Group stock 40.6 25.0 75.0 53.6
- ------------------------------------------------------------------------------------------------
Consolidated net income $ 407.3 $ 214.8 $ 450.9 $ 404.8
================================================================================================
Net income per share:
Loews common stock $ 1.98 $ 1.02 $ 2.03 $ 1.89
Carolina Group stock 0.70 0.63 1.29 1.34
================================================================================================
76
(a) Includes a loss of $352.9 (after tax and minority interest) for the six months
ended June 30, 2004 related to CNA's sale of its individual life insurance
business.
Three Months Ended June 30, 2004 Compared with 2003
Net income attributable to Loews common stock for the second quarter of 2004
amounted to $366.7 million or $1.98 per share, compared to $189.8 million or
$1.02 per share in the comparable period of the prior year.
Net income attributable to Carolina Group stock for the second quarter of
2004 was $40.6 million or $0.70 per Carolina Group share, compared to $25.0
million or $0.63 per Carolina Group share in the second quarter of 2003.
Consolidated revenues in the second quarter of 2004 amounted to $3.9 billion
compared to $4.2 billion in the comparable 2003 quarter. The decline in
revenues reflects CNA's sale of its Group Benefits and Individual Life
Insurance businesses as well as lower investment gains in the current period.
Six Months Ended June 30, 2004 Compared With 2003
Loews consolidated net income (including both the Loews Group and Carolina
Group) for the first half of 2004 was $450.9 million, compared to $404.8
million in the comparable period of the prior year. Income before net
investment losses attributable to Loews common stock amounted to $545.6
million in the first half of 2004 compared to $157.2 million in the comparable
period of the prior year. Net income attributable to Loews common stock
includes net investment losses of $169.7 million (after tax and minority
interest) due primarily to a loss of $352.9 million (after tax and minority
interest) for CNA's sale of its individual life insurance business, compared
to net investment gains of $194.4 million (after tax and minority interest) in
the comparable period of the prior year.
Net income attributable to Loews common stock for the first half of 2004
amounted to $375.9 million or $2.03 per share, compared to $351.2 million or
$1.89 per share in the comparable period of the prior year.
Net income attributable to Carolina Group stock for the first half of 2004
was $75.0 million or $1.29 per Carolina Group share, compared to $53.6 million
or $1.34 per Carolina Group share in the comparable period of the prior year.
Consolidated revenues in the first half of 2004 amounted to $7.4 billion
compared to $8.2 billion in the comparable period of the prior year. The
decline in revenues reflects the sale of CNA's Group Benefits and Individual
Life Insurance businesses as well as the impact of the $618.6 million
investment loss related to the life sale.
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 business decisions is discussed below:
In May of 2004, CNA entered into a definitive agreement to sell the business
of CNA Trust to Union Bank of California. As a result of the pending sale, CNA
77
classified the assets and liabilities of CNA Trust as Assets Related to
Businesses Held for Sale and Liabilities Related to Businesses Held for Sale
in the Consolidated Condensed Balance Sheets. See Note 16 of the Notes to
Consolidated Condensed Financial Statements in Item 1 for further discussion.
The transaction closed on August 1, 2004.
On April 30, 2004, CNA completed the sale of its individual life insurance
business. The business sold included 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, the Nashville, Tennessee insurance servicing and administration
building was transferred as part of the sale. Consideration from the sale was
approximately $700.0 million. The Company recorded a realized investment loss
of $53.0 million pretax ($15.5 million gain after-tax and minority interest)
and $618.6 million pretax loss ($352.9 million after-tax and minority
interest) for the three and six months ended June 30, 2004. An estimated
impairment loss was recorded in the first quarter of 2004 in anticipation of
the pending sale. The disproportionate income tax provision on the loss
related to the life sale for the three months ended June 30, 2004 arose from a
change in estimate related to the estimated tax benefit recorded at March 31,
2004. The change in estimate is due to the completion of a formal study of the
final tax basis of VFL. See Note 9 of the Notes to Consolidated Condensed
Financial Statements in Item 1 for further discussion.
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 $109.1
million ($163.0 million pretax), including an after-tax and minority interest
realized investment gain of $7.3 million ($13.0 million pretax) recorded in
the second quarter of 2004.
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. The Company
expects that the 2004 consolidated net operating results will include an
approximate $35.0 million after-tax loss (before minority interest) for these
three businesses, largely due to these corporate overhead expenses. This
amount has been revised from the $50.0 million after-tax loss (before minority
interest) estimate that was previously disclosed in the Company's 2003 Form
10-K/A primarily because of the impact of the loss on the sale of the
individual life business and favorable mortality and investment results in the
first quarter of 2004. The 2003 expense initiative discussed below did not
contemplate the sale or exit of these businesses, and therefore the savings
from that initiative will be partially offset by 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 had achieved the targeted workforce
reduction. Actions related to reducing commissions and other acquisition
expenses began in 2003 and will continue through 2004.
78
CNA has undertaken additional expense initiatives in 2004 that are expected
to produce expense savings in excess of $100.0 million beginning in 2004
through 2005. The primary components of the expense initiatives are a
reduction in certain business expenses through more stringent expense policies
and guidelines, reduced facilities cost through consolidation of locations,
and to a lesser extent, workforce reductions.
The capital plan, established in November of 2003, consisted of the November
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 and 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 $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 sale of CNA's individual life business,
discussed above. The sale of the individual life business resulted in an
addition to statutory capital in excess of $550.0 million. CCC received
insurance regulatory approval for the repayment of the $300.0 million CCC Life
surplus note issued in February of 2004, including accrued interest and repaid
these amounts in full on June 16, 2004. CCC plans to seek approval from the
insurance regulatory authority for the repayment of the CCC Group surplus note
in 2004. The purchase of the preferred stock and the surplus notes fulfilled
the commitment from Loews in relation 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 June 30, 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 June 30, 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
assets, liabilities, revenues, expenses and cash flows between groups, without
79
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 Financial below).
At June 30, 2004, the book value per share of Loews common stock was $58.78,
compared to $60.92 at December 31, 2003. The decline in book value per share
is attributable to lower unrealized investment gains reflecting the impact of
higher interest rates on CNA's fixed income portfolio, partially offset by the
net income reported in 2004.
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.
80
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
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, 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
81
billion against Lorillard. The court of appeal also decertified the class
ordered during pre-trial proceedings. The Florida Supreme Court has agreed to
review the case and has scheduled argument for November of 2004. The Company
and Lorillard believe that the appeals court's decision should be upheld upon
further appeals.
During May of 2004, a jury in the Circuit Court of Louisiana, Orleans
Parish, awarded $591.0 million to fund cessation programs for Louisiana
smokers in the case of Scott v. The American Tobacco Company, et al. The jury
was not asked to apportion damages in its verdict so Lorillard's share of the
judgment has not been determined. All post-verdict activity, including
defendants' motion for judgment notwithstanding the verdict or, in the
alternative, for new trial, had not been resolved as of July 16, 2004.
Lorillard and the other defendants in this matter intend to notice an appeal
in this matter to the Louisiana Court of 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 of this report for information related to the
Company's impairment charges.
In March of 2004, the Emerging Issues Task Force ("EITF") reached consensus
on the guidance provided in EITF Issue No. 03-1, "The Meaning of Other-Than-
Temporary Impairment and its Application to Certain Investments" ("EITF 03-1")
as applicable to debt and equity securities that are within the scope of SFAS
No. 115, "Accounting for Certain Investments in Debt and Equity Securities"
and equity securities that are accounted for using the cost method specified
in Accounting Principles Board Opinion No. 18, "The Equity Method of
Accounting for Investments in Common Stock." An investment is impaired if the
fair value of the investment is less than its cost including adjustments for
amortization, accretion, foreign exchange, and hedging. EITF 03-1 outlines
82
that an impairment would be considered other-than-temporary unless (a) the
investor has the ability and intent to hold an investment for a reasonable
period of time sufficient for the recovery of the fair value up to (or beyond)
the cost of the investment and (b) evidence indicating that the cost of the
investment is recoverable within a reasonable period of time outweighs
evidence to the contrary. The investor should consider its cash or working
capital needs to assess its intent and ability to hold an investment for a
reasonable period of time for the recovery of fair value up to or beyond the
cost of the investment. Although not presumptive, a pattern of selling
investments prior to the forecasted recovery of fair value may call into
question the investor's intent. In addition, the severity and duration of the
impairment should also be considered in determining whether the impairment is
other-than-temporary. This new guidance for determining whether impairment is
other-than-temporary is effective for reporting periods beginning after June
15, 2004.
The Company is currently evaluating the impact of this new accounting
standard on its process for determining other-than-temporary impairment of
equity and fixed maturity securities. Adoption of this standard may cause the
Company to recognize impairment losses in the Consolidated Condensed
Statements of Income which would not have been recognized under the current
guidance or to recognize such losses in earlier periods, especially those due
to increases in interest rates, and will likely also impact the recognition of
investment income on impaired securities. Such an impact will likely increase
earnings volatility in future periods. However, since fluctuations in fair
value for available-for-sale securities are already recorded in Accumulated
Other Comprehensive Income, adoption of this standard is not expected to have
a significant impact on shareholders' equity. Further information on CNA's
investments is provided in the Investments section below.
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
insurance coverage. As of June 30, 2004, the Company has credit exposure of
$85.0 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. Further information on this credit agreement is
83
provided in Note 14 of the Notes to Consolidated Condensed Financial
Statements included under Item 1 of this report, and the Liquidity and Capital
Resources sections, below.
RESULTS OF OPERATIONS BY BUSINESS SEGMENT
As a result of the strategic review and other actions described above in
"CNA Recent Developments," CNA changed how it manages its core operations and
makes business decisions. Accordingly, in the first quarter of 2004, 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., as well as globally. Specialty Lines provides a
broad array of 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. 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; and 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 results
of operations include discussion and results for all of CNA's businesses,
including those sold or exited as described above.
In the second quarter of 2004, the expenses incurred related to
uncollectible reinsurance receivables were reclassified from "Other operating
expenses" to "Insurance claims and policyholders' benefits" on the
Consolidated Condensed Statements of Income. Prior period amounts and ratios
have been reclassified to conform to the current year presentation. This
reclassification had no impact on net income (loss) or the combined ratios in
any period, however this change impacted the loss and loss adjustment expense
and the expense ratios.
84
In addition, until 2003, the operations of Bulova were formerly reported in
its own operating segment and are now included in the Corporate and other
segment.
CNA Financial
Insurance operations are conducted by subsidiaries of CNA Financial
Corporation ("CNA"). CNA is a 91% owned subsidiary of the Company.
Net Prior Year Development
A significant component of the results of operations for the period ended
June 30, 2003 was unfavorable net prior year development recorded for the
property and casualty and the non-core segments. Changes in estimates of claim
and allocated claim adjustment expense reserves and premium accruals, net, for
prior years are defined as net prior year development within this MD&A. These
changes can be favorable or unfavorable.
85
The following tables summarize the pretax net prior year development by
segment for the three and six months ended June 30, 2004 and 2003.
Net Prior Year Development
Standard Specialty Other
Three Months Ended June 30, 2004 Lines Lines Insurance Total
- ------------------------------------------------------------------------------------------------
(In millions)
Pretax unfavorable net prior year
claim and allocated claim adjustment
expense development excluding the
impact of the corporate aggregate
reinsurance treaties:
Core (Non-APMT) $ 115.0 $ 73.0 $ 2.0 $ 190.0
APMT 31.0 31.0
- ------------------------------------------------------------------------------------------------
Total 115.0 73.0 33.0 221.0
- ------------------------------------------------------------------------------------------------
Pretax unfavorable net prior year
development before impact of
premium development 115.0 73.0 33.0 221.0
- ------------------------------------------------------------------------------------------------
Unfavorable (favorable) premium
development, excluding impact of
corporate aggregate reinsurance
treaties (92.0) (13.0) 11.0 (94.0)
Ceded premiums related to corporate
aggregate reinsurance treaties 2.0 1.0 3.0
- ------------------------------------------------------------------------------------------------
Total premium development (90.0) (13.0) 12.0 (91.0)
- ------------------------------------------------------------------------------------------------
Total unfavorable net prior year development
(pretax) $ 25.0 $ 60.0 $ 45.0 $ 130.0
================================================================================================
Total unfavorable net prior year development
(after-tax and minority interest) $ 14.6 $ 35.6 $ 27.4 $ 77.6
================================================================================================
86
Net Prior Year Development
Standard Specialty Other
Three Months Ended June 30, 2003 Lines Lines Insurance Total
- ------------------------------------------------------------------------------------------------
(In millions)
Pretax unfavorable net prior year
claim and allocated claim adjustment
expense development excluding the
impact of the corporate aggregate
reinsurance treaties:
Core (Non-APMT) $ 246.0 $ 101.0 $ 118.0 $ 465.0
APMT (180.0) (24.0) (204.0)
- ------------------------------------------------------------------------------------------------
Total 66.0 101.0 94.0 261.0
- ------------------------------------------------------------------------------------------------
Pretax unfavorable net prior year
development before impact of
premium development 66.0 101.0 94.0 261.0
- ------------------------------------------------------------------------------------------------
Unfavorable (favorable) premium
development, excluding impact of
corporate aggregate reinsurance
treaties 116.0 3.0 (8.0) 111.0
Ceded premiums related to corporate
aggregate reinsurance treaties 105.0 14.0 119.0
- ------------------------------------------------------------------------------------------------
Total premium development 221.0 3.0 6.0 230.0
- ------------------------------------------------------------------------------------------------
Total unfavorable net prior year development
(pretax) $ 287.0 $ 104.0 $ 100.0 $ 491.0
================================================================================================
Total unfavorable net prior year development
(after-tax and minority interest) $ 168.3 $ 61.2 $ 58.5 $ 288.0
================================================================================================
87
Net Prior Year Development
Standard Specialty Other
Six Months Ended June 30, 2004 Lines Lines Insurance Total
- ------------------------------------------------------------------------------------------------
(In millions)
Pretax unfavorable net prior year
claim and allocated claim adjustment
expense development excluding the
impact of the corporate aggregate
reinsurance treaties:
Core (Non-APMT) $ 113.0 $ 74.0 $ 13.0 $ 200.0
APMT 40.0 40.0
- ------------------------------------------------------------------------------------------------
Total 113.0 74.0 53.0 240.0
- ------------------------------------------------------------------------------------------------
Pretax unfavorable net prior year
development before impact of
premium development 113.0 74.0 53.0 240.0
- ------------------------------------------------------------------------------------------------
Unfavorable (favorable) premium
development, excluding impact of
corporate aggregate reinsurance
treaties (108.0) (14.0) 10.0 (112.0)
Ceded premiums related to corporate
aggregate reinsurance treaties 2.0 1.0 3.0
- ------------------------------------------------------------------------------------------------
Total premium development (106.0) (14.0) 11.0 (109.0)
- ------------------------------------------------------------------------------------------------
Total unfavorable net prior year development
(pretax) $ 7.0 $ 60.0 $ 64.0 $ 131.0
================================================================================================
Total unfavorable net prior year development
(after-tax and minority interest) $ 3.7 $ 35.6 $ 38.3 $ 77.6
================================================================================================
88
Net Prior Year Development
Standard Specialty Other
Six months ended June 30, 2003 Lines Lines Insurance Total
- ------------------------------------------------------------------------------------------------
(In millions)
Pretax unfavorable net prior year
claim and allocated claim adjustment
expense development excluding the
impact of the corporate aggregate
reinsurance treaties:
Core (Non-APMT) $ 314.0 $ 99.0 $ 148.0 $ 561.0
Ceded losses related to corporate aggregate
reinsurance treaties (180.0) (24.0) (204.0)
- ------------------------------------------------------------------------------------------------
Pretax unfavorable net prior year
development before impact of
premium development 134.0 99.0 124.0 357.0
- ------------------------------------------------------------------------------------------------
Unfavorable (favorable) premium
development, excluding impact of
corporate aggregate reinsurance
treaties 75.0 (7.0) (23.0) 45.0
Ceded premiums related to corporate
aggregate reinsurance treaties 105.0 14.0 119.0
- ------------------------------------------------------------------------------------------------
Total premium development 180.0 (7.0) (9.0) 164.0
- ------------------------------------------------------------------------------------------------
Total unfavorable net prior year development
(pretax) $ 314.0 $ 92.0 $ 115.0 $ 521.0
================================================================================================
Total unfavorable net prior year development
(after-tax and minority interest) $ 183.6 $ 53.1 $ 67.5 $ 304.2
================================================================================================
89
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 ("IBNR"). 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 and additional information becomes available in
subsequent periods.
In addition, CNA is subject to the uncertain effects of emerging or
potential claims and coverage issues that arise as industry practices and
legal, judicial, social and other environmental conditions change. These
issues have had, and may continue to have, a negative effect on CNA's business
by either extending coverage beyond the original underwriting intent or by
increasing the number or size of claims. Recent examples of emerging or
potential claims and coverage issues include:
. increases in the number and size of water damage claims, including those
related to expenses for testing and remediation of mold conditions;
. increases in the number and size of claims relating to injuries from
medical products, and exposure to lead;
. 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;
90
. 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 sections 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
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.
91
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,
equity, business, insurer financial strength and debt ratings. See the Ratings
section of this MD&A for further information on CNA's ratings. In addition,
CNA periodically undergoes state regulatory financial examinations. See the
Regulatory Matters section of the MD&A for further information.
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 $56.0
and $93.0 million for the three months ended June 30, 2004 and 2003, and
$106.0 and $140.0 million for the six months ended June 30, 2004 and 2003. The
amount subject to interest crediting rates on such contracts was $2,696.0 and
$2,789.0 million at June 30, 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.
92
The amount subject to interest crediting on these funds withheld contracts
will vary over time based on a number of factors, including the timing of loss
payments and ultimate gross losses incurred. CNA expects that it will continue
to incur significant interest costs on these contracts for several years.
The following table summarizes the amounts receivable from reinsurers at
June 30, 2004 and December 31, 2003.
Components of reinsurance receivables June 30, 2004 December 31, 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Reinsurance receivables related to insurance reserves:
Ceded claim and claim adjustment expense $14,135.2 $14,215.9
Ceded future policy benefits 1,229.1 1,218.2
Ceded policyholders' funds 68.1 6.6
Billed reinsurance receivables 722.5 813.1
- ------------------------------------------------------------------------------------------------
Reinsurance receivables 16,154.9 16,253.8
Allowance for uncollectible reinsurance (503.6) (572.6)
- ------------------------------------------------------------------------------------------------
Reinsurance receivables, net of allowance for
uncollectible reinsurance $15,651.3 $15,681.2
================================================================================================
CNA has established an allowance for uncollectible reinsurance receivables.
The allowance for uncollectible reinsurance receivables was $503.6 and $572.6
million at June 30, 2004 and December 31, 2003. The net decrease in the
allowance was primarily due to a release of a previously established allowance
related to the Trenwick Group resulting from the finalization of commutation
agreements in the second quarter of 2004, partially offset by a net increase
in the allowance for other reinsurance receivables. The expenses incurred
related to uncollectible reinsurance receivables are presented as a component
of "Insurance claims and policyholders' benefits" in the Consolidated
Condensed Statements of Income.
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.
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.
93
Components of Earned Premiums
Direct Assumed Ceded Net
- ------------------------------------------------------------------------------------------------
(In millions) Six Months Ended June 30, 2004
---------------------------------------------
Property and casualty $ 5,393.0 $ 127.0 $ 1,758.0 $ 3,762.0
Accident and health 657.0 26.0 291.0 392.0
Life 323.0 205.0 118.0
- ------------------------------------------------------------------------------------------------
Total earned premiums $ 6,373.0 $ 153.0 $ 2,254.0 $ 4,272.0
================================================================================================
Six Months Ended June 30, 2003
---------------------------------------------
Property and casualty $ 5,281.0 $ 376.0 $ 2,222.0 $ 3,435.0
Accident and health 788.0 55.0 29.0 814.0
Life 529.0 9.0 211.0 327.0
- ------------------------------------------------------------------------------------------------
Total earned premiums $ 6,598.0 $ 440.0 $ 2,462.0 $ 4,576.0
================================================================================================
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.
94
The pretax impact of the Aggregate Cover was as follows:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)
Ceded earned premiums $ (3.0) $ (28.0) $ (3.0) $ (28.0)
Ceded claim and claim adjustment expense 78.0 78.0
Interest charges (22.0) (22.0) (42.0) (35.0)
- ------------------------------------------------------------------------------------------------
Pretax benefit (expense) $(25.0) $ 28.0 $(45.0) $ 15.0
================================================================================================
In 2001, CNA entered into a one-year aggregate reinsurance treaty related to
the 2001 accident year covering substantially all property and casualty lines
of business in the Continental Casualty Company pool (the "CCC Cover"). The
loss protection provided by the CCC Cover has an aggregate limit of
approximately $761.0 million of ceded losses. The ceded premiums are a
percentage of ceded losses. The ceded premium related to full utilization of
the $761.0 million of limit is $456.0 million. The CCC Cover provides
continuous coverage in excess of the second section of the Aggregate Cover
discussed above. Under the CCC Cover, interest charges on the funds withheld
generally accrue at 8.0% per annum. The interest rate increases to 10.0% per
annum if the aggregate loss ratio exceeds certain thresholds. During 2003, the
aggregate limits under the CCC Cover were fully utilized. If the aggregate
loss ratio would exceed these certain thresholds, then additional interest
charges on funds withheld would be approximately $32.0 million in 2004.
The pretax impact of the CCC Cover was as follows:
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------------------
2004 2003 2004 2003
- ------------------------------------------------------------------------------------------------
(In millions)